The Daily Reckoning PRESENTS: Dwindling supply...
skyrocketing global demand... and "price hawks" at the helm
in major OPEC nations, could mean benchmark crude at $50 a
barrel in the not too distant future. Oil expert John Myers
reports.
HYDROCARBON MAN
By John Myers
Just because the US Army has pitched its tents in the Iraqi
oil fields, that doesn't mean that Iraqi oil will soon be
flooding world markets or the price of oil is heading to $12
a barrel. Quite the contrary.
Indeed, one of the biggest post-war surprises is that the oil
price has jumped back over $30 a barrel. I can't say we're
surprised. We have stated repeatedly that the bull market in
oil has little to do with Iraq specifically. Although, the
politically volatile Middle Easy certainly plays a big role
in the oil price trend.
Removing Saddam Hussein from power doesn't change the
fundamental fact that the world is drawing down its oil
reserves at a record pace. Nor does it change the fact that
politically volatile Middle East nations continue to control
the lion's share of the world's oil supplies. Since most of
the rest of the world is rapidly depleting its domestic
supplies of oil, the world has become more dependant than
ever on Mid East oil. Forward-looking investors should be
looking to invest in oil and gas companies with substantial
North American reserves.
To predict what will happen to the world's oil supply, you
need only look at a single oil field. Whether you are talking
about Prudhoe Bay in Alaska or Leduc in Alberta, maximum
production of a given field is achieved some years after
initial discovery as the field continues to be developed with
additional step-out wells. But, after half the recoverable
reserves have been pumped from a field, there is a rapid
decline in the field's oil reservoir. It becomes less and
less economical to pump oil from the field until a breakeven
point is reached - a point where the expense of operating the
oil field equals the revenues produced by the field.
The physics that apply to a single field also apply to a
region or an entire country. Consider the continental United
States. The rate at which new oil was discovered hit its peak
in 1957. By the early 1960s, the nation's total proven
reserves reached its all-time high. Less than a decade later,
U.S. production peaked. Production was relatively stable
until the mid-1980s and then began to fall precipitously.
Year after year the Americans have made up the shortfall in
oil production by importing foreign crude. But what happens
when the world's output begins to fall?
Unless we find oil on Mars, there will be no outside source
to make up for dwindling production. It will be then that the
price impact of dwindling supplies will meet surging demand -
a formula for incredible profits in oil and gas stocks.
Global oil reserves have not increased since 1990. In fact,
over the past four decades, wildcatting has yielded fewer
results. In the 1960s, the industry discovered 375 billion
barrels. In the '70s, 275 billion barrels and in the '80s,
150 billion barrels were discovered. Fewer barrels yet were
discovered during the 1990s.
At one time, the world was blessed with somewhere between 1.8
trillion and 2 trillion barrels of oil. But beginning with
the first flowing oil well in April 1861, that endowment has
been consumed. By the end of 2002, humankind had pumped and
burned about 900 billion barrels of oil, or about half of the
total amount of oil the world has to offer.
Perhaps this year - and certainly no later than 2005 - world
production will hit its apex. That means that over the second
half of this decade world oil output will begin to decline -
just as global oil demand is surging.
Each year the world pumps and burns 26 billion barrels of
this non-renewable resource. That means that every four
years, more than 100 billion barrels of oil-five times the
total reserves of the United States-are consumed.
But world demand for petroleum is expected to soar by 56
percent, or 43 million barrels per day (bpd), over the next
two decades due mostly to strong demand for transportation
fuels. According to the International Energy Agency, global
oil demand would jump to 119.6 million mb/d in 2020 from its
current level of 77 million mb/d. But even today, oil is
being burnt at a torrid rate.
The implications are serious for what Daniel Yergin calls a
"Hydrocarbon Society." Despite the advent of the microchip
and explosion of the Internet, petroleum is the primary
economic engine powering the world. And even as world oil
output peaks and then tapers, there is little evidence that
the necessity of oil, and the demand for it, will wane.
"Hydrocarbon Man shows little inclination to give up his
cars, his suburban home, and what he takes to be not only the
conveniences but the essentials of his way of life," wrote
Yergin in his best seller, The Prize. "The people of the
developing world give no inclination that they want to deny
themselves the benefits of an oil-powered economy, whatever
the environmental questions. And any notion of scaling back
the world consumption of oil will be influenced by the
extraordinary population growth ahead."
Of course, not all oil-producing nations will experience a
reduction in output at the same time. As I mentioned, in the
United States production began to fall in the 1970s. Mexico
and North Sea production are now in decline, and few expect a
major discovery in those regions.
The only other major non-OPEC oil region is Russia. But new
oil discoveries in the former Soviet Union have been in
decline since the late 1980s. The expectation by most oil
executives is that we are on the verge of declining Russian
oil production.
With reserves of around 650 billion barrels, the Middle East
is the only major oil-producing region in the world that is
not yet close to its oil reserve half-life.
Until recently it has been oil production from non-OPEC
countries that has kept oil prices in check. But as
production in these regions enter into decline, more power
falls to OPEC, particularly Arab OPEC.
In 1988, Saudi Arabia was happy with an OPEC benchmark price
of $20 a barrel. But given the falling value of the dollar as
measured by the CPI, it takes $31 to buy the same amount of
goods and services that $20 bought in 1988. So even if Mid
East OPEC would accept the kind of pricing policy that the
Saudi's implemented 15 years ago, they would insist on $11
more a barrel to keep pace.
Trouble is, Mid East OPEC wants nothing to do with the
conservative pricing that the Saudis instituted in the late
1980s. Here's why: Most Mid East nations expect maximum oil
production to happen within a decade. Under such a timetable
- they want to maximize short-term revenues. That means a
more aggressive OPEC pricing policy.
Fifteen years ago, world crude demand had slowed to a crawl.
At the same time, millions of barrels a day were being
harvested from the Soviet Union and the North Sea. Saudi
Arabia understood that if it set OPEC prices too high, the
cartel was certain to lose market share.
Not much chance this will happen today. World oil demand is
growing by more than 2 percent annually. The only region rich
enough in oil to satisfy this demand is the Middle East.
In the 1980s, Saudi Arabia was getting arms and financial
assistance from the United States. In turn, the Saudis
exercised their influence to keep oil prices affordable.
Following the War on Iraq, that type of goodwill towards the
United States no longer exists in the Middle East, or even in
Saudi Arabia.
Rather than making life easy for the United States, most of
Arab OPEC would like to see things get more difficult... and
that means higher oil prices.
Sincerely,
John Myers,
for The Daily Reckoning
P.S. The bottom line is we could see another three or even
five dollar correction in crude prices. But low oil prices
are not part of the future. In fact, I am as convinced as
ever that we are headed past $50 a barrel oil by 2006. My
advice: don't buy any gas-guzzling SUVs. Do buy oil stocks
with significant domestic production.