The Hindu Business Line : Has Saudi oil production peaked?

Why, in spite of the record high oil prices and quadrupled rig counts, has Saudi Arabia not increased its oil production or its reserves? Does it indeed have the spare capacity it claims to, or is it past its peak oil production? RAM VENKATACHALAM and SHANMUGANATHAN N offer some answers.

Why is this question relevant? For the better part of the last three decades, Saudi Arabia has varied its production between 4 mbpd (million barrels per day) and 10.5 mbpd, according to the market requirements. It has also maintained spare capacity that has granted it the status of the swing producer of the world. Also, in terms of supply growth, Saudi Arabia remains the only country with the reserves (even if only on paper) to increase production by a significant quantity.

IEA (International Energy Agency) projections show the world consuming about 112 mbpd by 2030. These projections are based on very conservative estimates, such as population de-growth after 2015 and per-capita oil consumption of the emerging economies of China and India being lower by 2030 than even Mexico today.

To meet this requirement, the IEA assigns future supplies to all producing countries, increasing their production by an "acceptable" magnitude. The remaining deficit is attributed to Saudi Arabia and, hence, the IEA model shows Saudi Arabia producing 25 mbpd. The only way this demand can be met is by its filling this supply gap by tripling its current production of 9 mbpd. And, if Saudi oil has indeed peaked, the chances of meeting the estimated demand would be, statistically, zero. More important, it would mean that the world is most likely at the doorstep of peak oil. So, what is the evidence that Saudi oil production has peaked?

The Evidence

As can be inferred, Saudi Arabia's production has been flat for the latter half of 2005. Starting 2006, production started declining and is now down 8 per cent in spite of two new fields (Qatif with 800,000 bpd during 2005 and Haradh with 300,000 bpd in 2006) coming online. This decline raises several disturbing questions: Why, in spite of the record high oil prices, did Saudi Arabia not increase its production? Why, despite the quadrupling of rig counts, has it not been able to either increase reserves or production?

The price of crude oil is $60 a barrel and above when serious research into alternatives gets market attention. So why does Saudi Arabia allow the price to stay above this level for sustained periods, thereby creating some long-term competition? Why has it started producing below its quotas at a time of record-high oil prices? There are two possible explanations:

One, it is producing whatever it can, but that is not enough to cool down the oil market. It can no longer enforce a cap on oil prices, as it used to a decade ago, and prices are as much market-determined as they are for other commodities. For technical reasons, as well as to support a higher price band for oil prices, Saudi Arabia has mothballed a lot of its producing wells, even while bringing the new fields on stream.

Let us examine the validity of the first contention — that Saudi production has, indeed, peaked. When the US oil companies controlled operations in Saudi Arabia, they had reported reserves of about 180bb. Subsequently, no new oilfields have been discovered and there is no reason to believe that the reserves have increased.

Post-peak Declines

A Hubbert linearisation of Saudi Arabian production also shows the reserves to be between 170bb and 200 bb — a range influenced by whether we choose to add unconventional oil to the mix. Whichever way we look at it, given that Saudi Arabia has produced about 110 bb till date, it should mean that production should have peaked quite a few years ago, assuming that the peak happens at 50 per cent of reserves.

With gas and water injection to maintain reservoir pressures, large fields peak beyond the 50 per cent mark with post-peak declines in excess of 10 per cent. Cantarell, the second largest oilfield in the world, peaked in 2005 with a subsequent decline of 20 per cent in 2006, and is expected to fall at least 14 per cent in 2007. This rate sensitivity of pressurised oilfields could explain the steep fall of 8 per cent in Saudi Arabian production — and if we exclude the Qatif and Haradh fields that came online after the onset of declines, the observed declines would have been similar to Cantarell. The observed data are thus consistent with a peak in Saudi Arabian production in the context of the technologies that country uses.

The unfortunate part is we will not know for sure till well after events unfold over the next few years. The only way it can be predicted with certainty is to look at field-by-field production data. In their absence, the only inferences that can be drawn are as above.

However, if the above analysis is correct, Saudi Arabian production will continue to decline in the years ahead. Some of the declines would be offset by the new projects planned (0.75 mbpd in 2008, 1.1 mbpd in 2009, 0.2 mbpd in 2010 and 0.6 mbpd in 2011. Source: Megaprojects database, Chris Skrebowski). But even these will not allow the desert nation to produce more than 9 mbpd.

Does spare capacity exist?

Saudi Arabia produced about 10.5 mbpd in 1981. Between then and now, there have been several ramp-ups and ramp-downs in its production. But what makes the latest series of production drops look involuntary are the following:

This is the first time there have been steep declines in an environment of high and increasing prices. All previous declines could be reactions to falling prices. Also, 50 per cent of the reserves has been crossed this time, indicating that declines are unlikely to be reversed.

Increasing rig counts also demonstrate that Saudi Arabia is not complacent about the issue and that production declines continue despite that. All of the above indicate that Saudi Arabian production could well have peaked. The alternative explanation is that Saudi Arabia does indeed have the 460bb reserves that the Saudi Oil Minister claims it does, but is not particularly concerned about development of alternatives, as it understands it is very difficult to create substitutes that are scalable.

Our guess is that we will not have to wait much longer to find out the truth — maybe as early as this summer. With another active hurricane season predicted for the Gulf of Mexico and with the US petrol inventory at an all-time low (in terms of days of supply), crude oil prices could well soar past $90 this August/September. And if Saudi Arabia continues to insist it has spare capacity of 2 mbpd at that point, it would look pretty silly.

(The authors are Directors at Benchmark Advisory Services. They can be contacted at ram.venkat@benchmarkconsulting.in and shan.sundaram@benchmarkconsulting.in )