Oil Supply I: Production

Levels of global oil supply have remained relatively steady over the last decade. Years of low oil prices discouraged investment in developing new production capacity and left producers largely unprepared for recent rises in demand. The oil industry is in the process of adjusting, using part of the flood of new cash from current high prices for research and exploration. These record profits make expensive investments in new technologies and energy sources, such as tar sands and oil shale, more economically feasible (see box “Canadian Tar Sands” below).

More than 70 percent of the world’s proven oil reserves are found in the Middle East or Canada. Among the 20 leading oil producers, eight are members of OPEC and are responsible for 65 percent of global reserves ¹. The world’s top 15 oil producing nations in 2009 are: Saudi Arabia, Russia, the United States, Iran, China, Mexico, Canada, United Arab Emirates, the European Union, Venezuela, Kuwait, Norway, Iraq, Nigeria, and Brazil. ² This list differs slightly from the group of leading oil exporters, in which the U.S. holds the 20th position, but does feature Nigeria (#5), Kuwait (#6), Algeria (#12), and Canada (#8). ³

Source: BP Statistical Review of World Energy 2009, oil reserves.

The oil industry has faced growing uncertainty as production has declined in many advanced economies and the world has come to rely more heavily on developing or otherwise unstable countries. American crude oil production, for example, peaked around 1970. Declining production in Indonesia and Norway because of exhaustion of existing fields has been coupled with threats of terrorism in Saudi Arabia, political turmoil in Nigeria and Venezuela, increasing isolationism in Iran, and virtual chaos in Iraq to jeopardize global supplies.⁴

This section will discuss a number of topics relevant to global oil supplies, including: spare production capacity, the future of oil reserves, the role of the state in oil production, and market imperfections on the supply side.

The Question of Spare Production Capacity

In a tight oil market such as the current one, the question of spare production capacity is of signal importance. Does such capacity exist (a) to handle increases in demand and (b) to prevent potential supply disruptions?

For many years, Saudi Arabia, the world’s leading producer and exporter of oil, has served as a critical buffer, what some have called a “central bank of oil.” Saudi reserves are greater than those of Venezuela, Indonesia, Nigeria, and Libya combined.⁵ It alone maintains high enough levels of spare capacity to guarantee short-term supplies in the event of a disaster. ⁶. Saudi reserves are one of the key pillars of global energy security and a “cornerstone of [American] oil policy” ⁷. Saudi Arabia has used this excess capacity effectively several times, notably during the Iran-Iraq War (1980-88), both Gulf Wars (1990-1, 2003-present), and various periods of turmoil in Venezuela.

Increased demand has, however, somewhat eroded the value of Saudi Arabia’s spare capacity. According to some experts, “For the first time in decades, production capacity failed to outpace demand, leaving the world with no cushion in case of a sudden prolonged shortage.” ⁸ A chronic lack of investment means that, “The buffer has been in decline for some [time]…The world has been living off the legacy of spare capacity built up many years ago.” ⁹ In response, Saudi Arabia launched a massive $50 billion investment program in 2005 to add significant production capacity by 2009 ⁹¹⁰.

After the investment period, production is only two million barrels per day behind its initial increased capacity goal of 12 million barrels per day.¹¹   Saudi Arabia is still the largest oil producer, but as Non-OPEC countries slip further behind their capacities there is a fear that world demand will not be met. Huge amounts of capital will need to be poured into the Persian Gulf and invested elsewhere if future reserves are to meet projected demand.

STRATEGIC RESERVES Some countries, notably the United States, have addressed the uncertainty caused by slim margins of spare production capacity by creating strategic reserves. The U.S. began to stockpile strategic reserves in 1975, storing the petroleum in large underground salt caverns in Louisiana and Texas.12 In 1985, the amount of oil stored there was sufficient to handle a supply disruption lasting 118 days. Because of increasing domestic consumption, current reserve levels—705 million barrels as of October 2009—would only last about 70 days.13 The has put is reserves to good use when necessary, most recently in the wake of Hurricanes Gustav and Ike (2008).14 But, because oil prices are dictated by the global marginal price, when the U.S. opens its reserves, any price benefit “is dissipated around the world.” This is because American reliance on its own strategic reserves will translate into a decrease in overall global demand and thus in global price. Some argue that, contrary to being a “tool of national self-sufficiency,” the use of strategic reserves requires coordination among several key players to be effective. Thus, strategic reserves may be, counter intuitively, a “classic multilateral instrument.” 15

