Bill Totten's Weblog

Monday, December 13, 2004

The Energy Challenge 2004 - Petroleum

by Murray Duffin (November 17 2004)


Recent high prices of oil have raised the visibility of the petroleum challenge considerably, but there is still more heat than light being generated on the subject. For the first weeks of the recent price surge, most writers were trying to lay blame on OPEC for acting like robbers. In fact, as analysts are now beginning to realize, prices have gone up in two stages. The first in 2003 was simply due to the weak dollar. During that stage, the price in Euros barely budged. The second (2004) is due to worldwide demand outstripping supply, aggravated by security concerns. The weak dollar and the security concerns are direct results of Bush programs, that is, the tax reduction budget deficits, and the war in Iraq.

The gasoline price increases we have seen recently result from four primary causes.

<> Worldwide oil demand is at or above installed production capacity. There may be 2% of slack left, all of it in Saudi Arabia and Kuwait. World economic recovery and booming energy demand in China and India are outstripping production increases.

<> Second, the supply of low sulfur crude is even more critical, and most USA refineries are designed for low sulfur crude.

<> Third, no new refinery capacity has been added in the USA in nearly three decades, and with numerous different gasoline mixes mandated by our fifty states to minimize summer air pollution, refinery capacity is max'd out. USA gasoline demand is up about 3% year on year, mainly due to growing use of fuel inefficient SUVs.

<> Fourth is fears about middle-east instability causing governments to increase strategic reserves, and investors to go long.

You will hear that oil company profits are up 90% and that is true. What you will not hear is that oil company profits have been dismal for several years, which is one of the reasons that no refinery capacity has been added. Even after this nice rise, profits are not excessive. No, I am not a spokesman for the oil industry.

What most people don't know is that USA oil production has been in decline since 1970, with the rate of decline slowly increasing. It's at about 4% per year now. We now produce only about 40% of the oil we consume, and oil imports are the single largest item in our very negative balance of payments. If you had to pay at the pump to maintain the military we keep in the middle-east to keep the supply lanes open (not counting the cost of the war in Iraq), instead of having it buried in the defense budget, gasoline would be over $7 per gallon today.

To make things more interesting, worldwide oil production will probably be in irreversible decline before the end of this decade. The present high oil and gasoline prices are just the first tremors of the earthquake that is coming.

Some months ago Lee Raymond, the chairman of Exxon-Mobil made a presentation that included a curve showing historic oil production (in million barrels per day) and projecting future supply and demand. The supply curve, based on production from present known reserves sloped downwards. The demand curve sloped upwards. The growing gap between supply and demand represented new sources that we must discover to support world economic growth. Mr Raymond made the point that by 2020 we must find enough new oil sources to supply fifty million barrels per day. Today Russia and Saudi Arabia are each supplying a little more than nine million barrels per day, and struggling to get to ten. Their combined claimed reserves are about 400 billion barrels. One can extrapolate that we need to find and develop 1100 billion barrels of new reserves during the next fifteen years, or an average of about 75 billion barrels per year. During the last fifteen years, with plenty of incentive to find new oil sources, we have not averaged ten billion barrels per year.

Let's forget about economic growth, how about just offsetting declines. If Mr Raymond's curve reflects reality we would still have to find about thirty billion barrels per year. How are we doing? From we find the following:

The rate of major new oil field discoveries has fallen dramatically in recent years. There were thirteen discoveries of over 500 million barrels in 2000, six in 2001 and just two in 2002, according to the industry analysts IHS Energy. For 2003, not a single new discovery over 500 million barrels has been reported. Key findings of a recent Petroleum Review report are:

<> Between 2003 and early 2007 some eight million barrels per day of new capacity is expected to come on stream.

<> In 2005, eighteen projects with a potential peak capacity of three million barrels a day are due to come on stream, slowing in 2006 with eleven new projects followed by three in 2007, and three in 2008 adding a cumulative four million barrels/day of potential new capacity at their peak.

<> It appears likely that from 2007, the volumes of new production will fall short of the need to replace lost capacity from depleting older fields.

Further confirming this trend, recent E&D results strongly support the expectation of a near term peak in oil production. The net present value of all discoveries for the five oil majors during 2001, 2002, and 2003 was less than their exploration costs.

