Growth Continues, Production Does Not

Jim Brown
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The International Energy Agency (IEA) recently released their Oil Market Report (OMR). In it they warned the debt crisis in Europe slowed demand in October but fundamentals began improving in November.

The IEA revised down their estimates of demand for 2011 and 2012 once again. They now project demand for 2011 will average 89.2 million barrels per day, which is a +900,000 bpd increase over 2010. That represented a decline in their growth estimate of -70,000 bpd. For 2012 they cut their estimates by -20,000 bpd to 90.5 mbpd for a +1.3 mbpd gain. The IEA revises their estimates monthly so the totals may fluctuate but the direction does not. Oil demand is still growing steadily despite several European countries slipping back into recession as a result of austerity and despite a year-long effort by China to slow growth and curb inflation.

In the last couple weeks China's leaders have been talking down the monetary controls and suggesting they were preparing to remove some of the restrictions. Inflation has declined slightly and the economy is probably growing in the mid 8% range today. If they follow through and reduce their restrictions we could see China's growth surge over 10% once again.

In an effort to avoid limitations to growth they have ordered their refineries to implement a crash program to produce more diesel in order to avoid the shortages they suffered last year. Diesel was selling for up to three times the market price by bootleggers when it was available at all.

Tanker operator Frontline (FRO) said last week that tanker bookings for Very Large Crude Carriers (VLCC) had surged from the April high of 123 loads in April to 137 loads for November. The route being booked the most was from the Persian Gulf to China. Prices for tanker rentals had surged +11% in just the last two weeks.

OECD inventories declined another -11.8 million barrels in September. Inventories have now been below the five-year average for the third consecutive month and the first time since 2004. Preliminary data suggests OECD stocks saw another -34.3 million barrel drop in October to push them even deeper into the red.

The inventories are declining because of Libya. The -1.6 mbpd shortfall from Libya going offline was NOT made up entirely by Saudi Arabia, Kuwait and the UAE. They were able to increase production of some grades of crude but they did not have enough of the light sweet crude to satisfy European demand. Refiners were forced to turn to inventories as a way to supplement supply shortfalls.

Recent news from Libya indicates they have restored 200,000 bpd of production. However, the next increment to 350,000 bpd is not expected until the end of the second quarter. Even worse, for the entire 2012 period production is only expected to climb to 850,000 bpd by year-end. It is going to be a long and rocky road and those numbers could change if the current battles between tribes escalates. The government is going to have a very hard time organizing the restart if they are constantly faced with tribal conflicts making it unsafe to send foreign workers back into the oil fields. Theft of equipment is another problem. Any oilfield equipment not under guard tends to disappear within days of its arrival.

The key factor here is in the numbers. The IEA still expects demand to grow by 1.3 mbpd in 2012. Libya, under the most optimistic estimates, will only restore another +650,000 bpd in 2012. That means demand is growing at well over the restoration rate.

The IEA said OPEC oil supply rose +95,000 bpd in October to 30.01 mbpd. Increases from Saudi Arabia and Angola offset declines from other countries. The "call" on OPEC, the amount of oil the market is asking OPEC to supply, rose to 30.5 mbpd. Again, supply shortfalls are being made up from existing OECD inventories.

Demand is rising in the U.S. and fortunately production is also rising inside the USA. The shale oil fields are expected to increase production to more than 1.0 mbpd by 2015. The Bakken is now over 400,000 bpd. Various other shale oil fields like the Eagle Ford are still behind the curve but they are ramping up. In theory the U.S. should be able to cover its own increase in demand through its own production for the next four years if the economy continues to limp along at +2.5% GDP growth. If growth suddenly surges ahead the new production will not be able to keep up with demand.

Crude prices in the U.S. are nearing $100 again and home heating oil prices could reach record levels this winter. Gasoline prices are starting to move back over $3.50 and it won't be long before we start pressing $4 if crude prices hold. Distillate inventories in the U.S. are abnormally low and continuing to decline sharply. Distillate inventories declined -6.0 million barrels last week.

The press continues to ignore the peak oil story but a simple look at the facts above suggests the pressures are starting to build. The oil supply system cannot withstand any new shocks like Libya or civil uprisings in Syria and Nigeria. When demand is roughly equal to supply as is the current case, every hiccup only increases the problem.

