AMSTERDAM (ResourceInvestor.com) -- Although peak oil theories have been largely flawed by their main incapacity to take into account future technological developments and the effects of high crude oil prices, current production situation looks like a precursor of production plateaus.
Several peak oil protagonists have been lately hitting the headlines, showing their willingness to support the theory that production levels have peaked and doomsday scenarios have at last become a reality. The latter, based on current E&P technology, seismic technology and the fact that there are still vast portions of land unexplored - just think about Russia’s drive towards the North Pole lately – is, however, not the main reason for current high oil prices. It seems at present, as even the International Energy Agency (IEA) indicates, that high crude oil prices are the main constraining factor in increased global production levels. The latter is not only the case with crude oil production but increasingly with natural gas and LNG operations. The high levels of liquidity currently amassed by oil producing countries and the oil and gas majors has not yet led to a situation that there is a booming E&P sector showing a continuous upward potential the coming years.
More and more operators, oilfield services companies and national oil and gas moguls, such as Saudi Aramco, Nigerian National Petroleum Corporation or Kuwait Petroleum Corporation, are complaining that money currently cannot buy enough capacity to put in place the necessary projects. Some major multibillion projects are even put on hold, such as in Saudi Arabia, Kuwait, Qatar and Algeria, due to the fact that investors and operators, if willing to put in place an upstream or downstream project, see themselves confronted by project cost overruns reaching 150% to 200% of projected investments. In the end, the latter will put a major damper on further expansion.
The production factors are also being taken into account by the international energy consultancies, such as the IEA, the watchdog of the Organisation for Economic Co-operation and Development in Paris. The IEA has warned consumers and producers alike that high oil prices could be here to stay. The agency has warned that world oil demand will outpace supply this winter and that this gap will only widen if OPEC decides next month not to raise oil production. The only factor currently unable to be predicted - the impact of the coming winter - is currently putting a small damper on price levels.
However, analysts expect that if there is a normal winter in the U.S., EU and Asia, price levels will shoot through the roof. Inadequate supply levels to U.S. and EU, in combination with increased demand in Asia and in most oil producing countries, will put prices under pressure. Based on current statistical assessments, presented by the IEA, there is already a supply gap of 2-2.2 million barrels per day (bpd). Increased OPEC production volumes, which are expected by some analysts as OPEC will have its meeting in September in Vienna to discuss the market, will also not have a dampening effect on market conditions. Consumers should expect that new oil or extra volumes - if OPEC would open the taps - will not be hitting the consumer markets before the end of November. It takes around 6 to 8 weeks, in perfect conditions, for new oil to arrive on the market.
The next year, the situation becomes even bleaker, as global demand is expected to grow by 2.5% to 88.2 million bpd in 2008. Overall production will however stay around the same levels as current, with a possible volume increase of 1% to 1.2% at the most. In the so-called call on OPEC, global demand for OPEC oil will be higher than expected, as OPEC currently is only producing around 30.5 million bpd, which is 2.1 million bpd below market demand for the light crude. If not improving, the call on current strategic reserves in the West will become painful, showing the coming months extensive fall of the Strategic Petroleum Reserves (SPRs).
At the same time, the costs of the E&P projects also have increased exponentially. The IEA reported before that international oil producers will need to invest more than US$2.4 trillion into projects to expand crude output capacity to meet future world demand. The latter will, of course, need to come mostly from non-OPEC countries, such as Russia, Norway, U.S. and China or India. The total investment requirements of OPEC are slated to be US$680 billion. In its 2007 World Oil Outlook, the oil cartel has reported that US$455 billion will need to be channeled into refining with Asia-Pacific region having the lion’s share of capital expenditure. The report stated that “the estimate for upstream investment requirements accounts for not only the necessary net additional production capacity but also that which will be needed to compensate for natural declines in existing capacity in producing fields. Some of the investment needed would be to arrest such declines with workovers, for example, or new wells.”
This picture, even that analysts see it as possible, will become a major drain on financial reserves in the coming years. Potential disastrous results on the respective economies will be felt if the oil market would collapse. At the same time, in a very positive situation, increased costs will become a main constrain. Most non-OPEC countries will be fighting an uphill battle, as they want to increase production at a time that costs also are spinning upwards. OPEC has reported that expansion of non-OPEC capacity is, on average, two to three times more costly than for OPEC with the gap widening over time. The highest cost region is the OECD which also experiences the highest decline rates. To increase North American production volumes, costs are already set at US$20,000 per barrel per day of capacity. This will even increase as non-conventional sources, such as tar sands or heavy oil will be needed to become accessible. Costs in Western Europe are expected to rise gradually and remain the highest, reflecting the maturity of the fields. OPEC production expansion is also costly, as the average cost currently starting at US$10,200 per bpd.
The above painted situation shows a growing dependency on cash-making resources, not only to make more cash but in the end to sustain current production levels. This situation is on the long run not sustainable and will cause a decline in new project volumes. Further price increases will be the result, putting more and more pressure on economic growth in the long run. Investors should keep an eye on oil prices, but also increasingly on the underlying costs made to produce the volumes shown in financial reports.