The Future of Oil Reserves

Drilling for Oil

Source: http://science.howstuffworks.com/oil-drilling4.htm

There has been much debate about whether reserve levels will continue to increase in the coming decades or whether most of the world’s salvageable oil has already been discovered. Proven reserves—“those quantities that geological and engineering analysis suggest can be recovered with high probability under existing technological and economic conditions”—increased 50 percent between 1973 and 1990.¹⁶ The strength of this trend leads many to believe that future discoveries of additional reserves are inevitable. The amount of oil reserves currently thought to be recoverable is significantly smaller than estimated in the 1970’s, 80’s or 90’s, as shown by the bar chart below.


Source: Bill Korvarik, “The Oil Fallacy” http://www.runet.edu/~wkovarik/oil/.

In the 1970’s, major oil companies and the U.S. government made “doomsday” predictions, suggesting that oil prices could hit $100-250 a barrel by 2000. While this was not entirely true for the year 2000, statistics by the Energy Information Administration (EIA) show that crude oil prices averaged $72 per barrel in 2007. Furthermore, prices averaged $100 per barrel in 2008 and floated around $57 per barrel in May 2009. In June of 2008 oil price was at the highest for the year costing $123 per barrel. These numbers do not allow us to completely dismiss the “doomsday” predictions. ¹⁷    

The rapid pace of advances in science and technology give many hope that the oil industry will one day be able to exploit reserves that are currently considered unsalvageable. The “average oil recovery rate from reservoirs” has risen from only 20 percent thirty years ago to 35 percent today. Even with this improvement, “two-thirds of the oil known to exist in reservoirs is still abandoned as uneconomic, leaving room for tomorrow’s discoveries or innovations to lift recovery rates and magically push [projections of peak global oil production] even further towards the horizon.” ¹⁸

To read more about estimates of future global supplies, see Appendix C, “Hubbert’s Peak Theory.”

CANADIAN TAR SANDS Innovative technologies could enable future producers to look beyond traditional underground reservoirs for new sources of oil. The most promising of these new sources are the massive tar sands of Alberta, Canada . The sands are found in three deposits, each approximately the size of the state of Florida . Some studies estimate they could contain as many as 180-300 billion barrels of oil, an amount matched only by Saudi reserves.19 This projection – combined with similar estimates regarding the potential of oil shale in the United States, heavier crude oil in Venezuala, and deep-sea oil in the Gulf of Mexico – lead some experts to believe that “non-traditional” sources of oil could serve as crucial insurance against future production cuts by OPEC. 20 As oil prices rise, the expense of investments in non-traditional energy source becomes more justifiable.

Canada's Tar Sands

Source: http://www.fromthewilderness.com/images/TarSandsAlberta.jpg

Skeptics counter that “there are no more ‘killer applications’…left to transform the industry,” and the debate remains an open one. ²¹

1 International Energy Outlook 2006 27
2 CIA World Factbook 2009 “Oil Production Country Comparison.”
3 CIA World Factbook 2009 “Oil Exports Country Comparison.”
4 “History of Energy in the United States – Petroleum;” Pirog, “World Oil Demand,” 15
5 “Oil in Troubled Waters”
6 Mouawad, “Kings of the Oil World”
7 Morse and Richard: "King of the Hill"
8 Hoyos, “Will the Lights Go Out?”
9 “Oil in Troubled Waters
10 Dickey
11 Sambidge
12 Cooper, “Energy Security,” 82
13 Avro
14 U.S. Department of Energy “Strategic Petroleum Reserve FAQ.” 
15 Mallaby
16 Pirog, “World Oil Demand,” 5; Glover and Behrens
17 Historical Crude Oil Prices; World Oil Prices (EIA)
18 “Will the Oil Run Out?," http://www.eia.doe.gov/steo
19 “Bottomless Beer Mug”
20 Simon
21 “Will the Oil Run Out?;” Krauss
22 “Bottomless Beer Mug”