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.
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 specializing in media law. That sounded very solid, and I concluded that the article was authentic. Obvious is the article was 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 than my friends in ASPO.
Once again I went to CSIS and tried to get some information about Mr. Luttwak:
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 industrialized 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 to 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. Luttwaks main concern is the industrialized 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 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 economical 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 the 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 Army budget. A strategic problem for the 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 leading suppliers in the future are Muslim countries. The most important thing that we have to do shortly 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 on 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 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 than ten 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-Husseini in a recent article in the New York Times ), 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 matters is day-to-day output – but even there, the statistics are often false, not least because OPEC countries consistently cheat 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 than 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. No new giant fields are 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 about 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 thirty sons, and many of them 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. It 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 particularly since 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 the 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 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. Here is his reply:
Matt Simmons: The article is a well-written piece that is supported by zero data as the author 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 incredibly cheap with converted to terms humans understand. $.10 a cup for a non-renewable precious, 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 firewall 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 avoid doing anything to worry people. Luttwaks article is one attempt at such reassurance. If you have read all 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