Interview: Dr. Colin Campbell - Petroleum Geologist
18th December 2002
Yes, of course, we are running out of oil and we started doing that when we produced the first barrel.
When we will eventually run out of oil is a very difficult thing to estimate. And it’s also almost irrelevant, because what really matters is not when we finally run out, which is a long way into the future, but when production, which has being growing now for 150 years, reaches a peak and begins to decline. That, I think, will be some kind of historic discontinuity that will affect virtually all aspects of life, given that the world runs on oil. This is the subject we really have to address, primarily. The issue of running out is very secondary to the importance of peak and decline.
To try to explain the peak better, the first point, and we can all agree on this, is that you have to find oil before you produce it. So the issue to really concentrate upon is the discovery record. What is the record? What is the trend of discovery over the past?
And if we look into the data, we will find that many of the largest fields in the world were found pretty early on. In Texas, for example, in the United States, the peak of discovery was in 1930. And that once the oil is found, it takes some time to put it into production and drill all the wells. And so that was then followed, in case of the United States, after 40 years, by the peak of production. And since discovery had peaked so long ago and has been declining, despite every effort, ever since, it follows that production must also decline and there is really nothing to be done about that.
Nothing is black and white in this subject, because we also have to consider carefully what we are really measuring and what we are talking about, because there are many different types of oil. Obviously, there is a huge difference between a Middle East well flowing at 50,000 b/d and digging up a tar sand in Canada with a shovel.
So what we really have to do is identify, and very carefully, all these different categories, and see what their endowment in Nature is, what their costs and characteristics are, and what their depletion profiles are. For example, whereas a Middle East well will rise rapidly to a peak or a plateau and then decline as it approaches exhaustion, a tar sand in Canada is produced extremely slowly, and you can go on producing that forever in a day, gradually increasing production very likely in the future as the need arises. But it [production from tar sands] is very different. It is more like a mining operation than conventional oil.
Colin: Well, the first discovery of oil in modern times anyway was, I mean, oil has been known from antiquity. The construction of Babylon used oil as a kind of mortar, so it’s been known from the beginning of time. But the modern industry really has its roots in the middle of the nineteenth century, about 1859.
And we might just look at the evolution of the discovery patterns in the world. It started, one of the earliest places was the Caspian, but that was soon overtaken by Pennsylvania in the United States. It’s interesting to think about Pennsylvania a little bit because as this new oil, which was replacing whale oil at that time, used for lighting, which itself changed the way people lived, adding an evening to a working day.
And whale oil was getting depleted by over fishing, so suddenly they found this ‘rock oil’ as it was called, in Pennsylvania and the first well was drilled to a depth of 67 feet, more or less, a very shallow well, and immediately a boom took place. Everybody and his brother rushed in there and there was a great surge of activity and then, as always happens, before long this flood of new oil depressed the price, and so you go from boom to bust.
And then, in the early days, we had to try to control this pattern of depletion, which really reflects the nature of oil in the ground in a way. It comes flowing out of the well in a great surge with no effort; it’s not like digging it up with a shovel. And so Rockefeller in the end of the nineteenth century tried to bring a sense of control to this. He tried to match the market against the supply, controlled the railroads, and brought a sense of order to the thing. Of course he was much reviled. He was perceived to be establishing a monopoly to his own benefit, and no doubt he did benefit from it, and the independent producers hated him with a passion. Eventually in 1911 the Rockefeller Empire was broken up by anti-trust legislation in the States. But then exploration moved around the world, to Venezuela, Peru, Latin America was brought in, and then attention started turning to the Middle East. That’s a very interesting story itself.
The origins of Middle East oil really go back to the Germans, who wished to build a railroad from Berlin to Baghdad for certain military and political reasons, and they got a concession from the Ottoman sultan to do so. The engineers surveying the track of this railroad found oil seepages close to Mosul in northern Iraq as it now is. As a result of that the sultan had a man called Benkian (sp?) investigate these occurrences and simultaneously with that the Iranians became aware of this development and sought to develop Iranian oil. In 1906 the first oil was found in Iran by a British consortium of people. It began to be evident, really quite early on, that these countries around the Middle East had an enormous endowment of oil.
But then, in the United States, after the boom and the bust and all these events, interest shifted to Texas where a well came in I think in 1902, Spindletop near Beaumont, and this opened another such surge. Oil companies such as Texaco and Gulf Oil were created out of this sudden great surge of oil. And then the United States again found that this overabundance of production that inevitably follows an early find was dropping the price and causing all kinds of problems. So the famous “Alfalfa” Bill Murray, I think he was the governor of Oklahoma, sent in the militia or somebody to shut down the oil wells to protect the price. Out of that arose the Texas Railroad Commission that controlled the supply and production and price of oil in the United States.
And so it goes on in a repetitive kind of way and later the international oil companies did basically the same thing throughout the world, and finally we have OPEC, who tries, really quite valiantly one must say, to keep a sense of order in the way in which this stuff is produced, and they are greatly vilified for their efforts. They are regarded as the enemies of the west and holding the world to ransom and all of these kind of expressions, but actually they are doing as well as they can and not very well, either, a very good job, a needed job to keep a sense of order in the way in which depletion is managed.
Colin: Many people imagine oil just sits underground in a huge cavern and don’t really realize the very remarkable geological conditions that are responsible for it.
Briefly, oil is derived from successive algal growths that occasionally occurred in the geological record at times of extreme global warming. Basically what happened is you had this extreme heat from the climate, the algal growths proliferated in lakes and seas and in special geotectonic settings really, and they effectively poisoned the seas such that no life could continue. The thing was devoid of oxygen, and the organic remains of all of this stuff, the algae themselves and the marine life that had died fell to the seabed.
