The Great Debate

Running faster to stand still

November 24, 2008

–John Kemp is a Reuters columnist. The views expressed are his own–

John Kemp Great DebateLike a hamster trapped on a wheel, the International Energy Agency’s 2008 World Energy Outlook paints a depressing picture of an oil industry having to run faster and faster just to keep pace with burgeoning oil demand over the next 20 years.

WEO2008 estimates the industry will need to find 64 million barrels per day (bpd) of new oil production capacity to meet the expected growth in demand by 21 million bpd by 2030 and offset 43 million bpd of expected declines from existing fields. The total cost is put at around $5 trillion at today’s prices.

The gross capacity required is equivalent to more than three quarters of the world’s current oil production (82 million bpd) and the capital expenditure exceeds the total annual output of Japan, Germany or China.
WEO2008 strongly implies herculean efforts will be required to bring all this new oil onstream, and the industry has no more than a moderate prospect of succeeding. Only a structural upward shift in prices can generate the incentives and resources to make this investment programme possible. Oil consumers should accustom themselves to much more expensive oil throughout the forecasting horizon.

But projections over such a long period are notoriously sensitive to very small changes in the assumptions made. In particular, the WEO projections are highly dependent on assumptions made about the feedback between oil prices and long-term demand, and the cyclical relationships between prices, costs and supply.


Based on detailed data for the world’s 580 largest oilfields and an extrapolation to the remaining 70,000 smaller fields, WEO2008 estimates output from existing and future fields will decline by 6.7-8.6 percent a year.

The field study reaches some interesting conclusions:

(a) Observed output declines are much slower for super-giant fields (5 billion barrels of initial proven and probable reserves) than for giant fields (500 million barrels) and large fields (100 million barrels). Decline rates are just 3.4 percent per year for super-giants, rising to 6.5 percent for giants and an alarming 10.4 percent for large fields.

(b) Decline rates are much slower in the Middle East (2.7 percent) than for the world as whole (5.1 percent) and for OPEC (3.1 percent) than non-OPEC (7.1 percent).

(c) For the same field, decline rates accelerate from the post-peak period (5.1 percent) to the post-plateau period when production drops below 85 percent of peak (5.8 percent).

(d) Surprisingly, given accelerated declines over time within the same field, decline rates tend to be lower for the oldest pre-1970 fields (3.9 percent) than fields which entered production in the 1980s (7.9 percent) or the 2000s (12.6 percent).

(e) Finally, decline rates are slower for onshore fields (4.3 percent) and much faster for offshore shelf fields (6.6 percent) and super-accelerated for deepwater (13.3 percent).


What explains these differences? Decline rates are field specific and depend on natural pressure loss as the field is produced and water penetration, as well as oil viscosity and the permeability of the reservoir.
They also depend on decisions about the production profile and development expenditure (infill drilling, well workovers, replacement of well casings, water flooding and gas injection).

All these techniques increase the proportion of oil eventually recovered from the reservoir either by tappinginto isolated pockets of oil, sustaining pressure or pushing oil towards the wells.

Most of the supergiant and many giant fields are located in OPEC countries in the Middle East and were discovered between the 1940s and 1960s. They have highly favourable natural pressure and field characteristics; been produced by national oil companies at a moderate pace that has sustained pressure; and benefited from extensive development work (such as water flooding).

Most of the newer fields brought onstream since the 1980s have been much smaller, often located offshore and in deep water, making them much more expensive to develop on a per barrel basis. Private developers have pushed for accelerated production to recover huge capital outlays and maximise shareholder returns by front-loading cash flow and maximising its net present value.


Based on an expected average decline of 6.7-8.6 percent per year, WEO2008 concludes output from existing fields will decline from 70 million bpd at present (plus 12 million bpd of natural gas liquids, unconventional oils and oil sands) to 51 million bpd in 2015 and 27 million bpd in 2030.

By 2030, the world will need 104 million bpd of production, according to the IEA. WEO2008 assumes the gap will be filled by 23 million bpd of new conventional oil production from known but not yet producing fields; 19 million bpd from fields that have yet to be found (including 11 million bpd from offshore); an extra 9.5 million bpd of natural gas liquids; 7.1 million bpd of non-conventional oils such as orimulsion; 4.7 million bpd from oil sands; and 6.4 million bpd from enhanced recovery techniques such as CO2 injection.
In contrast, Saudi Arabia currently produces just 8-9 million bpd. The scale of the new sources that need to be developed is vast. All this will cost $210 billion a year (in 2008 dollars) assuming costs level off at mid-2008 levels.


