Friday, March 27, 2009

Oil production declines and what it means for the future

Oil industry has certain peculiar characteristics which makes it even more vulnerable to price volatility. Consider the most recent experience.

Oil prices had fallen to very low levels in the early part of this decade. It was thought that the addition of new fields had generated excess capacity and a glut in production. At such low price levels, producers naturally had little incentive to invest in exploration and investing in improving the productivity of older fields.

Then came the seven year long increase in demand (a sustained rally unprecedented in the oil insudstry history), especially from China led emerging economies and the consumption boom in the US. The reduced investments in the late nineties, meant that the producers were in no position to ramp up production in response to the increased demand. The result - oil prices sky-rocket upwards in 2007-08, touching $147 per barrel in July 2008. The high prices made hitherto unproductive reserves like the Canadian coal tar sands economically attractive to extract.

Oil now costs $46.25 a barrel, down from a peak of more than $147, and natural gas costs just less than $4 per thousand cubic feet, down from a peak of more than $13. The global economic slowdown and impending recession has driven prices down, forcing producers to again cancel or postpone their investments in exploration and capacity expansion. Many oil companies have delayed drilling in different newer areas of the world, or abandoned expensive efforts to flush extra oil from aging fields. The large inventories and reserves have also contributed to depressing prices.

It is now being argued that these cutbacks mean that oil companies will be unable to respond quickly to a future economic recovery. The excess inventories and spare capacity can turn into a scarcity as the global economy starts recovering and demand picks up, leading to another round of price spikes. The investment cycle would then start ...

The NYT draws attention to a study by Cambridge Energy Research Associates which says that the potential drop in production capacity is a "powerful and long-lasting aftershock following the oil price collapse". The report says about 7.6 million barrels a day of future supplies are "at risk" of being deferred or canceled, like heavy oil or deepwater projects, and which could bring total supplies to 101.4 million barrels a day by 2014, against the capacity projections of 109 barrels a day. Production declined in 2008 and do the same this year too, putting great pressure on meeting supply projections. It estimates that as many as 35 new projects in nations belonging to the OPEC may be delayed by 2013.

To the extent that global demand slowdown has adversely affected the oil industry and its short and medium term future is tied with the global economic propsects, Daniel Yergin, noted oil expert, feels that oil prices will depend more on the G-20 than the OPEC. He said that is now between 6 million and 7 million barrels of spare production capacity for oil worldwide, and demand for crude has fallen by 1.8 million barrels a day so far in 2009, on top of a 550,000 barrel-a-day drop last year.

It now appears that natural gas too may be following in the footsteps of oil. The NYT reports that the drilling cutback has been particularly stark for natural gas. Gas exploration had soared in recent years after technology advances enabled the exploitation of gas trapped in huge shale beds found around Fort Worth, western Pennsylvania, upstate New York and elsewhere. But that boom has created such abundant supplies that companies are not only drilling less but also deciding not to pump from wells already drilled.

As can be seen, natural gas may be following in the footsteps of its twin brother, oil, with a global market and its version of the boom-bust cycles. Natural gas in the United States costs a little over $4 per thousand cubic feet, down from a peak of more than $13 last year. On average, world spot prices for liquefied natural gas cargoes have come down by more than two-thirds since last summer.

However, it is also possible that with new capacity capable of cooling and liquefying gas for export due to come on line this year just as the economies of the Asian and European countries that import them to run their industries are slowing, global natural gas trade may expand dramatically even as prices decline to their lowest levels.

The global capacity for liquefied natural gas exports of 200 million tons a year will increase by 25% with the completion of six new plants in Qatar, Russia, Indonesia and Yemen, totaling $48 billion in investments, and the upgrading of a seventh plant in Malaysia. More large plants are due on line in 2010 and 2011. This is a legacy of the economic boom of the past two decades, and the increased demand for natural gas in the face of rising oil prices, which led to a boom in investments in natural gas exploration and refining activities.

Update 1
Nice article that seeks to rebut the Malthusian peak oil hypothesis.

Update 2
Canadian oil tar sands - a hydrocarbon paste of clay, sand, water and, bitumen — can be separated from the granular stuff and eventually refined into a variety of petroleum products and has the potential to produce upwards of a trillion barrels of oil.

However extracting oil from these sands amounts to one of the most expensive methods to extract oil from under the soil. Besides, the need to pump in huge inputs of natural gas are needed to separate and process the bitumen, generates perhaps 30 percent more greenhouse gases than conventional oil extraction.

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