Wednesday, September 28, 2005

Saudi Oil Reserves

A friend wondered what I thought about this statement from ExxonMobil and Saudi oil ministers that oil reserves in the Kingdom would soon be doubled. So I mixed myself a cocktail, tighened my robe and here's what came out.....

If memory serves, the oil majors all downgraded their proven reserves substantially a few years back, and were forced to pay significant fines for having overstated them so I take any statement from them with a large grain of salt. Besides, once the Saudis publicly state that their oil reserves are in decline, the West will begin to pull its support from the regime and then the ruling family is ....well, toast.

More generally, for a reserve to be "proven" it must be economically viable to be extracted. At $20 crude and current wage and capital equipment rates there are no proven reserves in Canada's oil sands. At $100, assuming wages and capital equipment costs stay the same, there are billions of barrels. At $1000 crude, other things equal, there are many trillions of barrels of proven reserves. That is, as the real price of crude rises, other things equal, proven reserves will grow. To think of it in labor terms, the more man hours spent, the more crude which can be extracted. Whether that change in labor and savings resource allocation is sustainable is another question, man can't live by oil alone. As a corollary, indigenous resistance to oil extraction reduces proven reserves by raising costs. To wit, proven reserves in Iraq are plummeting as the cost of the Iraq War keeps mounting.

I sometimes think the peak oil advocates overstate the case in their zeal to inflame the public mind and thus create a "straw-man" which is easy to refute for the skeptics. The issue isn't so much that the world is running out of oil, but rather that, for reasons which include the exhaustion of many large fields, greater extraction difficulty in the newer fields (including Hurricanes), and disputes over ownership of those remaining, the real costs of extraction are rising, currently quite quickly.

Ultimately, though, we will all have to wait and see in the Saudis have more oil. Of course, real oil prices have been high for years now, which, you might think, would already have spurred extra capital investment in Saudi Arabia. Heck, why spend $250B going to war in Iraq if $20B invested in Saudi's oil infrastructure would get you, according to the boys from Exxon and Saudi, more oil? I'm sure in the years before the turn of the last century there were many whalers on the New England coast who assured everyone that there would always be enough whale oil.


jeff poppenhagen said...


With regard to the comments from the Saudi oil minister and Exxon I would make the following observations: First, the major oil companies are never going to be the first to admit that Peak Oil is a possibility w/in a reasonable period of time. They would clearly not benefit as replacement costs would likely be far higher than investors are estimating and they would have a lot of stranded assets in their downstream businesses...refineries, tankers, gas stations, pipelines, all of which would see lower rates of utilization. As for the Saudis, I agree with you that they have an interest in convincing the US government that they have a limitless amount of oil. Without this, the need for the US to protect the Saudi royal family would diminish.

With regard to higher prices leading to more proven reserves, this is true only to a point. Also, you need to remember that geologists and financial types think about reserves somewhat differently. The financial types look at an SEC definition. That is, if you run a new pipe to a portion of a field that has been producing for years, to the geologist that would not be an increase in reserves, but for the financial guy it would be as the SEC requires a plan to produce said oil before it can be counted as a proven reserve. Also, oil reserves are based to a degree on pressure and flow, and this does not change as much as we would like with price. As an example, in 1970, when oil production peaked in the lower 48, light sweet crude averaged about $1.35. Today, that price is 48x higher, a rate of increase well beyond any associated costs in the oil patch (barring replacement cost). This has done nothing to change the one-way direction of the amount of oil coming out of the ground in the lower 48 states. Obviously, there comes a point when the capital is better deployed elsewhere because pressure and flow ain't going to cut it at current rates.

Additionally, replacement cost is a critical issue as we possibly approach Peak Oil. The world is now producing about 5x more oil than it is finding each year (if one backdates all reserve additions to the initial date of a fields discovery as shown in research by Colin Campbell). For a business to not shrink over time, it must produce and sell its product based on receiving at least replacement cost. Otherwise, it will shrink....this would be another way of coming to Peak Oil. To date, Exxon and the other majors have shown little interest in attempting to grow their business in unit terms. This is either because oil is not priced high enough to "economically" replace reserves via exploration and cover production and distributuion costs (Peak Oil is approaching), or they fear that the Saudis really have the goods. We just don't know.

To believe the Saudis or not is a very important question. You have already pointed out that the Saudis have a great deal to gain from the military ymbrella provided to the House of Saud by convincing us that they have the oil and the future production capabilities to meet long-term demand. Additionally, they want to have the world put off for as long as possible the conservation and search for energy alternatives and efficiencies that would certainly come with widespread adoption of the Peak Oil theory.

To date, the ability of outsiders to verify Saudi claims has been non-existent. Saudi claims of competitive neccessity have thwarted such efforts. Trust us they say. Well, if they say they have the oil, I am not sure what competitive disadvantage they would be at if the produced field by field data to verify such claims. Additionally, the US is paying a very big tax, in military expenditures, for the simple words of Saudi oil officials. My view of the situation shows that the US is currently spending about $650 bil./year on defense, wars in the Middle East and intelligence gathering. I would guess that at least half of this money is spent on being in, and being ready to get more involved in, the Middle East. Since the Mid East produces about 7 billion bar. of oil per year, the US is paying a tax of about $46/bar. for Middle East oil. I think we can come up with a better answer regarding Saudi assurance than "truist us." Alternatively, we could stand down in the Middle East (my favorite alternative and save the $300+ billion/year and take our chances with higher oil prices which we could handle to a large degree with the budget savings). Somehow, w/o better verification I am reluctant to believe Saudi promises as there appears to be no reason to not "show us the data."

Nevertheless, it remains a possibility that they do have the goods.

Dude said...


I agree with your general observation that humans in a position to gain or lose substantially depending upon a vision of the truth will be sorely tempted to see and describe the world as they wish it to be. This applies as well to the decadent House of Saud as it does to the US financial structure (perhaps Franklin Raines might think about applying for a job as Saudi Oil Minister).

Yes, I agree there are limiting factors to the real oil price rise = more oil reserves calculation, i.e. the relationship is non-linear, most likely similar to a population within a closed environment curve. As we cannot live by oil alone, everyone can't be working to obtain it, nor can all capital resources be designed for the purposes of extraction and refining. Indeed, the very value of oil is based on other necessary labors performed more efficiently with its use. If, for instance, auto manufacturers decided to redeploy their capital and labor resources in the oil fields, the supply of cars would decline and the need for oil would drop. As with the human body, balance between multiple systems is crucial.

This is the subtle point I didn't make clearly enough. Greenspan can wax poetic about "economic flexibility" all he wants but this change in real crude prices is already proving to be a tough shock to the system. I don't disagree with the general outline of Peak Oil Theory nor would I bet that the Saudis have all the oil they claim. I just think that the US' problems are more immediate. Long before the world runs out of oil, increasing real petroleum prices will devalue the existing capital stock of oil dependent nations, which serves as the basis for the financial system. In human terms, during periods of food supply decline the first concern is not starvation, but disease caused by malnutrition. To focus on the first effect is not to deny the eventual.

jeff poppenhagen said...


Yeah, the funny part about the Peak Oil debate is that PO may not even be driving oil prices yet. We just may be at the stage now where the massive credit creation of the last ten years has led to incredible malinvestment.....the building of lots of 4000 sq. foot homes without enough investment in energy infrastructure to allow people to be able to heat them. $70 oil and $14 gas may just be the result of many years of $3 trillion/annum of debt creation, negative savings rates and current account deficits that I would not have imagined ten years ago.