Normally it would have been oxidized in the process of falling or consumed by bottom-living organisms, but in this special condition it was preserved and then other sediments were washed in from the rivers surrounding the seas and buried the organic material in these troughs which occurred, subsided gradually, and more and more sediment filled them up. So that eventually the organic material was buried to a depth of about 2000 metres or so at which point the temperature had risen sufficiently for a chemical reaction to take place that converted the organic material into oil and gas. This chemical reaction caused volume to expand, it was as a result of the chemical reaction the volume expanded that meant that the oil was under immense pressure once it was formed, on its berth, and under this enormous pressure it fractured the rocks above it and gradually moved upwards. In some cases it may have just moved upward, and disseminated and was lost and was just a disseminated deposit of no use to anybody. But if it encountered in the course of its movement upwards a porous formation such as sandstone made up of grains of sand with pore space between the grains then the oil would move along this conduit, so to speak. If this conduit just rose straight to the surface the oil would simply flow upwards and escape at the surface of the huge heavy oil deposits of eastern Venezuela or western Canada. In fact, our examples are just that, where the oil just flowed up to the surface and it was weathered and attacked by bacteria and so on leaving behind this heavy, tarry material.
But if, in between where it was formed in the depths of the basin and the margin, the rocks had been folded or cut by faults, this created traps and the oil just accumulated in the highest part of this conduit through which it flowed. So you have structures called anticlines, geological structures which could be compared with an arch, and the oil accumulates at the top of it. Now oil generally contains some gas and so the gas under different conditions of temperature and pressure separate out, so very often you have a little gas cap above the oil leg, and beneath the oil you have water that filled the pore space in the rocks left over from when it was deposited. So that, in simple terms, is what an oil field is.
Now, where the oil source rocks are depressed further, much deeper, into much higher temperatures, then the oil is broken down into gas. So people sometimes say, “Well, we can drill deeper to get more oil”, but you can’t because at a greater depth it has already gone to gas, and gas behaves very differently simply because it is a gas. We can perhaps talk about that later. So that’s the essence of where oil is.
Now producing oil you drill a well down to tap into this sand. It’s a 6-inch diameter steel pipe put into this thing, and then you have to let off explosive charges in it to make holes to communicate the formation with the well bowl. And then the pressure differential, because the oil in the reservoir is under high pressure with the weight of the overlying sediment sitting on top of it, the column of water that is pressing it from the sides, so to speak. So there’s a high pressure in the formation and a low pressure in the well so the oil flows in and flows to the surface. But as you produce it then of course the water gradually rises underneath it and you have to go back to the well and seal off where the water would otherwise be invading. And sometimes the gas cap comes down and you’ve got to seal it off. So there’s a lot of work that goes on all the time.
Another important point to remember is that initially the well is able to drain the rocks immediately around it within a radius of a few feet, or a few hundred feet. As you produce it it then has to draw on oil ever further away. This oil that has to move through these torturous paths between the grains of sand. Of course, these form constrictions, and so gradually the production rate falls as it’s got to tap ever more difficult oil ever further from the wells. Well, of course then you can drill another well at a certain point; do infill drilling around to reduce the spaces between the wells. So that means drilling more wells. As you produce this field gradually production, when you first find it of course, production starts and if you’re onshore in Texas you can immediately hook up the first well, then you drill the next one and production rises. At a certain point you usually reach a plateau of some kind, which is a deliberate plateau, and it’s convenient to produce at a certain level steadily and you build the pipelines and facilities to match that level. But then gradually as the wells have to reach these deposits further and further from the well bowl the production rate begins to fall and inevitably the production of the field begins to decline, eventually to exhaustion. So you have this sort of bell-shaped curve that is characteristic of every single oil field. In the case of an individual field it isn’t a regular bell, it’s usually skewed to the left because flash production starts at a high rate and gradually declines. So when you found your first well you’ll have this inevitable pattern of starting production, rising production, peak, decline to exhaustion. This is very obvious, really. And then, of course, you can look for another field.
That brings us to the realm of discovery, and if you are in an oil province you very likely can find another field down the road, and another anticline fed by the same eternal source rock. But, going back to Pennsylvania, already by the turn of the century they had already found all the structures that could produce and that little old province was already in decline by the end of the nineteenth century. Now, in a museum in Titusville, Pennsylvania there is still an old well producing two or three pints a day. So this question of running out doesn’t happen for an awful long time, but there’s a huge difference between 30,000 barrels a day and a few pints in a museum.
As we’ve seen, oil started in the middle of the 19th century and its discovery peaked around 1964. In the early days when discovery peaked and production was about to follow in the next few years. But in the early years, this gas that was produced in conjunction with the oil was almost worthless; in fact, it was flared, they simply lit it and flared it away and it still continues in some parts of the world where there are no ready markets to use it. But over the last twenty, thirty years gas itself, especially in the United States as its own oil declined, was seen to have a great value itself and so gas was tapped and used and been progressively used for electricity generation, in particular because it is cheap and because it’s environmentally much better than oil –has fewer emissions, and so forth.
And so gas has become a very important fuel and many people believe that when oil declines, we simply switch to gas.
But gas carries its own problems because by virtue of being a gas, it has a much greater mobility than oil. I describe the difficulty that oil has flowing through the reservoirs to reach the well bowl, but gas can do that much more easily because it’s simply a gas and it moves much more easily. If you fully open a gas well you could drain an accumulation very quickly, just puff it away.
