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Review of “The Truth About Global Oil Supply”
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By professor Kjell Aleklett, President
of ASPO
I got a mail from James Morris and he suggested that I should read an article
with the title “The truth about global oil supply”. The author is Edward
N Luttwak, Senior Fellow at the Center for Strategic and International Studies
in Washington. (
http://www.thefirstpost.co.uk/index.php?menuID=1&subID=18
).
The article was posted on The First Post, a site owned by the First Post
News Group Ltd, formed by a group of private investors to develop new media
opportunities. The non-executive chairman of the company is Mike Turner,
a senior partner at Wiggin, a law firm specialising in media law. That sounded
very solid and I concluded that the article was authentic. Obvious is the
article written in the spirit to help investors to make the right decisions.
According to the web page for CSIS, the Center for Strategic and International
Studies has for four decades been dedicated to providing world leaders with
strategic insights on — and policy solutions to — current and emerging global
issues. Today oil is one of these issues.
The main message from Dr Luttwak is that “the world isn’t short of oil
and that the price will go down, not up”. Obviously CSIS has an expert who
might know more about global oil reserves and production then my friends
in ASPO.
Once again I went to CSIS and tried to get some information about Mr Luttwak
and this is the information they provided:
http://www.csis.org/experts/4luttwak.htm
.
Edward H. Luttwak, Senior Fellow, Preventive Diplomacy
Expertise: Geoeconomics; strategy.
An internationally recognized authority, Edward Luttwak has served as a
consultant to the Office of the Secretary of Defense, the National Security
Council, and the U.S. Department of State. He is a member of the National
Security Study Group of the U.S. Department of Defense, and an associate of
the Japan Finance Ministry's Institute of Fiscal and Monetary Policy. Dr.
Luttwak is a frequent lecturer at universities and higher military colleges
in the United States and abroad (recently in Russia, Italy, France, Japan,
Argentina, and the United Kingdom).
Not a single word that Dr Luttwak has any knowledge about oil. Let’s read
what he has to say:
The industrialised world needs more and more oil. The
price is effectively set by Saudi Arabia, which has the largest production
capacity and the loudest voice in OPEC. But - whatever happens in the wake
of King Fahd’s death - the desert kingdom is increasingly seen as a problem
rather than a solution in the global energy equation.
If the Saudis can't or won't pump significantly more oil, commentators
fear already-high oil prices can only go on rising - with disastrous effects.
KA: From the first sentence the tone is set; Dr Luttwak’s main concern
is “the industrialised world”. In 2002 USA, the crown jewel of the industrial
world with 5 percent of the global population, used 25 percent of all the
oil produced in the world, EU spent 18 percent and OECD in total close to
60 percent of the year’s production. The ones that really need more oil
in the future are the countries in the developing world. As the growth in
the economy in these countries is directly proportional to increasing use
of oil it would have been right to say that these countries need more oil.
The industrialized world needs to use oil more efficiently and to work with
energy systems that use much less oil. The idea that Saudi Arabia is a problem
is interesting to read. As a security adviser it would be interesting to
know what advice Dr Luttwak gives to the different governments.
This pessimistic analysis is seductive, but wrong - partly
because it is based on numbers that are unreliable and misleading. We don't
know precisely how much oil the world has left because the only reliable
reserve statistics come from advanced countries such as the US and the UK,
and even those can change as higher oil prices make old fields and small
wells more economic to exploit.
KA: Dr Luttwak is right when he claims that the US and UK have good, transparent
data, but the major oil companies are working all over the world and they
have a lot of global knowledge. It is correct that the data are less transparent
in some regions but we can also look at production numbers and from them
make conclusions for the future.
Reserve statistics for oil-rich but troubled countries
such as Russia, Iran and Iraq, by contrast, are so unreliable as to make
them useless: they may be underestimated because there has been no systematic
exploration using the latest methods, or overestimated because the true potential
has been reduced by over-pumping and mismanagement.
KA: We know that Iraq is considered to be a troubled country but it is
interesting that a security expert thinks that Iran and Russia are also
troubled. We know that president Bush recently made comments that indicated
that US was considering some military actions in Iran. By adding Russia it
is possible to build up a tension that can be used to increase the US military
budget. A strategic problem for US in the future is that Russia is the only
superpower that for the next 30 years will be self-sufficient in energy.
The US and EU, in other words Nato, are very dependent on imported oil and
natural gas and the main suppliers in the future are Muslim countries. The
most important thing that we have to do in the near future is to find a way
to collaborate with these countries in such a way that everyone benefits.
We must realize that these countries have an option to choose where to export
and the option is Asia.
But what we do know for sure, in simple terms, is that
there is enough oil under the ground to meet all our needs for many years.
The Saudi oil company Aramco estimates it has reserves of 460 billion barrels,
or 134 years of production at current rates – and the US’s government estimate
for Saudi Arabia is much higher than that.
