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Markets: Are We Running Out of Oil?
New York: July 23, 2004
By John R. Stephenson

If you’ve been to the gas pump recently you’ve had a bit of an unpleasant surprise. So, is it just hedge funds or speculators driving up the price of oil, fears of terrorism or is there something more fundamental that is underpinning the price of oil? For my money, we may be in for higher oil prices for some time to come.

The reson? We are experiencing higher rates of oil demand (almost 2.5% demand growth) — the highest rate of demand growth in sixteen years, all at a time when China and India are rapidly industrializing and their consumers are demanding all things western, including oil. The International Energy Agency estimates that by 2030, world demand for oil will zoom from approximately 80 million barrels a day currently to 120 million barrels a day. Demand for oil is growing and there is increasing evidence that some of the world’s major oil fields may be in decline leaving us with few alternatives but higher oil prices.

The reason for all the concern over oil supply? Twenty percent of the world’s oil supply comes from 14 fields, which makes us overly reliant on just a few oilfields and regions of the world for our oil supply. Not only is the oil supply fairly concentrated amongst a few oilfields, but there hasn’t been a major oilfield discovery for almost 60 years.

We are having difficulty discovering oil, and recently we have witnessed some troubling data from the oil industry. Non-OPEC oil supply was supposed to surge — instead it flattened out. Canadian and U.S. natural gas production has peaked and started to decline without much fanfare and production from the North Sea has peaked and started to decline. In most analysis of oil demand, analysts assume that incremental oil demand can be met through OPEC and through Saudi Arabia in particular. Both the Energy Information Administration (a division of the U.S. Department of Energy) and the Paris based International Energy Agency are predicting that Saudi Arabia’s oil output will double over the next fifteen to twenty years. But is this a reasonable assumption? I think not.

The basic problem with the thesis of a Saudi oil miracle is that all of Saudi Arabia’s big five oil fields are extremely old. The big five oil fields were all discovered between 1940 and 1965 and have accounted for 90% of all Saudi Arabian oil produced between 1951 and 2000. There is one standout field which is the giant Ghawar field and it is the world’s largest field (1/8th of the world’s total proven reserves). This field accounts for 55% to 60% of all Saudi Arabian oil production. In 1975, Saudi Aramco (the Saudi national oil company) estimated that Ghawar had reserves of 60 billion barrels of recoverable reserves. Based on the production from the field to date and assuming the 1975 estimate is correct, that would mean that the field is 90% gone.

Today, Ghawar still produces approximately 5 million barrels a day or 6.21% of the daily world oil demand. Increasingly, the production targets from the Ghawar field are being met by horizontal drilled wells and by in-fill drilling. Some industry estimates suggest that, based upon the current production levels per well and the recorded production declines, it will likely take some 46 rigs drilling an additional 333 new wells to maintain production levels from Ghawar in 2004. By 2010, some 600 wells will need to be drilled just to maintain Ghawar’s production at the current level. It is questionable that new drilling programs could be added quickly enough to maintain capacity if the industry observations are indeed correct.

It is often surprising to many industry observers just how fast seemingly prolific oilfields can reach maximum production and then begin to decline. An example of such a phenomenon is Oman’s giant Yibal oilfield. This field is illustrative because it has been exploited in a similar manner to that of Ghawar (water injection and horizontal drilling). After exploiting the field with vertical drilling in 1990, a vigorous program of horizontal drilling of Yibal was begun. By 1997, production from the field had hit a new record of 250,000 barrels per day and the field capacity was expanded. But by 2001, production from the giant field had fallen to under 90,000 barrels a day and by this year, it had fallen to between 40,000 and 50,000 barrels a day. The rapid decline in production caught industry observers by surprise.

The upshot of all this? The entire world assumes that Saudi Arabia can carry everyone’s energy needs cheaply on its back. But if their major field suffers from a decline in production or even if the Saudis are unable to double production to meet surging world demand, then we may be hurtling towards an energy crisis faster than we realize. In every major study of the world productive capacity, the assumption is always made that any spare capacity will come from Saudi Arabia. As a kingdom and as a closed society, there has been no independent verification of the Saudi oil reserves. With worldwide demand surging, it is questionable that the Saudis will be able to double oil production to meet the growing world demand. Even more worrisome is the fact that should the Saudi production volumes fail to materialize, there is no “Plan B” for world oil supply. If production is unable to match world oil demand, the world faces a giant energy crisis.

If production of low cost oil from Saudi Arabia begins to taper off, then we will be increasingly reliant on oil from regions of the world where the cost of drilling and recovering the oil are considerably higher. With the added cost of inflation to production, a likely possibility for an era of higher gasoline prices is extremely probable. With higher gasoline prices, look for firms in the transportation business to suffer and retailers (such as Dollar Stores) which cater to lower income consumers to suffer. Canadian oil and gas producers, which have historically sufferred from high production costs, could be the beneficiaries of reduced Saudi output. One name that is worth considering for your portfolio is Suncor Energy (SU-TSX - target price of $42) which has an 85-year proven reserve base and no exploration risk.


StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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