June 17, 2005
THE KINGDOM OF HOPE
Saudi Arabia, home to the world's greatest proven reserves of oil, claims it can double its current production. No mean feat, considering that the roughly 11 million-barrels a day (b/d) that it claims it currently pumps is just about the highest in the desert kingdom's history. History, in other words, offers no guide to the future on this matter, according to authorities who oversee those reserves. As such, elevating Saudi production to 23 million b/d in the years ahead is well within the country's capacity, according to Abdallah S. Jum'ah, president and chief executive of Saudi Aramco, the planet's biggest oil company, albeit one run by a government.
In a speech to Rice University last month, Jum'ah asked and answered the critical question, according to a transcript of the talk published by Aramco, the Saudi oil company: "Can Saudi Arabia and Saudi Aramco step up and deliver? It's a fair question, given what's at stake, and a question I can easily answer with an emphatic 'yes.'"
But a new book by Matthew Simmons questions the basis for such optimism. "This book tells a story about Saudi Arabia's oil that differs sharply from the official Saudi version," writes Simmons in Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy. "Instead of the oil abundance of the official version, it argues that Saudi Arabian production is at or very near its peak sustainable volume (if it did not, in fact, peak almost 25 years ago), and is likely to go into decline in the very foreseeable future."
In fact, Simmons told CS in New York recently that the "odds are pretty high" that Saudi Arabian oil production has already peaked. Over coffee at the Sherry-Netherland Hotel in New York earlier this week, he predicted to this reporter that Saudi output, if current production rates are maintained, could "collapse" by 50% to 90% in three years.
Far-fetched? Perhaps, but very much in keeping with the pull-no-punches style of Simmons, who's chairman and CEO of the Houston energy-oriented investment bank Simmons & Co. Indeed, he's been throwing water on the Saudi's optimistic claims about future production for several years now. Dispensing speeches around the world that Saudi reserves are less than they're claimed to be, Simmons has increasingly drawn the attention of the media and the ire of the kingdom.
Indeed, the Saudis have recently felt compelled to challenge Simmons in more direct terms. But as he points out in his book, the only definitive way to clear away any questions is to let outside oil experts assess the Saudi fields. To date, that's been a non-starter for a country that regards information about its oil fields as something of a state secret.
That leaves talk, on both sides, and the available data. The latter is the basis for Simmons book, i.e., more than 200 technical papers on Saudi oil fields published over the last 30 years by the Society of Petroleum Engineers (SPE). Some of the papers are written by Saudi oil officials of yore. Although there is something less than a smoking gun in the book, Simmons makes a compelling case for at least considering that the Saudi oil miracle is past its prime.
Some of the supporting evidence stems from simply understanding the history of Saudi Arabian oil production. That includes the realization that Saudi production exploded in the 1970s after U.S. production peaked and began its irreversible decline that continues to this day. The speed at which Saudi production was increased ultimately damaged the long-term capacity of its reserves, which are centered on a handful of "super-giant" fields, Simmons explains. The question is how much were the fields damaged. Whatever the answer, "the rush to produce as much oil as the world demanded strained the physical limits of the reservoirs…."
Saudi oil officials recognized the dangers of so-called overproduction early on, Simmons reveals, citing various SPE papers. Indeed, the Saudi production cutbacks during 1982 through 1986 were motivated by the need to "provide badly needed rest and recovery for Saudi Arabia's giant oilfields after a decade or marathon output," the book claims.
One of the more intriguing points in Simmons' book is that the questions about the viability of raising Saudi's production capabilities is old news. Twilight in the Desert digs up the mostly forgotten history of the 1974 U.S. Senate hearing on the question of the Kingdom's output. Among the issues raised, as recounted in a New York Times article by Seymour Hersh in 1979, was the worry by Saudi Oil Minister Zaki Yamani in the early 1970s that oil was being produced at such a high rate that it threatened to reduce output in the long term relative to what a more responsible production pace would otherwise deliver.