KA: First we must discuss how long “many years” is. From school I remember
that my teacher used to say that “few” was between 3 and 9 and with that
definition “many years” is more then 10 years. Ten years from now IEA,
Internationa Energy Agency, predicts that the global demand will be around
100 million barrels per day. According to IEA and major oil companies, the
decline in the production from existing oilfields is on average between 4
and 6 percent. If we assume the lower number, today’s production of 84 million
barrels per day will decline to 56 million barrels per day by 2015. To achieve
a production of 100 million barrels per day we need to get 44 million barrels
per day from new fields in production. Just now the industry cannot point
to even 20 million barrels per day of new production. To reach 44 looks to
be out of range. The statement “for sure” must be questioned.
It is right that the current Saudi production multiplied by 134 years gives
460 billion barrels of oil. The question is if Saudi will ever produce that
amount. The current Saudi reserve figures reported to the Oil&Gas Journal
is 260 billion barrels. In an article in the Oil&Gas Journal former
vice chairman of Saudi Aramco, Sadad al-Husseini (you can read more about
al-Huseini in a resent article in the New York Times, http://www.nytimes.com/2005/08/21/magazine/21OIL.html?pagewanted=all),
explained that reserves in production were 130 billion barrels and that
they had 130 billion in potential reserves. I think that his numbers are
more reliable than any statement from ministers in the country. If you read
“Twilight in the desert” by Matt Simmons you must also question the potential
130 billion barrels. The estimate from the US government that the
Saudi reserves are higher than 260 billion barrels, must be considered as
dreams or at least wishful thinking.
So global reserves are not the issue, and have little
impact on today's oil price. Likewise, speculation plays only a small role,
because the oil market is too big for speculators. In fact, the only thing
that really matters is day-to-day output - but even there, the statistics
are often false, not least because OPEC countries consistently cheat in order
to produce more than their official quotas.
KA: Dr Luttwak is partly right when he claims that the day-to-day production
is more important than the reserves. If we look back 50 years, 1955 we consumed
4 billion barrels per year, but the discovery rate was 30 billion barrels
per year. We built up an enormous reserve. The quality of the discovered
oil was different and the best oil was used first. Today we use 30 billion
barrels per year and the discovery rate is less then 10 billion barrels per
year. Even Chevron has an ad with the text: ”The world consumes two barrels
of oil for every one that discovered”. As we are using more then we find
we have to draw upon old reserves. As much of the good oil has already been
used, we now have to develop the not-so-good oil and that is harder. We can
see that oil companies are producing less even though they have quite large
reserves.
But again, what we do know for sure is that Saudi Arabia
has a dominant role as the marginal supplier at times of peak oil demand.
The mistake, however, is to assume that Saudi dominance will endure – unless
the Saudis themselves are prepared to invest heavily to make sure that it
does.
KA: Correct, we cannot hope that Saudi always can produce what we wish,
even if they invest heavily.
The latest figure for Saudi oil production for export
is 8.8 million barrels per day. Perhaps surprisingly, that's only slightly
more than is produced by the old and depleted US oil fields, and barely more
than the Saudis themselves were producing five years ago. The fact is that
they have been very slow in increasing their production capacity, in spite
of repeated promises.
KA: According to Matt Simmons it is hard to increase the production from
the old giant fields. There are no new giant fields waiting around the corner.
For many years, the maximum the Saudis could produce
has been estimated at 10.5-11 million barrels per day. To increase that
capacity to 18 million barrels per day - the level the US would like to
see, to ensure future price stability below today’s barrel price of $61
- is entirely feasible. In the huge and easily exploitable Saudi oil fields,
the cost of installing one barrel per day of additional production capacity
is only US$6,000 or less.
KA: It is not feasible for Saudi to increase production to 18 million
barrels per day. The other question is if they should sell off quickly the
only resource they have to support their growing population.
The whole job could be completed within five years for
around US$108 billion. The increase would be more than enough to absorb
current Chinese demand of 6.5 million barrels per day. It would absorb projected
growth in world demand from the present 84 million barrels to a projected
peak of 90 million in 2010. Unfortunately, there is no chance that Saudi
Arabia will add the capacity needed to make that happen.
The first reason for this is financial. $108 billion is not a daunting
sum in relation to the Saudis’ 2005 budget surplus of $26 billion, but there
are many other calls on their cash. The country’s per capita income is less
than a third of what it was in 1980, but its 22 million citizens are increasingly
demanding.
KA: Beside the thought that it is possible to do it in five years the discussion
is OK.
Most demanding of all are younger members of the royal
family: some already have palaces, villas abroad and private jets - but
thousands of younger princes are impatiently waiting for their share of
the spoils. The new, 81-year-old King Abdullah alone has more than 30 sons,
and many of his sons themselves have grandchildren - each with lavish tastes
to be indulged.
KA: Yes this is a big problem. According to some people, the Royal Family
has 5.000 princes and consists of 35.000 persons in total. In one more generation,
the Saudi Royal Family will exceed 100 000. This is a problem.
The second reason why Saudi Arabia isn’t going to invest
in significant new oil production any time soon is political. Saudis refuse
to allow foreign oil companies to invest in additional capacity in return
for production shares. Aramco retains a monopoly, but lacks the resources
and appetite to manage expansion – especially as the actual work has to
be done by foreign contractors.
KA: Read “Twilight in the desert” by Matt Simmons and you might get some
other ideas.