In practice, gas production is generally capped by the pipelines and people build the pipelines for a certain capacity and most fluctuation is just seasonal to meet the fluctuating demand between winter and summer and the ideal way to produce gas is to have a long, long plateau. This plateau, of course, has an in-built spare capacity and as you go along the plateau you’re progressively drawing down this in-built spare capacity.
In the open market, if there was just one gas company doing this, it could have a view of the future and it could plan in some sensible fashion and in places that have had state-run utilities they indeed have done that. But in the open market where you have different producers of gas and different consumers of gas, they trade on an almost hourly basis, and they go along the plateau, drawing down the in-built spare capacity and we aren’t really being conscious of it, the producers are vying with each other at exactly the rate at which they balance between how much money they want to make it and how quickly they want to make it, and how quickly they want to draw down their assets.
What happens is that a certain height as is now happening in the United States, you come to the end of this plateau and there’s no real market signal that you’re doing so because the cost of producing the last cubic feet of gas is much less than the first because you’ve written off all the exploration costs and early costs and you’re just simply drawing down the spare capacity.
And when suddenly you wake up one day and say, “Gosh, there just isn’t any spare capacity left,” and you say, “Oh, dear me, I must get compressors.” So they get compressors and they try to suck more out from the field and they can do that for a little while, add compressors, try to keep the pressure, try to produce, but tragically, they’ve got to run faster to stand still. And then suddenly, the end comes and it comes fast, and it falls like a stone. Whereas oil protects us from ourselves in a way, by depleting slowly towards the end because it moves through all these constraints and gas ends fast and without much sign that it’s going to do so in the open market.
Any engineer or geologist could foresee this quite easily but in the open market which drives the oil business, this is something that just isn’t realized. I think we face the situation now. The United States is the most mature place of all so all of these phenomena that we face eventually in the world as a whole are already being felt in the United States.
They, in response to this end of the plateau, have stepped up the rate of gas drilling far above the average of the past. They’re drilling just as fast as they know how, but what is left to drill now is either deeper or smaller or more difficult. But this time they don’t have the luxury of producing at less than capacity so the wells are flat out and are depleted in a matter of months. So they’re running and running faster and faster and faster, simply to try to meet the demand that is there.
I think they seem to be realizing this and so they’re building more and more electricity generating plants to use the gas and so they have to import from Canada. Under the NAFTA arrangements, Canada is apparently obliged to sell it. There’s no shortage of oil companies in Canada now being increasingly owned by American companies who follow normal market principles and sell as fast as they can to wherever they can.
And so, in a strange way, Canada is now being drained in the same way that the United States is. And then they’ve got to move to Alaska. There’s a lot of gas up in the Arctic regions but that means building more pipelines and it eventually follows the same eternal pattern imposed by nature over which nobody has anything to do about it.
And another thing, the way that gas is different from oil. Whereas oil can be easily and cheaply transported around the world, so you can tap multiple sources and try to meet your security needs in that way. Gas is sent by pipeline and so you can’t contemplate a pipeline across the Atlantic very easily. Gas is more regional. The North American market for gas has basically to live within its own capacity. Of course, you can liquefy gas and transport it but that’s expensive and really isn’t going to contribute enough to make any significant difference. It can be profitable, and it’s done and increase in the future, but it’s not really a panacea.
So North America has to live within its needs and so does Europe.
Europe very soon will be... Here we live in Ireland and here electricity in Ireland is generated from gas imported from England. Now England has had extreme hyperactivity under the most open of markets and as a consequence, production has now reached a peak, a very high peak, and is set to fall very rapidly now, such that the country will be importing 50% of its needs by 2010 – this is not far off, you know - and more after that. Its own fields are declining, falling like a stone. And so Britain will be relying on imports from Norway, which has a lot of gas, and later, increasing so, from Russia, and eventually Central Asia, North Africa, and even the Middle East, which in turn, is a huge geopolitical change that has happened. We no longer rely on our own supply but rely on something from far away.
What has happened already in North America which is reaching the end of the line, and they clearly are experiencing it, is also happening to the rest of the world too. Asia, Southeast Asia, Japan, and China are also very concerned about this issue. What we see already in North America is a world phenomenon, coming sooner or later in different places, but inevitably it follows the same overall pattern.
The idea of substituting gas for oil - we hear this expression: “the dash for gas is”- is a short term solution by all means, and you can flood this supply by this easy cheap gas that is currently available. But due to the nature of gas depletion, once it begins to decline, it declines fast so we’re buying a little time but building a greater problem for ourselves – and not that far away. As I said, Britain will be importing more than 50% in less than 10 years and North America is in an even more critical situation.
So the political consequences of this, as this begins to dawn, the governments themselves probably won’t appreciate it until it really hits them in the face and then they will wake up one day and say, “My goodness, where is the gas? I switched the light on and nothing happened.” This is a sort of doomsday cataclysmic kind of image that one paints, but really, what alternative is there? This is imposed by Nature, is given a finite amount of hydrocarbon resources and secondly, by the physics of the reservoir which is immutable and nobody can change them. And so we really ought to pay more attention to exactly what these trends are.
A: Many people also have the notion of the ‘resource pyramid’, like an iceberg that so far we’ve just tapped the easy peak of this huge pyramid. And they say, “Well, as costs rise or technology kicks in or whatever, we can gradually tap lower and lower levels of the pyramid”. This actually goes back to the experience of coal mining and mineral exploitation, which is very different from oil.
