Petroleum Review - Editorial - April 2004
Is depletion underpinning high oil prices?
With oil prices remaining firm and stocks generally on the low side, particularly for gasoline in the US, earlier confidence that oil prices will soon be weakening is starting to evaporate. Financial analysts are starting to hedge their bets and quietly raising their price targets, typically by $3-$4/b. Politicians no longer mention floods of cheap oil or cheap gasoline.
A whole series of factors are cited for the firmer price outlook. All have some merit, but none really explains what is going on. In no particular order, the usual favourites include Opec's reluctance to raise production even though prices are above their target range, but, as we show on p40, it is probably only Saudi Arabia that has any operable spare capacity. Speculative buying of crude futures by hedge funds is also blamed, as is the political and social unrest that is threatening production flows in Nigeria and Venezuela. Other factors are continuing high gas prices in the US and Canada boosting demand for oil products as substitutes; rapidly expanding demand in Asia, particularly China; and reviving economic activity in the US and Japan.
Depletion factor
The one factor rarely mentioned is the increasing impact of depletion. Depletion rates are not recorded or factored in. The IEA (International Energy Agency) or EIA (Energy Information Administration) have no standard procedure for recording depletion, and may not even recognise it as a significant factor. There is no qualification to growth projections to account for the impact of depletion. For many years this made little difference, the only major producer in decline was the US and the impact on world supply could be ignored.
However, depletion is now starting to have a significant impact - and one that can only grow. In the August 2003 issue of Petroleum Review it was shown, using the figures from the BP Statistical Review, that 21mn b/d came from producers already in decline. Total production in 2002 was 74mn b/d, so 29% of global production was already coming from areas where production was in decline.
Moving forward to 2004, demand is expected to reach 80mn b/d according to the latest (March) Monthly Oil Market Report from the IEA, with their latest demand growth projection now 1.6mn b/d. [Note: IEA figures are rather higher than those in the BP Statistical Review.]
In the absence of any reliable statistics a reasonable 'guesstimate' for average decline rates is 4%, which means the decliner group's production is going down by around 850,000 b/d a year but now only account for around 25% of total production.
The under-recognised impact of this is that, to meet this year's projected demand growth of 1.6mn b/d, the producers still able to expand production have to meet the 1.6mn b/d of recognised demand growth and make up for the largely unreported 850,000 b/d of decline. Thus, the required new production is 2.45mn b/d (1.6 + 0.85). But, as it all has to come from the producers with expansion potential, this means the real average growth rate required of them is not the overall 2.1% growth reported by the IEA but a rather more demanding 4.1% (2.45mn b/d on a production base of 60mn b/d). This would seem to be a key factor in the continuing strength of oil prices.
Over the last few months the IEA's monthly reports have been hinting that production decline is likely to overtake both China and Mexico by the end of 2004. If this happens, then, by early 2005, at least 27mn b/d of production will be in decline. This would be 33% of global production. At this point decline would be over 1mn b/d per year, so, to meet demand growth of 1.5mn b/d, the countries where production was still expanding would need to add 2.5mn b/d - or an average 4.5% growth.
Inbuilt bias
The conclusion is that slowing decline is as important as expanding production to meet future energy demand - but its importance will not be fully recognised until depletion is systematically reported by agencies such as the IEA and EIA. Until then there will an inbuilt bias to investments that expand production versus those that slow depletion.
The opinions expressed here are entirely those of the Editor and do not necessarily reflect the view of the EI.
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