The mentality of older princes, dominated by fundamentalist Wahhabi Islam,
is deeply xenophobic: they rely on the outside world for material comforts,
yet still take more satisfaction from imposing difficulties on foreign partners
than from co-operating with them. A younger generation, now in their fifties
and sixties, are more open to co-operation, but are invariably outvoted
KA: If you want to learn more about Wahhabi and other interesting political
issues in the Middle East, I recommend you read “Sleeping with the devil”
by Robert Bear.
The third reason is economic. The Saudis remember when
oil sold for $12 a barrel or less. They fear that if they add capacity faster
than their present very slow rate, the price will collapse again. So they
will only invest in 2-3 million barrels per day of new capacity over the
next five years - and that’s nothing like as much as the US hopes for. But
even if the Saudis won’t play ball, the good news is that the price of oil
is more likely to decline than to increase over the next five years.
KA: This is an interesting statement. Even if nothing is done that is needed
it doesn’t matter, as the price will decline anyhow. A lot of people seriously
question this now, including NYMEX traders.
It is easy to assume that today’s high oil price is caused
by current market factors: a lack of big new oil discoveries and the loss
of Iraqi output, combined with increased demand from medium-growth America
and high-growth China and India. But in reality today's $61 oil price is
chiefly a reaction to the low oil prices of the past 20 years.
KA: It looks as the price today is OK as it has been too low before. Fantastic
statement.
Cheap oil reduced investment in new, higher-cost production
capacity which would have exploited deeper offshore oil, heavy oil and tar
sands. It reduced investment in long-range pipelines and shipping to exploit
remote natural gas finds. It reduced investment in other energy sources
such as nuclear and coal, and in energy conservation. At the same time,
it increased energy consumption - thanks to America's ubiquitous SUVs, faster
ships and larger commercial aircraft fleets. High oil prices should reverse
all these trends. This will happen quite quickly in greater use of coal,
more gas transportation capacity and more oil production from high-cost
sources.
Some changes - including improved energy conservation - will come slowly.
Others, especially the increase in nuclear capacity, will come very slowly
indeed.
Nevertheless, logic and experience tell us that - in spite of added demand,
uncertain reserves and Saudi unwillingness to help - today's $61 oil will
itself be the chief cause of a fall in the oil price to come. Expect to
see it return to $40, then $30 - and maybe even less.
KA: At the end of the article we get the reason why Dr Luttwak has written
this article, he likes to say “Don’t worry, be happy”. He has not
convinced me at all. Now it is up to you to make up your own mind, but before
you do that you should take the time to read what Matt Simmons has to say
here about the article.
On February 24, 2004 — Matthew Simmons, president of Simmons and Company
International, and two Saudi Aramco executives, Mahmoud Abdul-Baqi, vice
president, exploration, and Nansen Saleri, manager, reservoir management,
analyzed the future of Saudi oil production at CSIS.
As Matt Simmons was invited by CSIS, the organization to which Dr Luttwak
belongs, to discuss oil production in Saudi Arabia and also recently published
a book about the “Twilight in the desert: the coming Saudi oil shock and
the world economy”, I asked Mr Simmons if he could read the article
and make some comments. This is his replyt:
Matt Simmons: The article is a well written piece that
is supported by zero data as the author actually sort of admits. Like many
others who love to write and opine on energy issues, he makes clear that
Saudi oil reserves are essentially boundless and the only difficulty we will
have is their leaders having the will and making the right investment decision
to provide access to this oil. But even with his doubts about them ever
adding so much oil, the writer can still not conceive that oil prices could
ever stay at such ridiculously high prices of over $60 a barrel. Why he
thinks $40 is a logical price is also not supported by any factual analysis.
All he has in strongly opinionated hunches.
I am sticking to what a modest stack of 235 SPE papers laid out. The age
of the Saudi Royal Family is far less important than the age of the five
key producing fields. This aging issue will not change, regardless of how
high oil prices go. I also think that $65 oil per barrel is extremely cheap
with converted to terms humans understand. $.10 a cup for a non-renewable
extremely valuable, very capital intensive raw material strikes me as unsustainably
low.
Why so many "experts" assumed Middle East oil was so vast and so cheap
is a riddle historians writing about the transition into the 21st Century
will puzzle for decades. Why we also thought oil should sell for $.02 to
$.04 a cup is an even great mystery. Was transparency so bad and knowledge
of energy so poor in 2005 that society chopped down the last tree without
realizing the tree was the last one around? Is this why society as it existed
in the first few years of the 2ist century suddenly collapsed?
The sooner these vague but well written stories cease and people awake
to the crisis that is at our door, the faster we put a fire wall between
us and what "us" can easily become: a collapsed civilization.
End note: Dr Edward N Luttwak is a military and national security expert
and CSIS claims to provide world leaders with strategic insights on — and
policy solutions to — current and emerging global issues. Security just
now is to avid doing anything to worry people. Luttwak’s article is one
attempt at such reassurance. If you have read al this and have an opinion
about the article, my analysis or the comments by Matt Simmons you are welcome
to express your opinion.
Kjell Aleklett, President of ASPO
aleklett@tsl.uu.se
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