Oil market tightness is likely long term

by Jeffrey Rubin

If the depletionists are right, global production of conventional crude oil should be peaking within the next couple of years, at somewhere in the neighbourhood of 65 mm bpd. Recent production estimates from the International Energy Agency show global oil production in January is already well through that mark at 82 mm barrels. But the IEA numbers include 8 mm bpd of non-conventional production such as oil sands and deep-water oil, and another 8 mm to 9 mm barrels of LNG.
Strip out unconventional sources of supply, and crude production is hovering around 65 mm barrels, where it has been for the past four years. Has the world already seen the peak in conventional crude production?

Not only has conventional production not grown over the past four years, but there is virtually no spare capacity left among producers belonging to OPEC. Excluding the brief period when Kuwaiti and Iraqi oil wells were ablaze during the Persian Gulf war, OPEC has not operated with such spare capacity -- 2.7 mm bpd at present -- in nearly 30 years.
You can call it just-in-time inventories or you can call it what it really is -- Saudi Arabia running out of reserves. In fact, some commentators such as Matt Simmons of Simmons Associates believes the giant Ghawar field, home to one-eighth of the world's known oil supply, may be 80 % to 90 % depleted. Moreover, Mr Simmons notes that depletion from Ghawar, whose production has already slowed despite massive injections of salt water to maintain well pressure, is far exceeding the discovery of replacement oil elsewhere in the kingdom.

The tightness in today's crude market is unlikely to change unless there are major supply discoveries. Production in most of the world's major oil fields has already peaked and is now declining. For example, the United States, which is still the third-largest crude producer in the world, pumps out 25 % less oil than it did 30 years ago. And even the remaining reserves in the Middle East may be substantially smaller than currently believed. Just in February, Shell, the world's third-largest oil company, cut its estimate of its global proven reserves by a whopping 20 %.
Of course there is always the chance of finding another Ghawar, and billions of dollars of investment go chasing it every year. Considering that half of the world's oil supply comes from the 100 largest fields, the challenge of discovery is in the words of one geologist "a chase for elephants, not squirrels." But it is more than disconcerting that all 35 of the one-billion-barrel-plus oil fields in Iran and Iraq were found between 1906-1979.

New discoveries are made, but newly found sources of supply are trivial compared with the major finds made 60 or 70 years ago. For example, the much-anticipated Arctic gas reserves are no more than the equivalent of a medium-sized oil field. There have been no giant oil field discoveries since the late 1960s and early seventies, when the North Sea and Prudhoe Bay in Alaska were found. Both are now well past their production peaks.
Economists will argue that higher prices will elicit greater supply, but they are only partly right. Higher prices cannot bring forth greater supply, if the supply of cheap available oil no longer exists as it once did. But economists are right to believe that as oil prices rise, previously uneconomic sources of oil supply will suddenly become economic to exploit. And if the depletionists are right about a pending production peak for conventional supply, it will be precisely the growth of non-conventional oil production that will meet future energy demand.

It already has, having risen from just 2 % of global crude production a decade ago to 11 %. Nowhere has that growth been more dramatic than in Canada's oil patch. Crude extraction from the Athabasca and Cold Lake oil sands already accounts for one-third of Canada's total crude production, and will soon account for more than half. Similarly, the tar sands in the Orinoco basin in Venezuela currently yield 400,000 bpd in production. Since Venezuela's conventional crude production has already peaked, tar sands represent a growing share of that country's oil production as well.
However, non-conventional supply does not flow cheaply, as the recent $ 2.1 bn cost overrun in the Syncrude oil sands project attests. It requires steadily rising energy prices to make its problematic economics work. All the same, Syncrude's cost overruns are a lot easier to swallow if conventional crude production begins turning south. Based on the production numbers of the past half decade, there is a good chance of that starting to happen right about now.

Jeffrey Rubin is chief economist and chief strategist at CIBC World Markets.