Thursday, May 05, 2005

Scenarios for Peak Oil
The idea that oil production is approaching a geologically-determined peak gains more credibility and supporters, the longer high oil prices persist. I've commented on this periodically, usually to point out the inherent uncertainty of such an event, and the disservice that simple forecasts of a particular peak year can do. Thanks to a lead from a friend, I followed a posting at to a recent report on this subject by Science Applications International (SAIC.) SAIC was commissioned by the Department of Energy to look at the likelihood and potential impact of a peak in oil production, and to evaluate strategies to mitigate those effects. The result is a highly-readable document that adopts just the right tone of concern and reasoned recommendations. Their ultimate conclusion happens to align neatly with mine, in seeing peak oil primarily as a risk management issue.

Although I could quibble with some of SAIC's assumptions and the relative simplicity of their scenario formulations, the assumptions are clearly stated and the scenarios quite understandable even for those not familiar with this tool. I would have also liked to see more country data on the production side, since the global production profile is really the aggregation of all the country profiles, which in turn aggregate all the individual oilfield profiles within their boundaries. Nevertheless, this report is a must for anyone interested in the topic. Don't be put off by the length, at 91 pages, since it has a good executive summary and is quite skimmable.

Where I differ from many of those looking at this issue is in the importance I place on non-geological issues, such as geopolitics, access, and industry investment patterns. These could create something resembling a geological peak, but sooner and with less uncertainty--or at least without the inherent unknowability of the geological scenarios. As I was reading the SAIC report, an idea occurred to me that I hadn't considered before: Could an OPEC policy aimed at increasing prices by restricting access to reserves result in a premature, but nonetheless permanent peak in oil production, either deliberately or inadvertently?

Here's how this would work: Based on the most recent estimates from the Oil and Gas Journal, OPEC holds roughly 70% of total world oil reserves of nearly 1.3 trillion barrels. These eleven countries have an average reserve life (R/P) of 81 years, compared with under 20 years for the non-OPEC producers. Non-OPEC production will peak before OPEC's, as mature basins such as the North Slope, North Sea, and US onshore and continental shelf production decline. This can be offset for a while by increases from the US deep-water Gulf of Mexico, Russia, Caspian and non-OPEC West Africa, but they will reach their limits, too. (Many analysts have commented on this in the context of the ongoing consolidation of the international major oil companies, in their race to replace reserves.)

If OPEC continues to constrain production through a combination of internal under-investment and restrictions on the development of OPEC reserves by the international oil companies, then increases in OPEC production could easily be inadequate to offset declines in non-OPEC countries. Total global production would then reach a temporary peak and begin to decline. This peak would become permanent if OPEC were to delay its own development program long enough that the combination of project timelags and steepening non-OPEC decline rates made it impossible ever to catch up with falling non-OPEC production. Such a peak might occur a decade earlier than if access to reserves was determined by free-market economics, instead of OPEC politics.

There are two questions you have to ask about such a scenario. First, would OPEC see an artificial peak in global oil production as being in its best interests, in the short, medium and long term, considering the kind of responses it might stimulate? Since OPEC is hardly monolithic, I wouldn't be surprised if at least a couple of its members thought so, but not all of them. That suggests this scenario likely happens by accident, if at all.

Second, how soon could it happen, given that we know a lot more about the performance of non-OPEC oilfields than we do about OPEC's? I would say not in the next couple of years, in spite of the mounting number of pessimists who might disagree. There's still some life left in the non-OPEC dog, especially if Russia gets its act together. But as long as demand continues to grow as it has recently, the day when OPEC will hold the whip hand gets closer.

Finally, from a risk management perspective--in line with SAIC's thinking--time is wasting. This issue should be debated not just on blogs and in the media, but on the floor of Congress. We need to get past the talking stage and well into planning and creating options. Merely doing that would send important signals to OPEC that their inadequate reinvestment in capacity could truly cost them their market and leave much of their oil in the ground forever.

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