The Hindu Business Line : Reserve additions, over a barrel

What has really increased the oil reserves is a change from an economic environment that encouraged understatement to one that rewarded overstatement.
RAM VENKATACHALAM and SHANMUGANATHAN N say that far from ‘reserve additions’ there will in the years ahead be ‘reserve subtractions’.

The annual BP Statistical Review of the World Energy report, released in June, indicated that the world’s proven reserves had increased steadily over the last two decades. Other things being equal, one can expect this trend to continue into the future. However, this situation of increased reserves was largely the result of a one-time event and, hence, any extrapolations of the trend would not be valid.

Given that no new field has been discovered in the last 25 years, the increase has been attributed mainly to “reserve additions” — an increase in the estimated recoverable reserves from the existing oilfields. Optimists, thus, argue that even without discovering new fields, one can continue to extract more from the existing ones. The main reasons for reserve additions are the following:

An increase in the original oil in place by discovery of satellite fields nearby.

Technological development that allows greater recovery of oil.

An increase in the reserves of the field due to historical understatement.

Had the reasons for the increase been on account of the first two factors, one could have expected the trend to continue because of improvements in technology and increased exploration. The reality, however, is that almost all the increases have been because of the third reason — historical understatement — and hence this cannot be a sustainable mechanism for increasing reserves.

Analysis of Reserve Increases

The BP chart shows that three regions (EU-25, OECD and non-OPEC — Organisation of the Petroleum Exporting Countries) have reported zero to negative growth in the 20-year period. The main additions have come from OPEC, Tar Sands and, to a limited extent, the former Soviet Union.

First, including Tar Sands as part of the reserves is not correct as significant net energy gains cannot be derived from them. In an earlier article (“Of Tar Sands and sand castles”, Business Line, dated August 16, 2006) it was pointed why Tar Sands would not make a significant difference to the timing peak oil. Also, we have been producing crude from Tar Sands for the last 40 years and, hence, to consider the same as part of the current reserves while ignoring the same for previous periods is misleading. Therefore, the main reason for the increase in reserves is OPEC and, hence, a historical analysis of this event would be relevant. OPEC countries increased their reserves by 50 per cent to 200 per cent between 1985 and 1990 (see Table 2).

So why did OPEC reserves increase when no new fields had been discovered? The reason was that the OPEC quota was fixed on the basis of proven reserves and, hence, these countries had an incentive to inflate their reserves. The subsequent series of events would make “Yes Minister” appear as serious theatre in comparison.

Kuwait first reported a 50 per cent increase in its reserves to 90 billion barrels (bb) from 64bb in 1985.

Other nations pondered for a few years till Kuwait again raised them to 92bb in 1988.

Not wanting to be left behind, Abu Dhabi increased its reserves to 92bb to match Kuwait.

Iran decided that it was better than Abu Dhabi and so reported its reserves at 93bb.

Iraq, not to be outdone, then decided to report a round 100bb.

Kuwait, the original player in the game of “paper barrels”, was so peeved for having the lowest reserves in West Asia that it increased them to 94bb.

Venezuela then more than doubled its reserves to 56bb.

Saudi Arabia finally stepped in to play its part when it increased its reserves to 258bb in 1990.

Interestingly, all these increases happened without any new discoveries. Pertinent to note is that the North Zone, which was jointly operated by Kuwait and Saudi Arabia, had no such motive and, hence, its reserves remained at the original estimates. Also, these reserves have remained static in spite of the copious production (Saudi Arabia has probably produced about 80bb since 1980) that has happened over the last two decades.

It transpires, though not officially acknowledged by OPEC, that these numbers represent the original and not the remaining reserves. From an OPEC viewpoint, it makes sense to have a static number to decide on quotas rather than numbers than change annually and which could cause much haggling. But why did BP choose to report these numbers as part of the proven reserves without asking even the most fundamental questions?

Historical Problem

But why were the original numbers (as reported in 1980) so low? The West Asian oilfields were originally owned and operated by the “Seven Sisters”. These multinational oil companies had reasons to understate their reserves — attracting less attention from local governments, tax-incentives based on depletion rates, smoothen reserve appreciation over a period to support lean years of discovery, and so on. But when the operations of these fields were taken over by the national oil companies, the reasons for understating reserves became irrelevant.

Almost the entire increase in reserves over the last two decades can be attributed to the OPEC phenomenon of fixing production quotas on the basis of reserves. This should not be surprising as, if the other two factors mentioned earlier had been responsible for reserve additions, there should have been reserve additions all over the world.

What has really increased the reserves is a change from an economic environment that encouraged understatement to one that rewarded overstatement. Extrapolating future increases based on historical trends would, hence, be misleading. To the contrary, when the world accepts that OPEC reserves are not actually remaining reserves as is generally believed, we would have a phenomenon of de-growth in reserves.

Forget “reserve additions”; what we will witness in the years ahead is “reserve subtractions”.

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