You see, a coal deposit covers a wide area in Britain: much of Yorkshire, for example. In the United States there are also vast areas where this coal deposit is. This is called a resource. The term ‘resource’ is introduced for this huge deposit covering hundreds of square miles. But where it is actually mined is where the seams are thick, where it’s concentrated. You have the concept of concentration which is absolutely critical in mineral mining and in coal mining. They go to the place where the seams are thickest and it’s more economic, and also access has something to do with it. So in the case of coal, as prices rise or costs fall, then lower concentrations can be profitably developed. And so you have indeed in the case of coal you have a pyramid like this, so that it is an issue of concentration and you can gradually tap lower and lower concentrations and there’s not what I would call a crisis. There’s a gradual progression, and you become very evident of rising costs and you can see clearly where you are.
Oil is different because it’s a liquid, and it’s concentrated in nature in a few places, and the contact between the oil in the reservoir and the water that underlies it is a just a matter of a few feet. So it’s a strange polarity about oil; it’s either there in profitable abundance or it isn’t there at all, and this gives rise to a very different mindset. Many people in the resource domain had their background in mineral exploration and think in terms of concentration, and they tend to fail to grasp this strange polarity about oil, not only in the individual fields but where it is. I mean, only a simple glance at the oil map shows clusters of fields in some place that has got the right geology separated by huge barren tracts. And these tracts are barren not because people haven’t looked there. It’s because they don’t have the right geology. So this affects also the way in which the stuff is produced and this whole subject of peak and decline. There’s a great polarity about oil, and even more about gas in a sense.
Colin: Why don't know we know more about this whole issue? The reasons basically are the extremely unreliable nature of public data in this. The reasons for this unreliable nature of things is a little bit complicated to cover but it goes back to the early days of producing oil in the onshore fields of the United States. A strange feature of the United States is that there, and almost uniquely there, the mineral rights belong to the landowner. Elsewhere it usually belongs to the state. That means that the fields in the United States were highly fragmented, with a huge number of different owners, each operating their little bit of this large oil field. And of course in the early days there was no shortage of promoters and speculators and various unscrupulous people who were promoting these various ventures and exaggerating the size of the reserves that they had. So the Security and Exchange Commission moved long ago to try to control all of this, and it allowed these companies to report as so-called ‘proved reserves’. Proved reserves is the technical term, for financial purposes, only such oil as is being drained by the current wells. Now this means that proved reserves, and these are reported for financial reasons, they do enter the public domain, and they naturally grow over time as people drill up their fields. They don’t really say anything much about the size of the field as a whole. This was simply a pragmatic, sensible way in which reporting was controlled in the early days.
Now, moving internationally and offshore rather different conditions were obtained, because here these fields are normally developed as a single field by a group of companies. One company is appointed the operator that does the work on behalf of a group of companies. So offshore and internationally they do indeed look at the full field size rather than just one little part of it. And certainly offshore, where they have to build a platform - a hugely costly platform - to produce the oil, they have to know more or less what the full field will deliver.
But they still continue these old-fashioned reporting practices, imposed in fact by the stock exchange rules, that allows them only to report what is being currently drained and says very little about the field as a whole. Of course, they found in practice, there is no conspiracy, this is just how it happened to unfold, they found this was a rather attractive way in which to work because it meant that the companies had large amounts of discovered but unreported oil which was a sort of inventory that they could draw down. It looks rather bad for an oil company to have a periodic discovery and then ten lean years in between. This doesn’t sit well with the investment community. And so they were able to ‘smooth’ their assets by this reporting practice, and furthermore it saved tax because they had the lower the reserves the higher the depletion allowance, the higher write-off and so forth. In foreign countries it also had a certain political element. You know, you don’t want to be seen to be too wealthy, so if you understate your assets you are less a victim for expropriation.
So for all of these many sound, sensible commercial and regulatory reasons reserves have been under-reported, and these under-reported numbers have entered the public domain and as a result they have grown. So if you simply plot national reserve numbers as is in the public domain you have a fairly straight upward line and it makes imminent sense, if that’s all you had to work with, to project this ever upwards and say “Well, there’s just no problem. We’re finding more and more oil.” And the oil companies of course understand. Well, the oil companies do and don’t understand their own business. I mean, obviously there are people within it who do, but they also have their planners and economic people who think in that mindset. So when they see this upward progression of reserves they say, “Oh well, we’re doing better and better technology, we’re getting more skillful.” These are all desirable attributes to which medals are pinned on the chest. And so it’s not very convenient for them to admit to when they actually found all of this oil.
And it’s very significant I feel, extremely significant, that just in the last few days that the chief executive of Exxon-Mobil, Mr. Harry Longwell, has indeed published the correct discovery trend, backdating all of these revisions to the dates on which they were found. This gives an entirely different picture. This shows that discovery peaked around 1964 and it has been declining relentlessly ever since. Mr. Longwell himself, and this is no mean authority, this is the chief of the worlds largest oil company, he says only looking ahead to meeting demand out to 2010 less than half of it can come from existing fields and it would cost more than a trillion dollars to deliver. He speaks of the challenge of doing so, but this is an oblique way of saying it can’t be done. So here we have a confession, really, from one of the world’s largest oil companies that this just isn’t going to happen.
And I think really what has happened is reserve growth applies to the large oil fields where they had the luxury of under-reporting what they found. Now the more recent fields, the deep-water fields, the more difficult offshore fields, the smaller ones, a short production life, and very likely they have to be pretty optimistic in planning the project to get it to go at all. And so we find, and Norwegian experience confirms this, we find that many of these smaller fields in fact disappoint. Far from having reserve growth you have negative growth. So the great mistake that some analysts, including in particular the US Geological Survey, is to extrapolate the growth of these big old fields into the future, which is just a non sequitur. The new fields that are being found are not going to grow in the same way that some of the old ones did. And when I say ‘grow’, nothing actually grew; it was simply in the reporting procedures and practices.