Six months later, in World Energy, Mr Raymond admitted that we have to find enough new oil to provide eight times Saudi Arabia's current output, that is, at least five new Saudi Arabias, or seven Russias. How likely is that too happen? Oil in the earth's crust is distributed fractally along a curve of declining field size versus increasing field occurrence. There are very few super giants, a few more giants, more majors, et cetera down to many, many insignificant fields. Because they are the easiest to detect, the big ones are found first, and they have been found. There are about 41,000 known oil fields worldwide, of which about 21,000 are termed very small to insignificant. The probability that we have found so many small fields, and overlooked any more big ones, let alone a Saudi Arabia or Russia, is near zero.


In the two months since the rest of this paper was written the price of oil has bounced off of $56 per barrel. In the past, when supply and demand were in close balance (due to artificially constrained supply), price has been very volatile. A 1% change in the balance can cause a 30-50% swing in price. When supply has been constrained below demand, price has doubled or tripled in a very short time. Excluding a very small slack capacity for sour crude there is a large possibility that we are now at another tipping point. In current dollar terms, during the prior "oil shocks" prices went to $70-80 per barrel; oil is a much smaller portion of USA GDP than in 1973; gasoline is a much smaller portion of household budgets than in 1973; and China's labor costs are so low that energy cost increases can easily be passed on to customers. Given these facts, we can expect prices to continue to increase, possibly with brief declines. Do not be surprised if oil prices spike to $80 per barrel in the next weeks, as cold weather raises heating oil demand. On the other hand there is some evidence that China and India have been building strategic reserves, and if their capacity fills, a temporary drop in demand could send prices back to the low 40s for some months. Simmons expects another large demand increase in 2005, so lower prices are not likely to last long.


Analysts, economists and industry spokespersons seem very reluctant to talk about depletion or production decline. Chris Skrebowski of ODAC has analyzed the 2004 BP Statistical review of World Energy and has noted that there were 32 countries that were able to increase production in 2003 versus 18 countries which have been in decline for three years or more. In 2003 the growers had to increase production by 7.5% to offset declines of 4.9% for the decliners to give net world growth of 3.7%. Production from the 18 countries now in sustained decline peaked in 1997, and had fallen 10.7% by 2003. More countries are joining the decliners list, their rate of decline is increasing, and the growers list is not growing, so the burden on those still growing is increasing rapidly.

In 2003 several of the growers increased production by near 10%, mainly by reopening wells that had been shut in during the price declines at the end of the last century. Now every one is operating close to or at installed capacity, so a similar increase cannot be repeated. To increase capacity significantly will require large investment and some years. Declines however continue to accelerate. It is only a matter of time, and not much time, before growth is no longer able to offset declines.


There is a phenomenon, well known in the oil industry, but little publicized, that when an oil field has been about 50% depleted, production begins an irreversible decline. In 1956 a petroleum geologist named M King Hubbert applied this concept to an analysis of the lower 48 states, and predicted a decline of production starting about 1970. He was derided at the time, but lower 48 USA oil production has been in decline since 1970. The phenomenon has been named the Hubbert Peak, and the production growth and decline curve is often referred to as a Hubbert Curve.

In 1998, using the best petroleum industry database available, two petroleum engineers (Campbell and Laherrere) applied a Hubbert analysis to the entire world, and predicted a peak between 2000 and 2010. Refined analyses since then focus on 2005 to 2010. In fact, due to economic and political factors, there is more likely to be an irregular plateau, with possibly several small peaks before the decline, but an irreversible decline by 2010 seems inevitable. There is a great deal of real data to support such a view and little but untenable optimism to support alternative views. "In God we trust, others please bring data!"

We know that Middle East reported reserves grew by about 280 billion barrels between 1987 and 1990, with little additional exploration, and remained constant during the 1990s in spite of continuous production. It is certainly more likely that reserves are overstated than understated. Middle East reported reserves seem to have been influenced by OPEC quotas.