Picture a racer in the Tour De France bicycle race. With all the riders roughly equal it boils down those with the best endurance. If at every rest stop someone dropped a brick in the saddle bag of the favorite rider it would become increasingly harder for that rider to keep up with the pack as the weight increased. Regardless of how hard he tried the slowly increasing weight would eventually put him well back in the pack and eventually out of the race.

There are 196 countries in the world and all are in the race to consume more oil and improve their economy. There are 54 oil producing nations and only 14 are still capable of increasing production on a geologic basis. The other 40 countries have already peaked and production is declining. For instance, Iraq can increase production if it can solve its internal problems. Venezuela could increase production if Hugo Chavez was removed from power and the country opened up for outside investment. Neither of those events are going to happen soon. Many of the countries with the ability to increase production currently produce well under a million barrels per day. Increasing Thailand from 300,000 to 400,000 would be a 33% increase but it would not do any good towards adding to global excess capacity.

The 14 countries still technically able to increase production are offset by the 40 countries that have peaked and where production is declining every year by increasing amounts. Those 14 countries still in the bike race are taking on bricks at every turn in the form of increasing consumption by the 182 countries increasing consumption but not increasing production. There are far more demands on those producing than they will ever be able to meet. Eventually all will fall into the declining production column and it will not be pretty.

Even if Iraq and Venezuela got their act together 5-10 years from now they will be so far behind the curve that they will never be able to produce enough to offset the declines by the other countries.

Peak oil is a mathematical truth. We can't produce our current 33 billion barrels of oil per year forever. That is billion with a "B" and that is an incredible amount of liquid fuel that goes up in smoke every day. Every barrel that comes out of the ground is a barrel that no longer exists. We have to keep "finding" and "producing" MORE than 33 bbpy or the wheels will come off the global economy. Literally, without liquid fuel the transportation sector will slowly grind to a halt as the remaining fuel becomes progressively more expensive.

The biggest conventional oil field on the planet is in Saudi Arabia. It is the Ghawar field and it has been producing for more than 60 years. It peaked at 5.7 mbpd in 1981. It has a single continuous reservoir covering 693,000 acres. It has produced to date more than 53 billion barrels of oil. They began flooding the field with water in the early sixties in order to maintain pressure and push the remaining oil towards the wells. This is a strategy that is implemented as fields get older in order to squeeze the last few drops into production. This was started in the sixties, more than 40 years ago. Ghawar is the great, great, great granddaddy of oil fields and it can't possibly produce much longer. Saudi does not release production data but it is thought Ghawar still accounts for 45% of Saudi production despite thousands of wells drilled in other reservoirs over the years.

Ghawar is a symbol of our global production problems. There are thousands of fields which have already peaked, declined and been shut down completely. The IEA claims there are only 800 producing fields of note in the world and the majority of production comes from only a handful of those fields.

When large, well managed fields like Ghawar reach their end of life it can occur very rapidly. Because they have been managed and engineered so well, when the end comes it can be abrupt. When the water flood being pumped in around the edges of the field reaches the production oil wells the field is dead. The oil column has been depleted and replaced with water. End of story. There are persistent rumors the water cut, the amount of water produced with the oil, has risen to as much as 90% in Ghawar. That means for every 10 barrels pumped out nine of them are water. Of course not every well behaves the same way and some are probably still producing oil. We know from satellite photos that numerous wells that have produced for decades have been shut in and torn down. That is a good clue for researchers and some believe that some wells are being left up with a crew to move trucks around and simulate activity in order to make it appear the well is still active. Saudi does not want other OPEC nations or the world in general to know the health of Ghawar.

Oil prices are rising despite numerous people continuing to predict a return to $60-$70. Given the billions in oil futures bought and sold every day you have to wonder who is right? Why is the general public, the press and quite a few analysts still in denial about the eventuality of peak oil? Is it because they simply don't want to believe the changes ahead or are they hoping if they ignore the problem it will just go away?

The problem is not going away. Oil price averages are higher than ever and rising. There will be fluctuations but the eventuality is a mathematical fact. Ignoring gravity does not make it cease to exist. Ignoring the future decline in oil production will not make it hurt any less.

Jim Brown

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