So that largely explains. In order to backdate the revisions to the discovery of the fields that they came from means that you have to have access to the details of every field when it was found on a field-by-field basis, and you simply flat can’t do it on national statistics which don’t attribute it to individual fields. So the reason, even if people understood this particular strange phenomenon that’s distorted the picture, they’d be very hard pressed to actually make the corrections unless they had access to what we can call the industry’s database. The industry’s database is a commercial database that has been built up with the cooperation of the companies which does indeed cover the full spectrum of what is known about every single field. It covers some 20,000 fields throughout the world. There is the complete record from the discovery up to the present production, reserves, depths, everything connected, ownership connected with it. But this thing is expensive. This is an industry, and the industry kind of likes to keep it to itself, too, for very good reasons. So it’s very hard for ordinary mortals to get access to this. That explains why so few people understand it.
The other reason people don’t grasp this is it’s very counter-intuitive. People say the Stone Age didn’t end because we ran out of stone, you know? They say man’s imagination and ingenuity will always find a substitute. We hear a lot of that, and how the Stone Age gave way to bronze, and bronze to iron, and iron to steel, and steel to computers. This whole upward progression is deeply embedded in our mindset. We think this way. Everybody thinks this way. So it comes as something of a shock to find that oil, which is the driver of the modern economy… I mean, wherever we look we see the impact of oil for transport, for agriculture. Don’t lets forget agriculture; it’s very heavily dependent upon oil. It comes as a shock to suddenly find that here, this prime thing, is heading for a peak and a decline with no sight, as of today, for a substitute that comes close to it in terms of convenience and low cost.
A: First of all, let’s just look at the actual reality of what happens in this full cycle of finding oil and producing it. We start with the explorers who are looking for prospects. Prospects are geological structures that have the appearance of meeting all the criteria necessary for being an oil field. They have to be in touch with a source rock, they have to have a reservoir, they have to have a seal. The timing of all of this has to be right. There’s no point having a structure that developed after the oil moved. So there’s about six or seven fundamental parameters that have to come together in the right place. There are many uncertainties about all of this. One doesn’t answer all of this easily looking at seismic data or regional knowledge.
Anyway, you can more or less make a good, in most cases with the amount of knowledge and modern seismic and such, you can get a pretty good estimate of what the volume of this prospect would be. And really, if you’re honest about it you can pretty much say whether or not it has a chance of being a success or not. But in the real world, at least the real western world, it isn’t as simple as that because these companies operate with affiliates around the world, each of whom are competing with each other for financial support in order to drill the well, to test whether this prospect is valid or not. So it’s common practice that you tend to exaggerate the size. You know pretty well in your own mind what it is, but in order to get the money with which to drill it you make it look a bit better than it really is. And then, if it should come in as a success, and only about one in ten do. So there are many failures in this whole business, even a growing number of failures. Well, not so much. The number of failures is getting better because it is getting more difficult to cheat, actually. With a modern seismic you have less latitude to invent prospects where none exist, but the size of discovery is falling.
But anyway, if it is a success then the engineers come in and they design it and they have every good reason to be very conservative in their estimates, especially in a big field. They don’t have to claim it all up front. Take Prudhoe Bay for an example. Prudhoe Bay in Alaska, the largest in North America, was found in 1969 and already by 1977 the company had internally estimated its reserves at about 12.5 billion barrels. Then it reached a plateau around 1980 I think, set by the capacity of the pipeline. Then by 1982 they started to pressure maintenance and horizontal drilling and gas injection, all the sophisticated technology they could throw at it to hold up production. But by about 1989 decline set in. I forgot to say that in 1977 when they made their internal estimate of 12.5 they reported 9 to comply with SEC rules that allowed them only to claim what the existing wells were going to do. You couldn’t claim what you hoped to be able to develop in the far future. That’s a different story, and quite reasonably for strict financial purposes. Anyway, by 1989 decline set in for two or three years and then indeed this gas injection procedure that had been used did work, and so it arrested decline for one year. But then decline resumed, and now at a steeper rate. So if you extrapolate this steeper rate you come out to about 12 billion, which is what they thought all along. This demonstrates very clearly that technology has had no particular impact on the reserves themselves. It has held production higher for longer, which has made more money, but it really hasn’t added to the reserves. Although 9 billion was reported in 1977, which then grew to 12 over the next ten years, it wasn’t really added over the next ten years. It all belonged back to the original discovery date of the field back in 1969.
So this backdating issue enters into it. We have to recognize if you want to talk about discovery trend don’t talk about financial return or other things. Strictly for to know the discovery trend you need to know the discovery trend with which to project the future. That is the critical thing. You know, you don’t have a career unless you are born. Discovery is everything. So to get this right discovery trend we have to backdate these upward revisions that are reported for financial purposes, and perhaps with new knowledge. Or even in some cases with certain new technologies that weren’t originally available. It doesn’t matter why the reserves should be revised up. They all relate back to the original discovery, simply, if you want a discovery trend. There may be other reasons you want to report it differently, but if you want discovery trend with which to project the future you just have to do this right. You need to know the amounts, the real amounts, and you know the real dates. Dates are almost as important as amount. And this isn’t at all evident to many people.
At the end of the war, the industry set off again in the post war epoch and it was dominated by the seven international oil companies, Shell, Anglo-Dutch, BP - British, and Exxon, Mobil, Gulf, Chevron, Texaco. These were the international oil companies who basically controlled the supply of oil from the wellhead in the Middle East, through the tankers, through the refineries, eventually to the forecourt. It was a good system. They could plan, long term planning. It was a highly centralized organization – really, in a way an extension of wartime central planning with almost a military kind of style.