This vast expenditure will require substantially elevated prices to provide the incentives and resources for a massive investment programme. But how realistic is the cost assumption?

Costs are strongly pro-cyclical. Upstream capital expenditure increased from $120 billion to $390 billion per year between 2000 and 2007. But WEO2008 estimates that two-thirds of investment increase was swallowed up by higher unit costs.


Drilling accounts for around half of upstream capital spending. As demand has surged and utilisation rates for floating rigs and semisubmersibles have hit 100 percent, daily hire-rates for floaters have risen 350 percent since Jan 2004 and rates for semisubs are up 750 percent, according to ODS-Petrodata Consulting and Research (http://www.ods-petrodata.com/odsp/day_rate_index.php).

Other costs (cement, steel, aluminium, seismic surveys and skilled labour) have all surged as the industry has experienced a cyclical boom.
In the United States, for example, the cost of offshore oil and gas exploration and development per foot drilled has soared almost 88 percent between 2002 and 2006.

Given the long lead times involved, firms have so far been reluctant to cut exploration and development expenditure, despite the recent slump in oil prices. Rig rates have remained firm. ODS-Petrodata estimates that about 160 new offshore rigs will join the existing fleet of 730 between 2009 and 2011. Most of these are already fully committed.

But raw materials prices for steel, aluminium and cement have already fallen substantially. Labour and rig costs will be subject to downward cyclical pressure and in the longer term to structural factors as high rates and wages increase the supply of field services and workers.
It is not clear using the 2008 cyclical peak is a good way to project investment costs over the whole 2008-2030 period.

Long-term projections are terribly sensitive to these assumptions. In response to higher prices and evidence of both cyclical and structural demand destruction, IEA has already cut its estimate for 2030 production by a staggering 10 million bpd (9 percent) since WEO2007 (when it thought 113.7 million would be needed by 2030).

Both the amount of new oil production required by 2030 and the scale of the investment spending are unfeasibly large in WEO2008 (and worse in WEO2007). But that is more a confirmation that the demand-growth and cost-inflation rates witnessed in 2005-2008 were unsustainable rather than a good prediction for the future.

Market forces are already ensuring a correction is well underway, with both cyclical and structural declines in crude demand and the cost of supply.

There is no need to despair just yet.

9 comments so far | RSS Comments RSS

I always consider oil-reserve estimates suspicious. An engineer has great difficulty estimating how much oil has leaked from a storage tank without digging. So predicting available oil reserves from geological formations and drilling samples is a type of pie-in-the-sky science. I am still under the impression that the invasion of Iraq is at least partly related to securing oil supplies. So mission not accomplished.

One of the benefits of this market chaos is that governments around the world will be preoccupied if not crippled supporting stock markets and domestic companies. Because some folks who have too much time and money on their hands seem to get themselves in trouble. Perhaps it is time to realign our foreign policies – to steer away from the Middle East and Israeli conflicts in general. Energy is a huge challenge all on its own. We can do a lot to improve domestic energy conditions without going abroad.

Posted by Don | Report as abusive

If one concludes that burning fossil fuel is a contributing factor to climate change then waiting for market conditions to generate interest in investing in green energy solutions puts even more of humanity at risk for drought and famine. The need to develop green energy and energy independence for the U.S. is paramount. The government could accelerate development by either heavily taxing fossil fuels to discourage use or redirect industry through huge capital outlays mandating production of green vehicles, homes, power generation and the refurbishing of existing structures and vehicles. Neither of these actions would be painless. I also believe that any outcome is uncertain. The alternative is to do nothing and wait until oil production begins it’s inevitable decline and endure the economic and environmental consequences. Then there will be market incentive. Do we really have that much time to forestall this necessary investment?

Posted by Anubis | Report as abusive

A quick Google search will show that best estimates of world population growth is approximately 150 to 200 hundred thousand more people EACH day. Trying to out produce (or conserve thru) that growth is like spitting in the wind.

Posted by Ben | Report as abusive

We have no choice but to allow the market to create incentive. We are on the edge of the most challenging ecomonic climate of a generation. The last thing we need is for the government to institute more taxes and more cost on energy. What we really need is for the government to leave us alone, to let Americans decide for themselves how much to invest in alternatives. Then we will find out where true value exists and where legitimate solutions can be found.

