A global oversupply of oil enabled by OPEC's quota violations could lead prices to fall. (image: tehrantimes.com, blog.redfin.com, and AP via cbsnews.com)

Monday, an article in the Financial Times questioned the strength of OPEC in light of its members’ extensive quota breaking, and stated some analysts believe that a current global oil glut could drag down prices by the end of the year.

OPEC quota compliance has become an especially important issue as quota “cheating” is happening with increasing frequency, and OPEC announced on Wednesday that it would maintain current quotas, despite some members exceeding them.

Back in December 2008, the cartel responsible for 1/3 of the world’s oil agreed to make the biggest production cut in its history; a slash in output of 2.2 million barrels per day. The cut was motivated by the financial crisis’ blow to global oil prices, which plummeted by nearly 70% in the months following July of that year. Since then, OPEC’s official quota has not budged, remaining at 24.845 million barrels a day despite the widely-recognized fact that the true output of its members has run hundreds of thousands of barrels per day above this level.

In 2008, analysts estimated OPEC overproduction ranged from 600,000-800,000 barrels daily. This past January, Reuters Africa reported that an OPEC document registered overproduction at 1.87 mbpd. The FT article stated that OPEC quota compliance—a percentage measure of how real output matches agreed-upon levels—has slipped to a low of around 50 percent (its highest in the past two years was 80 percent, in spring 2009).

Iraq’s lode of international oil contracts could soon boost OPEC production by several million barrels, the article pointed out. With the second-largest oil reserves in the world, Iraq’s new participation in OPEC (after years of sanctions and disruption brought by war) could, in a scenario where quotas remain unchanged, either force the body to curtail the above-quota production in other countries, or explode the fissure in compliance to a point where OPEC loses the unity it needs to keep order and retain control over prices.

When OPEC nations break their quotas, they profit from the higher prices permitted by the supply restraint of fellow members.

However, some countries pump excess crude in order to stave off consequences of their own economies’ severe fragility. This is the case with the worst quota breakers: poverty-stricken Angola, which has observed no cuts in its production, and Nigeria, which was overproducing by 300,000 barrels daily in December. It’s also an expected motivation for war-torn Iraq, which is currently the only OPEC member exempt from quotas but whose pending contracts will soon change this as its production soars.

Additionally, when many members break their quotas and overproduce, previously compliant nations are pushed to overproduce in order to make up for the loss in profit that resulted from the supply glut’s depreciation of their oil. Compliance brings higher prices through supply restraints, so quota violations bring lower prices through increased supply. In a somewhat ironic feedback loop, members increase output to compensate for lower prices; the further increase in world supply contributes to lower prices.

Exceeding quotas, in conjunction with low oil demand worldwide, could be the reason for the oversupply the FT article mentions:

Some analysts and traders note that despite recent upward revisions in demand – especially from China – markets remain oversupplied and Opec faces some risk that prices will fall this year.

A global oil glut has been present for years, ever since the recession dampened demand from developed economies, and worldwide oil demand has only increased nominally in the last year or so. The current supply-demand imbalance would indicate that prices should fall, yet the price of crude has climbed by 79% over the past 52 weeks.

Therefore, any price declines would have to be brought on by a confluence of several factors. According to the FT, some analysts see nearing-termination of government stimulus packages (both the US and China), and the new limits on energy trading in the US (which could lessen price-hyping speculation activities) as two such important factors.

Researchers at Kuwait University’s College of Engineering and Petroleum recently published a study on world oil production that includes a new prediction of when conventional oil production will peak. (image: buthaina.wikispaces.com)

A new study published in the journal Energy & Fuels predicts that world conventional oil production will hit its peak in the year 2014, GreenCarCongress.com reported on Wednesday. The study, undertaken by researchers at Kuwait University and Kuwait Oil Company, looked at oil production in the top 47 oil-producing nations and found that humanity has extracted about 54 percent of total world oil reserves and that conventional oil production will reach its peak of 79 million stock tank barrels per day (an industry term, abbreviated as STB, that refers to the number of barrels of crude oil successfully extracted and “treated”) in about four years.