Then it started in 1951 when the fall of the Shah, problems in domestic politics in Iran and Iran expropriated the local subsidiary of BP which had an exclusive concession in Iran since 1906. This was a fairly devastating result for BP and they couldn’t believe that the British government having just won a major war wouldn’t send in a gunboat to enforce the sanctity of the contract that they had.
But the British government tired after the war and didn’t do so – have no stomach for such things. So BP lost its prime position which was really critical for its past and to its future. But with remarkable resilience, it set forth to find new oil. It went into Libya, it went into Alaska, it went to all kinds of places and it was extraordinarily successful. In fact, in Alaska it found the largest field in North America, in the very backyard of the American companies.
The next extraordinary event that happened was Suez, in 1956 when Nasser sought to expropriate the Suez Canal. While the British and French tried to stop him, they were effectively frustrated when the United States government didn’t support them. The message was not lost to the other producing countries around the world that the sanctity of contract was not going to be enforced any longer. And so you had a succession of expropriations – Saudi Arabia, Iraq, Venezuela, and so on.
Now the oil companies had probably begun to anticipate... The aftermath of the Iranian situation in BP had alerted the companies that this was a likely kind of direction and so they had already long before the oil shocks of the ‘70s gone out to vigorously research new places which they would not have needed had they had control of their traditional sources. And they were successful and when the oil shocks came in, the offshore became viable with the higher prices and there was great activity around the world developing the offshore. Then over the last 30 years until the last five years the oil companies had this great inventory of under-reported oil that they knew they could draw on as they needed. They had a comfortable position to let this continue. It was very easy – it was not difficult to make money in such a situation.
But then eventually, this inventory was drawn down progressively and they more fully realized that future production without future discovery was falling. They could see the trend, now published by Exxon, see the decline in discovery from 1964 until now and they obviously weren’t oblivious to this. And their first reaction was to go to the last frontier, the deep, deep water, drilling in 5-6-10,000 feet of water. There are only a few parts of the world that had the right geology even there.
The oceans are deep over many areas but there’s only a few selected places, mainly in the Gulf of Mexico, off Brazil, off West Africa, that have the right geology. They started doing that and the fact they were willing to look in 10,000 feet of water tells you there wasn’t anywhere else easier accessible; so there’s another message. They kept on in this way and continue even to this day to make optimistic noises about how we’re running into oil, not out of it. This is a famous statement of BP.
And then, I would say in the last few years, you begin to detect, “Can this be the end of that particular chapter of trying to hide, if you like to put it bluntly, the essential nature of depletion?” You have BP – for example, a couple of years ago changed its logo to a burst of sunshine and the chairman said that BP now stood for “beyond petroleum” and they started investing in solar energy and various alternative things.
I think, initially, primarily, as a public relations exercise, but also as a kind of position to take in relation to the investment community because in the modern age, everybody has to sing to the investment community. If the investment community would say, “Well, just how much are you finding?” and a few delicate questions of this sort, they could say, “Well, you know, we are an energy company.” Now they like to say “We now longer... Oil, well, yes oil is useful of course, but we’re moving on to gas, and then when gas is gone, we’ve got solar, and then into biomass in Bolivia...”
This was a sort of happy way to evade the issue of the underlying depletion of their principal asset of which they depend. So this was imagery, you could say. And I would say some of them even believed their own imagery, probably. It’s not entirely cynical public relations; some people can think this way, too.
But then even this sort of ran its course and you had this merger that began to take place. The first was Gulf Oil that had a corporate raid at Boone Pickins, the famous Boone Pickins who saw this moribund inbred management of Gulf Oil with the company jet taking the president’s wife’s dog to the vet and this kind of behavior and he interceded and made a sort of bid for Gulf as he had become a major shareholder of it.
And of course, the major companies joined ranks; at that point they couldn’t bear this to happen and so Chevron bought Gulf out and solved that little problem because the oil companies don’t like any kind of chink in the image of the fact that they’re on top of everything and they’re in control and whatever happens, we are going to deal with it. That’s what they like to present.
So Gulf was the first to go to Chevron and then Amoco, Standard Oil of Indiana as it used to be, a Pan-American, a big U.S. domestic company was bought out by BP. It was the next one to go. Then the Europeans consolidated – Totall Alph of France and Fina of Belgium got together. Then more recently, Chevron – Texaco was merged. So where you once had these seven, and then finally, Exxon – Mobil, so whereas you previously had seven major oil companies, you now only have four.
Shell was the only one to remain in splendid isolation, so to speak, who has not gone down this merger... Even now it has bought out a small company, Enterprise, the other day, for its reserves. That’s an interesting thing to it. It bought Enterprise and Enterprise had nothing but some reserves in the North Sea, effectively given to it by Mrs. Thatcher at that time. They paid quite a lot for this company and so the fact that they’re willing to buy reserves on the stock market actually undervalued –debase the common stock value of their portfolio, their reserves to add to this expensive reserves later. So that gave a little message that they needed some more reserves. And they were on the criticism from the investment community who were saying they weren’t doing enough in exploration and production to offset that declining production.
Then when you look actually, and I haven’t really done it in detail but I have the impression, that if you look at the result of these merged companies you’ll end up finding that the staff is still the same as one of the... half of their staff has been let go. You find an enormous amount of outsourcing and contracting out. In fact, I think BP is officially said it would like to contract out on short-term basis about 30% of its workforce. This tells you they don’t want the commitment of employing these people for a very long time.