Why would Aramco produce at a potentially dangerous high rate and threaten its bread and butter over time? Yes, world demand was growing and the oil was badly needed as the 1970s progressed. But as Simmons explains, citing the Hersh story, there's another issue to consider, and it relates to the fact that Aramco's senior management in the early 1970s (primarily employees of Chevron, Texaco, Mobil, and Exxon) thought the Saudis would soon nationalize the oil company. They were right, of course, and out of that fear Aramco intentionally overproduced so as to cash in before nationalization took away the money-printing machine from the Western oil firms and their shareholders.
The question of whether the Saudi oil fields were permanently damaged in the 1970s is a question that can only be answered by inspecting the wells on the ground. Ditto for the doubts raised by Simmons about whether Saudi Arabia has sufficient untapped reserves to double oil output, and thereby offset any decline from existing wells.
Bucking conventional wisdom, the Saudi peninsula has been widely explored, and so the odds of any great new discovery of oil remains unlikely, Simmons warns. Meanwhile, the still-copious flow of oil from the Kingdom relies on aging super-giant oilfields. "There is a genuine probability that Saudi Arabia is now overproducing some or all of its key giant oilfields, and this introduces a risk of accelerated decline," he writes. Indeed, oilfields have a finite life. For a time, output increases, then peaks, then declines. Saudi fields must ultimately live, and die, by this law of oil drilling. The fact that the main wells that make up the bulk of Saudi output were abused in the 1970s suggests that time is running out.
"Thus, I must conclude that the odds are better than even that oil output from at least several of Saudi Arabia's key oilfields is now at risk of entering an irreversible decline," Simmons concludes.
Timing, of course, is open to debate. Arguably, so is Simmons' reasoning. Aramco claims that its reserves are underestimated, according to an Energy Information Administration profile of the country. In any case, EIA accepts the promises that Saudi production will rise materially, projecting, that the kingdom's output will reach 18.2 million b/d by 2020 and 22.5 million b/d by 2025.
Simmons can only question such optimism, and provide some reasoned analysis based on the limited information he's privy to. But this much is clear: in order to prove Simmons wrong, the Saudis almost certainly will have to come up with replacements for giant oilfields that have been in production for decades. To date, there's a lot of talk about tapping new reserves, but the hard data remains to be seen. The stakes, however, are sky high. If Saudi production materially reversed, the shock waves would reverberate like an earthquake in the market, making the recent rise in oil prices look modest by comparison.
Meanwhile, the Saudis insist there's nothing to worry about. But absence the inspection of the Saudi fields and related data, it's all talk from an outsider's perspective. And as recent trends in the oil futures markets suggest, talk is still cheap, and a barrel of oil's getting pricier. Indeed, oil moved above $56 a barrel in New York yesterday for the first time since early April, just shy of the $57-plus record set that month. To judge by this book, that may prove to be a bargain in the years ahead.
Posted by jp at June 17, 2005 7:09 AM
6 years uptrend in oil prices and there are people who call peack and top and etc. when was the last time when WallSt. ANALysts called top correctly ?
Posted by: Anonymous at June 17, 2005 7:44 PM
Econbrowser has an interesting post on this.
quote: "...some people have been trying to keep track of the total quantity of oil that gets loaded onto tankers from Saudi Arabia, and these numbers suggest that the Saudis may have been producing somewhat less than is officially claimed. The Oil Drum called my attention to this May 24, 2005 account from Rigzone which claimed that "numerous outside sources say the Saudis haven't hit 9.5 million b/d since at least December, if ever."
Posted by: The Prudent Investor at June 17, 2005 7:12 PM
supply discussions aside (and for what it's worth, i am highly suspicious of anyone who hides data, for whatever reason (aka ThomasJefferson, who had a similar view)), you cannot increase refinery capacity in north america in less than 8yrs (some say a decade), so absent a dropoff in demand (highly unlikely given the energy consumption patterns in place), energy costs will increase on the back of the refinery squeeze - new nuclear plants are also at least a decade away (nevermind replacing aging existing plants) and even nukes only address the electricity side, which (at present) misses most of the transportation sector.....
it'll take 20yrs to enact material changes in the world's advanced economies such that we are less dependent on petroleum, which also coincides with expected waning of chinese growth (due to their demographics) - not sure when/if india is expected to slow - ofcourse, india/china is a good bet to be the next place for a large war
Posted by: franko at June 17, 2005 9:04 AM