The study began with the Hubbert forecast model, named for peak oil pioneer M. King Hubbert, who successfully predicted that crude oil production in the US would peak in 1970. Though proven to be a useful tool in predicting peak oil, the Hubbert model has limitations when applied to more complex and diverse oil production methods and measures of the 21st century. The Kuwaiti researchers accounted for those limitations in the study, and also allowed for updates of their findings as new oil production data becomes available. The authors explained their methods in the study’s abstract:

Even though our approach originates from Hubbert model, it overcomes the limitations and restrictions associated with the original Hubbert model. As opposed to Hubbert single-cycle model, our model has more than one cycle depending on the historical oil production trend and known oil reserves. The presented method is a viable tool to predict the peak oil production rate and time. The model is simple, accurate, and totally data driven, which allows a continuous updating once new data are available.

It should be noted that the study, no matter how sound its methods, reports exclusively on conventional oil (liquid crude that can be extracted from the ground relatively cheaply), and in doing so paints an incomplete picture of world oil supplies and the expected arrival of peak oil production. If the study were to include data on unconventional sources such as Canada’s tar sands and oil shale deposits of the American West, the supply figures would grow substantially and the date of peak production would likely be pushed forward by at least a decade or two. However, because the technology and costs associated with extraction of unconventional oil vary widely and face an extremely uncertain future, it is logical that the study excludes unconventional oil figures.

This new fodder for the peak oil debate will probably do little to bring about a consensus on whether peak oil production is a real or imagined phenomenon and, assuming it is real, when it will occur. But the addition of new and complete data that can be updated over time will hopefully bring new insight to the world of oil supply data and help the world better prepare for the peak oil eventuality or something like it. The more prepared governments and citizens are for any supply declines that could lead to rapid price increases in consumer fuels like heating oil, diesel, and gasoline, the less disruptive those increases will be to our daily lives.

Reports of an unprecedented bounty of domestic oil and gas reserves are open to misinterpretation. (image: trcc.commnet.edu and i.ehow.com)

On Monday, a report released by a national contractor for state utilities claimed that the United States contains more than 2,000 trillion cubic feet (tcf) of natural gas and 229 billion barrels (bbl) of oil—as observed by The Energy Source blog at Forbes.com, that’s more than the average OPEC nation holds. Noting that a chunk of these reserves lie in areas barred from drilling, the report also found that leaving these reserves untouched would cost the US $2.36 trillion in lost GDP over the next twenty years.

It’s no secret that the US contains its own oil and gas reserves. According to Reuters, Previous estimates have placed those figures at 1750 tcf and 186 bbl for gas and oil, respectively.

The study, two years in the making, was sponsored by the National Association for Regulatory Commissioners in conjunction with the industry-funded Gas Technology Institute. The government-protected reserves amount to 43 billion barrels of oil and 286 tcf of gas and are located in the Arctic National Wildlife Refuge and in areas just off the coastline of the continental US. The US currently consumes an average of 20 million barrels of oil per day, and produces 6 million barrels per day.

The research was done according to standard methodology by SAIC Corp ie data collection and processing, and the report attributes the reserve increases to advances in drilling technology and gas extraction methods. The real thrust of the study comes from its economic figures. This appears to be the first time a hard dollar amount—and a whopping one at that—has been attached to the value of those reserves.

According to Bloomberg, the $2.4 trillion number was arrived at through calculating the expected revenue from employment, taxes and government holdings that would result from the development of untapped reserves. According to Reuters, the figure also incorporated the increased cost of foreign imports in the same period that would result from a failure to make use of the reserves. At $1.6 trillion, this chunk alone comprises over half the cost.