I think the combined budgets are slashed so I think the net result of this is a downsizing. I can’t, of course, say it in so many words, but that’s what it amounts to and I also noticed that there is very little investment in refineries so if production was set to rise, as some of the imagery would have us believe, you would wonder why they weren’t building some refineries to process this stuff. I think we can see that the major oil companies are declining. I think they recognize that themselves, internally. They will go into ..., perhaps, what just started as public relations becomes more real as the need for it increases and as nature imposes on them the decline of their principle past assets, they’ve got to do something or else they just wither away. And I would say, in a sense they are already withering away into what you could call financial institutions rather than old-fashioned oil companies with spanners and hammers in their hands.
What they say and what they do is not quite the same. You get this bland kind of imagery that they like to put out and it’s very hard to say whether this is quite deliberate or it’s mindset, or what it is. For example, Lord Brown, the chairman of BP at the Davos meeting a couple of years ago, said he expected oil production to reach a maximum – maximum was the choice of word – a maximum around 2010 and it would begin to run out 40-50 years after that. Well, the impression left with his audience was that the maximum would be reached and then have this happy plateau until it began to sort of fade away, in 40-50 years, far beyond anybody’s concern.
In a word, what he was actually saying is it would reach a peak and begin to decline in 2010. He didn’t exactly say that. So it’s a clever choice of words. When people choose their words with such care, it gives you the impression they do so deliberately and therefore they know what they’re trying to do. It’s not just an accident. All kinds of glib words are said all over the place. “Challenge” is a great word they like to use. In this latest statement by Exxon, he says that having depicted the declining discovery, he says, “Well, we face a big challenge to meet demand by 2010.”
So looking ahead to the role of the oil companies in the future, it strikes me.... I should say also that we’ve only spoken of the major international oil companies. Of course, there are huge numbers of smaller oil companies and they too are merging. And the contracting business is contracting. In fact, this is a certain constraint, because with this outsourcing of everything in the industry, the oil companies rely heavily on the contractors to supply rigs and offshore equipment and so on. The contracting business has little knowledge of the true nature of this long-term situation and so they often make mistakes in over building or under building or whatever.
It’s hard to foresee the direction of the oil companies. But after all, we’re not running out of oil as we’ve already discussed. There’s about as much left as we’ve used already, so there’s a considerable role for the industry into the future, producing. They’ll need every skill they can martial to take on ever more difficult projects and the slower production, the heavy oil, and all these things. There’s a certain future of the oil companies, but a rather different style of things from what they have known in the past.
The price of oil, apart from the early huge fluctuations before it was kind of brought under control by Rockefeller and the various instruments - Standard Oil, and the Texas Railroad Commission, and eventually OPEC - was very stable for about 30 years from 1930 till 1973.
The oil traded over this long, long period for two to three dollars a barrel. And then we had the Israeli problem in the Middle East, and certain Arab countries decided to use their control of oil as a weapon against the occupation of Palestine - and we had the first oil shock in 73. They embargoed just for a few months - the United States and the Netherlands - who were perceived to be particular allies of Israel. And the price of oil went up 5 times almost over night, and this problem - the real problem - didn’t last very long but the price never fell back again.
And then 6 years after that in 1979, there was the fall of the Shah and this triggered a second oil shock, and this was occasioned not by any embargo or any action by anybody, it was just panic buying in the west who feared that the fall of the Shan would interrupt Iranian supply - itself not all that significant in the world sense - but enough to create a short of small shortage.
In the way that oil is traded the price is set by the marginal barrel so that a small surplus, or a small shortage, has an entirely disproportionate effect to the overall supply. So there was panic buying in the West and oil - in today’s prices - oil shot up to almost $100 a barrel briefly - and this tipped the world into recession. And so it was about 12 years or so before - and recession then further curbed demand, and demand fell, reduced pressure on price - and so it was about 12 years before the production of oil rose again to the level it had been in 1979.
And then of course we had the boom years in the Eighties, and the Nineties was an economic boom throughout the world. And the demand for oil rose at about 1.5 - 2% per year consistently over this period, and the industry succeeded in supplying it. Party still coming from the Middle East under the control of OPEC, and partly from the offshore, this whole new province was opened up - the offshore, and Alaska, and the North Sea, which provided the oil that was needed to meet this growing demand.
But then by about 2000, came I think - and this is not entirely sure - but
this is my impression anyway, that we began to feel the capacity limits.
There’s a lot of rubbish spoken about spare capacity - spare capacity can mean many different things - but let’s say capacity that can be turned on by opening a valve, that kind of capacity.
The world was beginning to run out of it at late 2000, there just wasn’t enough of it around anywhere. The Middle East is having to run ever faster to stand still as it offsets the natural decline of its old fields found more than 50 years ago. It’s not surprising they’re declining. So I think in 2000 we began to feel the edge of this capacity limit, and probably no body saw it as such, but the traders at their screens were beginning to see that there was more demand then there was supply being offered. And the price of oil began to move upwards through the 30’s - again up to 30, 35, 36 - and I personally thought, this is it fellas we’ve reached the capacity limit, we’re facing 50, 60 dollars a barrel quite soon - but I was wrong. Because, as before, and as in all previous occasions, the sudden surge in the price of oil led to recession.
In part, there were probably other factors as well - but probably coincidence
- that this oil price shock, and the dot com bubble, and all of those other
things, tipped the world back into recession. And demand fell such that production
in 2001 is 5% down.
It doesn’t sound a huge swing, but in this very delicate market with this price set by this marginal barrel, it was enough to depress the price of oil, and so oil fell back down around to the low twenties for a while, even briefly below.
And then, OPEC has great troubles in enforcing its own rules - its members cheat of course. And so it tried to stabilize things and now it’s up in the mid twenties again. And of course if we now have a war in the next few weeks or months, then one can - well its impossible to forecast the outcome of that - but the likely outcomes is that oil prices just go through the roof. Because there is no way production can be brought on quickly in Iraq and there’s no place else. And the whole tension and uncertainty would likely lead to high oil prices.