The USA consumes about 25% of world oil production and imports more than 60% of the oil it consumes. With growing demand from developing countries and exploding populations in OPEC countries, we will not be able to maintain our present share of world oil, short of occupying the entire Middle East. When world availability begins to decline, our availability will decline faster. Imagine a world where natural gas availability has suddenly dropped by half, and oil availability has gone into irreversible decline, and we have done nothing in advance to compensate. That is the world we face with the present Congressional energy bills, and it will lead to an economy that will make the Great Depression look like a picnic. We can alleviate that probability by addressing energy conservation and efficiency, and developing renewable electricity alternatives vigorously, starting now, but that is the polar opposite of the emphasis of present pending legislation!

So far, in their speeches Vice President Cheney and Secretary Abraham have looked out ten to twenty years, but not beyond twenty years. By 2030, oil availability will be less than 50% of our peak year (which should occur before 2010), and before 2040 there will be no availability for general energy needs. The pittance remaining will be allocated to chemicals and agriculture. What kind of world will we leave our children if we have not succeeded in developing a new electricity based energy economy long before 2030? What chance do we have to succeed if we not make good strides by 2010? What can we gain by the present policy of focusing on accelerated depletion of severely limited supply side resources?

For detailed petroleum information visit, and look particularly at the newsletters archived there. For a presentation on Saudi Arabia oil prospects go to: or try the tiny URL at:


Poor information and silence

Understanding the Petroleum challenge is hampered by a lot of non-information, misinformation, disinformation and confusing information. There are numerous myths floating around, a few of which need to be addressed. Fortunately the most insidious myth of all, the implied myth of silence on the subject, is now dying. High oil and gasoline prices have recently led to a growing spate of articles in the printed media, and frequent mention on television. Most recently the topic has been featured in business-oriented magazines like Business Week and Fortune, both in August 2004. The ability of government and industry to keep the issue under wraps is rapidly eroding.

USGS Disinformation

In their year 2000 report, the USGS (United States Geologic Survey) project estimated ultimate recovery (EUR) of 3,000 billion barrels, with "potential" discovery plus reserve growth adding 1300 billion barrels to reserves from 1996 through 2025. The word "potential" is not defined. They seem to have taken USA reserve growth history and applied it to recently reported world reserves, a statistically invalid approach. With eight years of the period in question now elapsed, actual reported discoveries are less than 30% of the needed run-rate. Reserve growth is not reported, but the highest number that could be inferred is less than 80% of the needed run rate, and the likely number less than 30%. Both are in decline. A cumulative number by 2025 above 300 billion barrels (versus 1300) seems very unlikely.

To increase available oil (discovery plus reserve growth) by 1300 billion barrels in thirty years, as the USGS projects, means an average increase of 43 billion barrels per year. This is more than four times the experience of the 1990s, and would mean sustaining the highest level ever achieved during a single decade, over three decades. Such a projection simply does not stand the test of reason. The USGS underwent a Congressional investigation and was found guilty of misleading Congress after the 1973 oil shock. It is clearly time they were subjected to a new investigation.

Non-conventional oil

Many economists pin their hopes on "non-conventional oil", generally shale oils, tar sands, Orinoco bitumen and very heavy or very deep oils, not recoverable or refineable by conventional technology. To do so they forget recovery rate. For sure, such resources are vastly larger than known conventional oil. However, after decades and billions of dollars of effort, shale oil recovery has been abandoned. Tar sand and bitumen recovery are now about 1% of total oil consumption, and even with economy-breaking investment, are unlikely to exceed 10% of present world demand by 2020. Tar sand recovery is also an environmental nightmare. Further, it has been estimated that no more than one-sixth of unconventional resources will ever be energetically recoverable. Unconventional oil will never be a solution. At best it will slightly reduce the rate of decline.

Enhanced recovery

Others believe that enhanced recovery technology such as pressurization, water or steam injection, and horizontal drilling will greatly increase recoverable oil. For fields that have been in decline for long enough to project the estimated ultimate recovery (EUR), and for which enhanced recovery has been employed, recovery has briefly improved, and then decline has resumed on a steeper curve, leading to the same EUR. Enhanced recovery usually accelerates depletion, but does not increase available oil.