Industry representatives speaking about the report are unabashed about using the study to encourage changes in national energy policy. According to David Parker, president of the American Gas Association:

“It’s clear from this report that the status quo on energy production simply won’t suffice… We encourage lawmakers to heed the results of this study and take a closer look at the energy-rich areas in our country that are currently off limits.” (Reuters)

And from O’Neal Hamilton, former chairman of South Carolina’s Public Service Commission, “Our research allows policy makers to know the extent of the resource base and the effects that maintaining the restrictions would have on the country.” (Bloomberg)

However, curiously omitted from the report’s publicity and the document itself are the types of oil sources included in the total reserve calculations. As previously explained on HeatingOil.com, proven liquid oil reserves are very different from “unconventional reserves,” a moniker assigned to oil that exists in non-liquid form, either mixed with sand and too thick to flow (tar sands) or embedded as a wax in solid rock (oil shale).

Unconventional oil is worth significantly less than its conventional counterparts due to the highly expensive extraction and refinement processes it requires to even reach a barrel. The steep costs (in money, energy, and in many cases, water) of turning unconventional oil into useful crude make it anything but a profitable bet for oil producers, so even if restrictions on unconventional oil extraction were lifted, it’s unclear whether anyone would be interested.

It should also be noted that report specifically incorporates “shale gas,” or gas trapped in shale bedrock, into its reserve numbers for natural gas. Recent advancements in drilling technology and techniques have made these previously unreachable reserves accessible. However, some of those advancements pose risks to the environment and the public that have yet to be rigorously studied. Most notably, the advanced method for extracting shale gas known as hydrofracking has been anecdotally linked to contamination of drinking water used by residents near drilling sites. The price of a filtration plant alone runs over $10 billion. Who would absorb this cost?

The exclusion of these mitigating factors and the clear industry ties to this report at a time when drilling leases are the subject of an ardent tug-of-war between the current administration and the oil and gas industries leave its provocative economic figures in need of stiff critical analysis.

There is a flame of hope in the dark desert of Kurdish/Iraqi oil negotiations. (image: kurdistan4all via flickr.com)

In Iraq, what promised to be one of the greatest oil bonanzas of modern times is now looking less like the proverbial spouting geyser and more like a crude-based quagmire. Since 2002 more than 30 foreign companies have set up operations in oil-rich Kurdistan, a semiautonomous region in Iraq, hoping to cash in on the immense oil reserves recently discovered there.

However, according to Sunday’s New York Times, a complex political dispute between Kurdistan and Iraq, involving the scrutiny of at least one oil contract held between the Kurdish government and an outside company, still threatens to choke off oil production and send profit margins into the red, though there are some faint glimmers of hope.

The controversy first arose in November, in the wake of revelations that a former American diplomat maintained a business relationship with Norwegian oil company DNO while acting as a political adviser to the Kurds during the drafting of Iraq’s Constitution in 2005. The scandal helped to exacerbate the more contentious issue of profit sharing between Kurdish authority and the central Iraqi government, and led some officials in Baghdad to question the legitimacy of the region’s production-sharing agreements. Kurdistan contends that it has every right under Iraq’s Constitution to sign the contracts, while Baghdad maintains that they are illegal in the absence of a national hydrocarbons law, and has gone so far as to blacklist the companies operating in the region.

However, there is some promise of reconciliation, however slight. In an effort to ease some of the immediate business concerns of the heavily invested foreign oil companies now operating in the region, the Kurdish government recently presented Baghdad with a major compromise that would permit DNO, along with a Chinese-Turkish joint venture called Ttopco, to resume exports of about 100,000 barrels a day via Iraq’s pipeline network. The proposed compromise would require the two producers to offer their oil to Iraq’s State Oil Marketing Organization, which would compensate them initially just for their costs.

While the compromise is yet to be accepted by Baghdad, it could lead to at least some oil coming out of Kurdistan. With talk of peak oil and rising demand for crude in China and India, much of the industrialized world has begun to look to Iraq to provide a major boost in supplies in the near future. Whether this happens or not may depend on how and when the dispute between Kurdistan and Iraq is finally resolved.