Posted by skeptical | Report as abusive

Anubis – Your comments and ending question are at the crux of the matter. No matter what, resources of all kinds are getting harder to find and recover and we are burning up resources it took the planet millions of years to produce. It seems humans are very poor at planning for a future even 100 years from now and I suppose the assumption is that science and technology will cure all our problems. It’s not so. They may slow down the inevitable but they will never be a panacea.
We need big investments in solar, wind, tidal, OTEC and geothermal power or civilization as we have known it will rapidly come to a screeching halt and it’s not at all certain that the brick wall will recede from view even with those investments. Lovelock has predicted billions of human deaths by the end of this century. I hope he’s wrong but I don’t much doubt his prediction. I’m afraid Henny Penny was right and we are the living embodiment of the naysayers.

Posted by Ray | Report as abusive

The picture painted by the IEA report is not new and suffered only minor changes from last year’s. It has been long known that the country will depend on others to supply a commodity that will be scarcer over time, and government should have intervened years ago to control energy waste instead of letting engines and trucks grow bigger, and come up with a different alternative.

I know many people may not like the idea, because it is “nice to have” a big car, but “nice to have” and “need” are different things. So if we want to make a difference, we need to start by reducing our energy consumption, be aware and plan for the end of cheap oil, because even with huge amounts of money thrown at oil supply, it will not be enough to sustain the future demand.
We should not wait for others to come up with the oil to continue with our consumption habits that are not sustainable, because they will not be able to get it. We should not wait for the market incentive (i.e. even higher oil prices) because when that happens it will be too late. Unlike other industries, developing new production takes a long time besides money and

The U.S. has put itself in a situation where it does not depend on itself for its energy needs on the future. Citing free market as an excuse, past governments have refused to act to guarantee energy security and left the country in a bad situation and created the framework for the social problems and conflicts of the next decade.

Posted by aware | Report as abusive

Nonsense. Consider the following, published in The Times Online, June 12, 2005.

http://business.timesonline.co.uk/tol/bu siness/industry_sectors/natural_resource s/article532387.ece

Prices are returning to where they should be and due to over-supply will continue fall below that. The authors numbers (e.g. industry capx) only serve to substantiate this claim.

To the apocalyptic ideologues: hydrocarbons are not going to destroy civilization. Some of you think you are being very clever and are long on alt-energy. You should do your research. The rest of you are nutters.


Posted by noema | Report as abusive

Lets just analyse this ‘green power’ problem. The oil producers are currently trying to produce less oil to increase the price and therefore their income. The oil reserves have grown due to the availability/use of new technology and better methods of finding/assessing new and existing fields – if you’re not an engineer and/or don’t understand the technology – don’t knock it.

On the green power capability, wind power is useless, totally variable with no relationship to actual power needs, costs far more to produce and setup a turbine than the return you get, excess power cannot be stored, the wind farms are a complete eyesore in areas of natural beauty and elsewhere a danger to navigation and need backup power generation sources!!! what a waste of time!

Wave power after all these years of experimentation is going nowhere, solar power can supply power in the right conditions, death valley etc., and in individual house roof applications, but not on a national or global basis.

Geothermal is great for those areas capable of applying it, but beware the release of lethal gases.

All in all this great cry of green power/global warning and of course ozone layer depletion has cost us all a tremendous amount of wasted income as governments and the EU/UN etc., have climbed on the band wagon with massive quangos and useless jobs.

The only technolgy that is of any use for the future is nuclear and due to the green power waffle of the past few years this has been delayed to the point where we need to very quickly build coal power stations as an interim measure whilst new nuclear plants are built. The effiency and technology of coal fired plants has greatly improved compared to the old plants as has the incinerator plants for rubbish disposal which would tackle another green problem and provide some spare power as a side benefit. So there you all go – OTU

Posted by Entaxei | Report as abusive

“If one concludes that burning fossil fuel is a contributing factor to climate change”

Well, there you go again! Who says burning fossil fuel causes climate change? Al Gore? Michael Moore?

Notice how you’ve had to change the name of your fantasy from “global warming” to “climate change”? How come? Could it be that the earth is actually in a cooling phase now? Gee, how could that be? Just a couple of years ago you “sky is falling” Chicken Littles were telling us how the earth was going to be turned into a wasteland of deserts due to global warming. Now, you’ve completely changed your tune and are predicting a new Little Ice Age. How come?

Could it possibly be the sun’s activity and now lack of activity had to do with the earth’s heating and cooling? Global Warming and Climate Change are scams people! Don’t fall for this scam. The emperior truly has no clothes.

Posted by p | Report as abusive

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