Reserves to production (R/P) ratio

Another frequently quoted statistic is reserves to production (R/P) ratio. Recent BP/Amoco statistics provide an R/P of about 38 years, based on 2002 production rates and known reserves. Optimists note that this ratio has been near forty years for at least two decades. There are several problems with this argument:

<> We are not discussing the end of oil (total exhaustion of reserves); we are talking about the end of cheap oil, the post-peak decline, when half the original endowment is still available.

<> The implicit premise of the R/P is that production can be held constant until oil is exhausted and then drop abruptly to zero. Petroleum doesn't work that way.

<> The USA R/P ratio has been near constant for three decades, while both R & P have declined in lock step.

<> When low on gasoline, you can continue to accelerate your car until the tank hits empty. Increasing production does not imply that we are far from peak availability.

Misstated reserves

The scariest probable myth of all is stated reserves. It is likely that at least some of the reserve increases claimed by OPEC in the late 1980s were political, not geologic. The virtually unchanged reserves during the last fifteen years, while about 120 billion barrels have been produced by OPEC, is simply not credible. Real world reserves might well be 200 to 300 billion barrels less than claimed, and the world production peak might well be in 2004.


<> As T Boone Pickens has recently noted, sub $30 per barrel oil is a thing of the past. Sub $40 per barrel will not be experienced often or for long.

<> We are much more likely to see $80 per barrel oil than $30 per barrel oil in the near future.

<> There are no fossil fuel supply side answers to the challenge of high oil prices.

<> We had better start developing demand side and renewable solutions while we still have abundant fossil fuel to develop them with. There is no second chance.

<> Present industry and government awareness and responses are contrary to our needs, and must be changed, urgently.

<> Up to now the Power and Gas segment has not perceived petroleum as their concern. Declining petroleum completely changes their future also, and they need to wake up to the fact.

PS: This just in,

Some of the industry's most informed participants believe there is little that can be done to increase worldwide oil production. Earlier this year, British Petroleum announced that it will be returning to shareholders all cash flow it receives in excess of US$25 per barrel. For every dollar the company receives in excess of US$25 per barrel, BP will adjust its dividend or increase its share buyback program to return the cash flow to shareholders. BP has essentially given up its effort so increase production or even keep production flat. Instead, the company has chosen to give shareholders back their capital with interest.


Other key Internet sources include:

Copyright 2004 CyberTech, Inc.

Murray Duffin is a seventy year old "concerned and informed citizen", retired from the position of Corporate Vice President for Total Quality and Environmental Management of a $5 billion+, 35,000 person, leading European based multi-national corporation in the field of microelectronics. Born in Canada and naturalized in 1964, he has lived and worked abroad, in Europe and Asia, for 27 of his 44 working years. He has a BScEE 1956 from the University of Manitoba, Canada, and has done post-graduate study, first in electronics at UCLA and then in Business Administration at Arizona State University. He has authored numerous published papers and lectured extensively on Total Quality Management, primarily in Europe.

Under his leadership, his employer became the only corporation in the world to win all of the European Quality Award, the Singapore Quality Award, and the Malcolm Baldridge National Quality Award, each at the level of the local total corporate entity. They also won the Malaysian, Maltese and Moroccan Quality Awards at the local plant level. They were the first non-American-owned corporation to win the Malcolm Baldridge.

In addition they were the first corporation in the world to have all plants (17) worldwide EMAS validated and ISO 14001 certified. In 1999 they were identified in the "Dow Jones Sustainability Group Index" as the world's leading electronic sector company for sustainability, and were the only semiconductor company awarded the highest (AAA) rating by Innovest Environmental Research.

The combination of TQM and environmental responsibility in industry led directly to considerations of energy efficiency. During his last five years in corporate management he led a worldwide effort involving seventeen factories that effected a 30% reduction in energy in per unit of good production out, with the needed capital investments having an average economic payback under two years. This work provided evidence that a properly designed greenfield plant could operate on about one-fourth of the energy traditionally needed by a microelectronics factory.

Since retirement he has also designed and built one house and retrofitted another to provide comfortable living on one-third of the energy of similarly sized conventional neighborhood homes.

For the last five years his number one preoccupation has been the energy future of the world, but more particularly, out of concern for children and grandchildren, of the USA.

Bill Totten


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