This chart from JBC Energy shows that distillate supplies in floating storage remain ample, even if crude supplies are falling. (image: blogs.ft.com)

For oil traders, it seems that contango—a market situation in which futures prices are higher than spot prices—is no longer such an exciting dance. The Wall Street Journal reported yesterday that floating supplies of crude, kept at sea during times of low demand in the hope of future profits, are finally dropping after more than a year. The volume of crude oil currently stored on supertankers has more than halved, down to 43 million barrels from its record high of 90 million in April of last year, and the Wall Street Journal notes that land-based surpluses are falling as well. Analysts estimate that the quantity of crude at sea could drop to 27 million barrels by March, which would be the lowest level since the current contango began at the end of 2008.

Some analysts are trumpeting this development as a sign that the oil market is rebounding, and that the contracting of floating crude reserves may even herald a price spike. But the Journal takes a more cautious view, noting that “Appetite for oil in industrialized countries, which plummeted during the recession, remains depressed. Demand in the U.S. shrank 2% in the last four weeks from a year earlier and supply is still plentiful. Moreover, spare capacity in oil-producing countries remains high.”

In addition to plentiful supplies and ample spare capacity, most of the oil in floating storage is currently in the form of distillates, such as heating oil, so even if the contango for crude is coming to an end, the world’s oceans are still the largest oil storage facility around. A JBC Energy estimate cited yesterday in the Financial Times puts floating storage of distillates at 75–85 million barrels. Their figures also show that as floating storage of crude has dropped, there’s been a corollary rise in the shipboard volume of distillates. Last March, there were only 8–10 million barrels of distillates stored offshore, a number that has increased tenfold since then.

While the dip in crude reserves might mean that the market is tightening slightly, it’s really a drop in the bucket when viewed against mid-January’s twelve-year high increase in oil inventories. The Financial Times supplies a telling quote from JBC’s report: “Even if the rest of the winter turns out to be very cold, we expect the distillate glut onshore and offshore not be consigned to history until at least late 2010.”

The Orninoco oil belt territory, Venezuela. (image: vheadline.com)

As reported by the New York Times on Monday, a new USGS survey concludes that Venezuela’s Orinoco tar sands have more than twice as much “technically recoverable” oil than previously thought. The survey concludes that the Orinoco belt, thought to contain 235 billion recoverable barrels of oil, actually holds 513 billion barrels. This, “the largest accumulation ever assessed” by the USGS, goes a long way toward validating Venezuela’s claim to have the world’s largest oil reserves, ahead even of Saudi Arabia.

However, the critical caveat is “technically recoverable”—getting oil from tar sands is a labor-, capital-, and energy-intensive process, at least compared to “simply” sinking a well. For example, the Orinoco is believed to have 1.3 trillion barrels of oil locked up in its sands, of which only around 40 percent is now thought to be extractable. The rest is not practically reachable by today’s techniques. However, even for the 40 percent that can be recovered, the question remains: is it worthwhile to recover at today’s prices?

Extensive mining, big equipment, and elaborate processing make tar sands a less-economical source for oil than conventional resources. (image: treehugger.com)

Technically recoverable is not the same thing as economically viable, as Shell has concluded. As reported by Reuters on Monday, Shell has decided to scale back investment in and production of oil from Canada’s tar sands. Instead, the energy giant will look to increase conventional drilling to overcome a nearly decade-long decline in its oil output. Shell attributes its decision to ample opportunities for conventional oil production that are made possible by investments it made in exploration and discovery; however, the bottom line is more likely the bottom line—while oil prices are higher than the anemic global economy can account for, they are not high enough to make extensive tar sand development worthwhile. That’s the reason why Shell is allowing 20 billion barrels of oil—one third of its total reserves—to lie fallow; they’re not worth exploiting at current oil prices.

That is the fundamental paradox, at least for now, of unconventional oil reserves, especially tar sands: they are coming to represent a larger and larger percentage of the world’s total oil reserves, but are not presently worth exploiting to any large degree. In the future, when economic and technological conditions for them improve, they will supply a major part of the world’s oil; but at a time of weak demand and abundant conventional supply, they represent hundreds of billions of barrels that may simply not be worth taking out of the ground.

