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March 28, 2007

Peak Oil -- The Power of Declines

This is the first in a series of weekly columns I will be writing on this website. I wish to thank the ASPO-USA Board of Directors for the opportunity to keep the public informed on peak oil and other related energy issues — Dave Cohen

The peak of the global oil supply refers to the uncontroversial observation that the world's incremental production of conventional oil, a finite resource, will reach a high water mark and then decline thereafter. What is more controversial is when the peak will occur. In its usual usage, the phrase "peak oil"  refers to the hypothesis of a near-term peak in the oil supply. Additional complications regarding what "conventional" oil is muddy the waters. Analysts such as CERA will tell you — for $1000 — that the peak will not occur until the 2035 to 2045 period, which, to most people, seems too far in the future to matter much. However, those studying the near-term hypothesis worry, and have good reason to believe, that the peak will occur by 2015.

Since 1870, the health of the world's economies have hinged more and more on a secure, dependable and growing flow of conventional oil. The consequences of a near-term peak could irrevocably damage global economies unless mitigation steps are taken to smooth the transition to a world that must consume less oil with each passing year. Because petroleum provides the bulk of the world's liquid fuels, the immediate effects on transportation will be the most pronounced. Disconcertingly, the list of all the other products we consume that are made (in part) from oil is very long, as even those in school grades 3 to 7 can understand. Ailing, contracting economies would have harmful effects on people's lives. So, the debate about the timing of the peak is not "academic" — much depends on a correct analysis of the future oil supply.

There has been a lot of rancor and obfuscation in the debate about a near-term peak in the oil supply, largely because so much depends on the outcome for both producers and consumers. A highly placed representative of Cambridge Energy Research Associates (CERA), who characterize the hypothesis as "a myth", has called the near-term peak notion garbage. Others in the popular press often give the impression that "peakists" are claiming that the global oil endowment is almost depleted. The media uncritically cite huge recoverable reserves numbers taken from CERA or ExxonMobil, amounting to trillions of barrels, to "prove" their point. However, you can not put oil reserves in your car's fuel tank until they have been produced, transported and refined.

In the near-term, what is running out is the world's ability to increase the oil supply to meet growing demand, not the oil itself. The peak oil hypothesis, properly understood, is about constraints limiting the conversion rate of oil reserves into useable flows. One important consequence is that cheap oil is a thing of the past.

Future columns will discuss constraints limiting future oil production in some detail. Here, it suffices to expand our understanding of why the near-term peak hypothesis is plausible. As it turns out, the biggest problem is that many optimists considering the problem know how to add, but have forgotten how to subtract. Look at the figure below, which is revision of Chris Skrebowski's Oil-a-Gator.

Gator The graph describes the global oil supply over time. The alligator's jaw is defined by the projected demand on the top and declines in the current oil supply from existing reservoirs on the bottom. The middle line (the x-axis) is the breakeven point -- the increasing amount of oil that needs to be replaced year-on-year to compensate for these declines. The red line defines the amount of oil that is actually produced and consumed starting at time t0. As such, it represents additions or subtractions with respect to the breakeven point. If CERA is correct, the red line will rise steadily over time to both make up for ongoing declines and meet future demand — at least out to about 2035 or so. However, the graph reveals that increasing the oil supply to meet growing demand becomes more and more difficult over time, as the 'gator's gape gets wider and wider. At some point — t1 in the graph — this Herculean, ultimately unsustainable, task will become impossible and the world will no longer be able to breakeven. This is the time of peak oil.

So far, nothing has been said about the initial time (t0) and the peak date (t1). Assume that the starting point is 2006 and further consider that we've got some ability to look ahead at the future, as described in the MegaProjects list compiled by Chris Skrebowsky, editor of Petroleum Review. This database is a schedule of large (> 40 thousand barrels per day) oil projects coming onstream between 2007 and 2012.  Because there is a long lead period (several years) between the time an operator decides to go ahead with a project and the time the first oil is produced, we can be confident that almost all large developments out to 2012 are accounted for.

First, we must learn how to subtract i.e. establish the decline rate. Using a baseline of 2005, the Oil & Gas Journal (OGJ) data indicate that the world consumed 80.099 million barrels per day (b/d) that year, where "conventional" oil is defined as the sum of crude oil, condensates and natural gas liquids. The OGJ data further indicate that usage in 2006 was 80.594 million b/d, an increase of 0.495 million b/d. According to Skrebowski's data, 3.219 mb/d of new oil was produced during 2006. Given the smaller net increase, a straightforward calculation shows that the "visible" decline rate was 3.4% for existing oil production, i.e. this is the rate that could be seen in the raw production data. There are dangers in assuming such a rate going forward in time because historical data shows that "visible" declines may underestimate true declines based on new production capacity additions. Next week's column will discuss the subject in detail.

It is informative to consider a specific country, Brazil. The OGJ data tells us that oil production in some countries declined in 2006. Examples include Norway, Indonesia, the U.K. and Egypt. These countries are in what Skrebowski terms Type-3 Depletion  — they are past peak and so will only decline year-on-year from here on out. Others, like OPEC members Nigeria, Saudi Arabia and Venezuela, declined, but it is not clear whether their peak production has been reached. However, declines in existing production are also happening in oil suppliers that increased production in 2006, as in Brazil or Russia. In these cases, new oil production has not only offset declines, but has also been sufficient to provide net gains. Looking more closely at Brazil, Skrebowski's data indicates that for 2007 projects, some of which will reach full capacity in 2008, this large offshore producer is scheduled to add 0.610 mb/d to the world oil supply. However, according to Rigzone's  Brazil Petrobras Plans to Bring 2 New Platforms On Stream in May, PetroBras indicates that they expect a net production increase in 2007 of only 0.141 million b/d on average for the year. Why?

The explanation lies in the problem posed by ongoing declines. Much of the new production Brazil will put onstream will  compensate for declines in their existing offshore fields. Beyond that, new production will result in only modest net increases. The underlying problem is that declines in existing fields are often invisible to the oil & gas analyst, whereas there is usually ample information about new projects coming onstream.

Moreover, there are often delays in new production. For example, the Rigzone article indicates that —

Production at the P-50 rig which Petrobras took on stream last April [in 2006] now has reached 170,000 b/d, Eduardo Molinari, coordinator for strategy and portfolio management of exploration and production at Petrobras, said. The P-50 originally was supposed to reach its full 180,000 output capacity last October [in 2006]. But problems with drilling equipment had delayed the ramp-up schedule.

So, delays happen, even as declines over time continue. The Brazilian example illustrates the power of the 'Gator graph as we anticipate the future global oil supply. Reading the media accounts, one might be forgiven for thinking that world oil production is continually increasing at a rate fast enough to meet projected demand. However, those worried about the peak oil hypothesis have remembered an important elementary school lesson that the press does not report — knowing how to subtract, as well as add.

Next week, I will explore decline rates and the near-term future of the non-OPEC oil supply.


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