But ignoring a war, let’s say we manage to avoid this war somehow, and let’s say that the economy should begin to pick up again in the near future. Well as the economy picks up, oil demand will pick up in parallel until it again hits this capacity limit, which is falling all the time. So I see a picture unfolding in the next few years of a kind of a of vicious circle. As the economy tries to improve - hits the capacity limit - that in turn imposes recession again, falls off again. And then you have an escalating system of repeating oil shocks and recessions, and oil price shocks and recessions, until some kind of new stability unfolds in the future.
And not too far in the future when the recognition of this underlying depletion situation is absorbed into the economic system of the world, and somehow it comes to live with it in some kind of equilibrium. Because obviously the world can’t go on with recurring recessions and booms - as that wouldn’t be a feasible thing to go on too long. So, that’s another aspect of this whole thing, but still oil is not infinitely elastic, so even recession can’t curb it forever, because in particular we rely on oil for agriculture - I don’t think we mentioned that particularly.
The new types of crops that are being developed to produce wheat and so forth depend heavily on nutrients - artificial nutrients - and these are made from hydrocarbons - gas particularly. And they also have a voracious appetite for water, and water is commonly pumped by diesel-fuelled pumps. Not to mention the mechanised farming, the transport, the storage, and all of that. So we have seen in fact, an almost exact parallel between the growth of oil over the last 150 years, and the corresponding growth in population.
So you could see a close link in population, which has increased three fold during the lifetime of the present Queen of England, and the growing amount of oil that has supplied. Not only the energy for the economy - but for directly - the food with which to live and supply all these people. And so it poses the question of when oil peaks and begins to decline, around 2010 let’s say, well what does that do for people? So, I sure don’t have an answer to that question, but it’s certainly something to ask!
The way governments react is a very good question, and it’s really an extraordinary situation. Just take, let’s say the British government for example.
Well, no one really expected to find oil in the North Sea; it was only during the late sixties that the potential of the North Sea became evident. And at that time it was a socialist government, and you had the British Gas Council and various nationalised institutes and institutions, and you could say that energy policy was a matter for government concern.
And the Gas Council and these official bodies, did take a long-term view of it, they checked their contracts with the oil companies back to the reservoir. They wanted to know for sure what was available in order to plan their whole activities. But then after Mrs Thatcher blew all that away - then you have an open market, and there’s a great belief in the open market.
Under the classical laws of economics, if you have an open market, supply will always match demand. If wheat prices go up, the farmer grows more in the next season – this is the embedded mindset in many of the advisers to government. And so we had a free-for-all really in Britain – they opened the floodgates, and there were very nice tax arrangements whereby all the costs were written off against taxable income, so the companies weren’t really spending real money to do all of this.
And we had a great surge in discovery, and for a brief period it looked an enormous success story. I heard Nigel Lawson the other day compliment himself on his wisdom in creating all of this. He said look, in earlier years people warned me about depletion but I rejected the advice, and I felt we should go forward with market principles, and let loose this great ingenuity of mankind, and all of those good things. And here he said, look at us today; production is way up on what it was before - it’s been a great success story.
But somehow - even now - he hadn’t appreciated that he’s looking “peak” in the face and a decline that follows. That means that Britain had this fortunate windfall of falling into oil and gas in its own territories, which in earlier years no one would have expected - and they blew it all away in twenty years or so. And the mere fact that they overproduced in this short period of time had a big impact on the world price of oil; it reduced the world price of oil, such that not only did they blow it away in a couple of decades, but they blew it away at low prices.
So it’s really very hard to picture a less satisfactory policy from any long-term point of view of national interest. But that’s what they did, and I’m sure they did it in good faith, in this undying faith in the open market, which just isn’t structured to deal with the depletion of a resource. This is something that’s never addressed in the past, because it hasn’t happened in the past. And then you have another thing that governments – politicians - don’t get there without having good noses; you know they know what is a vote catching, desirable kind of thing to go into, and they know what is good not to know.
So to this day you cannot find, within the British government, within the Department of Trade and Industry – you cannot find – any group of people actually studying depletion, they just don’t do it. And so they deny themselves the information with which they could react in some sensible way, and no doubt they do it deliberately ,because if they studied it themselves, they would be lumbered with the results of their study, which would be hard to suppress.
So they find it much better not to study the question. You could say the same for the European Union. The European Union is absolutely, incredibly, ignorant of this subject. These are trained economists, they’re not oil people – they work with public data, they do all kinds of studies and stuff, but they lack any kind of depth of knowledge into this. And in part this relates to the International Energy Agency (IEA) – I should say a few words about this.
In the aftermath of the oil shocks of the seventies, Kissinger established the International Energy Agency, which has a headquarters in Paris, and it belongs to the OECD governments – I don’t know how exactly many, about 20 or so governments have funded this thing. And its mandate – they set it up with a treaty, which is an excellent treaty – it was instructed to study resource constraints, look at the evolving position, and be prepared for interruptions. And in those days they were pictured as deliberate short-term interruptions of a political nature, but even so the mandate was to study security of supply. They were given executive powers over strategic stocks, because at that time the western countries felt obliged to have stocks to meet short-term interruption of ninety days, I think, and so the IEA administers this.
But the IEA itself has not studied the resource base. This is an obvious starting point for anybody concerned with security of the supply, is to study the resource base. It seems so obvious, but they don’t do it. They have denied themselves access to the industry database, which they could certainly afford, and they put out these reports every year written in the blandest of tones - 'business as usual' is the great