Shell and Petronas aim to increase Majnoon’s oil production by more than 1 million barrels per day. (image: news.sky.com)

BBC News reported that on Sunday, oil leviathan Royal Dutch Shell and Malaysia’s state run oil company, Petronas, finalized a contract to develop Iraq’s 12.6 billion barrel Majnoon oil field. The deal includes a 20-year service contract and the companies will receive $1.39 per barrel of oil. Shell owns 60 percent of the venture and Petronas owns the remaining 40 percent.

The agreement was signed at Iraq’s oil ministry in the presence of Iraqi oil Minister Hussain al-Shahristani and Mounir Bouaziz, an executive at Shell.

This joint venture is the latest in a line of deals for Iraqi oil, and is part of Iraq’s plan to increase its oil production and make it one of the world’s largest oil producers. To revive its oil industry, which has been affected by years of sanctions and war, Iraq needs the assistance and expertise of foreign oil companies.

The size of Iraq’s known oil reserves ranks only behind those of Saudi Arabia and Iran. At about 2.4 million barrels, Iraq’s daily output is relatively small for a country with as much known oil reserves. However, the country aims to triple its output over the next several years.

Shell and Petronas have pledged to increase the Majnoon oil field’s output to 1.8 million barrels per day from just 46,000 barrels per day.

According to Black & Veatch, in 2034 windmills like these won’t provide much more energy than they do now. (image: media.supereco.com)

What will America’s fossil fuel consumption look like two decades into the future? Not much different from the picture today, to listen to the predictions in a set of findings by energy consulting firm Black & Veatch. The New York Times Green Inc. blog picked up the story yesterday, summarizing the firm’s findings with a minimum of commentary.

According to Black & Veatch, by 2034 our dependence on coal, oil, and natural gas will have declined less than 10 percent—from 76 percent to 68 percent of the total. Renewable energy sources such as wind, solar, and geothermal will account for that decline, growing from 5 percent now to 13 percent. Coal plants supplying electricity will decline, but this will occur primarily because of the retirement of aging infrastructure, not due to any major shift in usage.

The Times points out that there are several factors that do not play into this analysis, with nods to the unknown results of possible cap and trade policies, as well as the growth of the renewable energy sector. Black & Veatch’s projections are rather bleak on that score, however. Not only do they predict that California will not achieve its ambitious goal to power the state with 20 percent renewable energy by the end of the year, they believe that by 2034 it still won’t have reached the longer-term goal of 33 percent (due to take place by 2020), though only just. The firm also suggests that growth in renewable energy technologies will slacken off once states such as California have met their legislated renewable portfolio standards (RPS).

Largely missing from this picture are several important developments of recent months that could have substantial bearing on whether our energy grid will shift away from fossil fuels. On the legislative front, both a climate bill that is currently bogged down in the Senate, which would cap carbon emissions at 17 percent below 2005 levels, and the EPA’s December endangerment finding regarding greenhouse gases could do much to alter the costs of supplying power and heat with fossil fuels in a future much nearer than 2034. In addition, market forces governing oil prices—and the finite nature of oil and other natural reserves—may change Black & Veatch’s picture rather dramatically. After a brief decline from the high crude oil prices of last winter, the cost per barrel has climbed back up into the neighborhood of $70–$80 (with some decline last week), and several analysts predicting that prices may remain that high—or higher—for a long time to come. With oil at such prices, it seems probable that a shift towards renewable energy could occur of its own accord.

Saudi Finance Minister Ibrahim al-Assaf. (image: arabnews.com)

As reported Sunday by the Economic Times, Saudi Arabia will invest in oil production and refining to “achieve stability in the international oil markets.” According to the nation’s oil minister, Ibrahim al-Assaf, the goal is to “increase production and refining capacity to maintain balanced and acceptable prices by both producers and consumers.”

It’s a good story, but does it make sense? Saudi Arabia recently completed a huge expansion of its production capacity, bringing it to 12.5 million barrels per day. However, it doesn’t actually pump anything like that—it’s currently producing 8 million bpd, which means it already has more than 50 percent surplus capacity.
Second, Saudi Arabia has so much surplus because it, unlike such OPEC members as Nigeria and Qatar, honors the organization’s production quotas. If the kingdom is voluntarily pumping less than it could, why does it need yet more capacity that—by its past practices—it will not use?

Third, most analysts who believe that oil prices will rise next year think prices will be driven by demand increases—particularly increases in Chinese and Indian demand. If demand, not supply, is in the driver’s seat vis-à-vis pricing, Saudi Arabia’s role in “stabilizing” price may be limited.

No, substantial expansion of Saudi capacity would seem to require some paradigm shift in the oil market to make sense. Two possibilities:

• The Saudis privately feel that oil demand will soar far more than even bullish analysts predict. Saudi Arabia’s existing capacity would support daily oil global consumption of almost 90 million bpd—substantially up from 2009’s 84.9 million bpd, and ahead of analysts’ 2010 predictions of 86.4 million bpd.

• The Kingdom intends to stop restraining itself and export as much oil as it can. For example, suppose that Saudi Arabia fears that structural shifts in energy markets, such as carbon emission reduction, the development of alternative energy, and/or increased focus on conservation and efficiency, have the potential to substantially reduce oil demand in the mid- to long-term. If that were case, it might make sense to monetize as much of their oil reserves now, while prices are comparatively high, as they can.

Of course, the above is pure speculation, and if there’s anything we know, it’s that speculation (in every sense of the word!) in or about oil is easy—divining the future accurately, that’s the hard part. However, it does seem that there needs to be something beyond what’s being said to motivate Saudi Arabia’s otherwise almost-inexplicable increases in production capacity.

The Discoverer Clear Leader, currently under contract to Chevron for the bargain price of $500,000 a day. (image: ports.co.za)

A video posted on Monday to the Wall Street Journal website profiled what offshore drilling giant Transocean claims is the world’s most powerful drilling ship. The ship, called Discoverer Clear Leader, is drilling for oil in the Gulf of Mexico, 190 miles south of New Orleans.

The Clear Leader is owned and operated by Transocean, who is using the ship’s technology to drill for oil in places that other oil rigs cannot. “We are drilling in 12,000 feet of water, 40,000 foot holes, because we have the horsepower to do that,” John Redington, offshore installation manager for Transocean, told the Journal. He went on to say that third- and fourth-generation oil rigs get to 20,000 or 25,000 feet, and then “start wheezing.”

Although the Clear Leader’s technology is expensive—Chevron, the ship’s first customer, is paying almost $500,000 per day—the oil industry may not have much choice. The oil fields of the 20th century are either pretty much dry or off limits to drilling, forcing oil companies farther and farther offshore in search of untapped resources.

Said Gary Luquette, president of Chevron North America Exploration and Production, “The cheap, easy stuff has pretty much been picked over, and these pools or pockets that you are looking at are much smaller.”
Chevron is searching for oil in areas that may be a challenge to tap into, but also have “greater promise for larger discoveries, which is what it takes,” Luquette said.

Crude oil is currently trading at about $81 per barrel; such high prices may make expensive deep-water oil exploration performed by rigs like the Clear Leader worthwhile to oil companies, and ultimately help lower future oil prices by increasing supplies. In addition, the Gulf of Mexico appears to be far from tapped out.
For example, on November 14, BP announced that it had made what it termed a “giant” crude oil discovery in the Gulf of Mexico. The presence of oil was confirmed in the Lower Tertiary formation, about 5 miles west of BP’s Tiber reservoir.

On December 7, the Houston Chronicle reported that oil companies made 12 discoveries in the Gulf of Mexico in 2009, marking the largest number of oil finds in the area since 2002, and confirming the Gulf of Mexico as a major source of oil for years to come.