Why we're over a barrel

Twilight in the Desert
September 9, 2005

Colin Campbell welcomes an alarm call for an industry approaching crisis

Oil prices soar on world markets to levels not seen for 25 years, prompting those with long memories to recall the shocks of 1973 and 1979. The immediate response for many people may be to shrug and say something like: "We've been there before: the shocks lasted only a short time before market forces kicked in to bring in new supplies."

Indeed, conventional economic theory proclaims both that supply must always meet demand in a properly functioning open market, and that one resource seamlessly replaces another as the need arises. The Stone Age did not end for want of stones, according to the well-worn cry from a camp of flat-earth economists who think they live on a planet of limitless resources.

This book by Matthew Simmons therefore comes at a timely moment to challenge these outdated theories and general complacency. The oil shocks of the 1970s were responses to the Israeli-Palestine conflict and the fall of the Shah of Iran, and did not reflect resource constraints, on the evidence available either then or today.

This time we face something different as resource constraints imposed by nature appear. Oil was formed only rarely in both time and place in the geological past, which means that it is a finite resource, subject to depletion. Production cannot go on rising for ever, and has to mirror discovery after a time-lag. When a director of the world's largest oil company, using valid industry data with reserve revisions properly backdated, tells us that the peak of discovery occurred 40 years ago, that should ring the alarm bells, indicating that the corresponding peak in production cannot be far away. (See H. Longwell, "The future of the oil and gas industry: past approaches, new challenges", World Energy , 5:3, 2002.) The geological reasons why oil is unevenly distributed around the world are well understood, with much of the supply concentrated in the five countries bordering the Persian Gulf, of which Saudi Arabia has the lion's share. In earlier years, Saudi Arabia's production and reserves were routinely reported under strict Stock Exchange rules by a group of American companies owning the Arabian-American Oil Company, which produced the country's oil before it was nationalised in 1979. Since then, these critical numbers have become effectively state secrets.

Simmons started his career intending to be an investment banker in Utah, but chance found him raising venture capital for a contractor in the offshore oil industry. The oil shocks of the 1970s prompted him to concentrate on this sector, seeing his role as delivering superior objective advice and analysis to his investors. He found himself often having to question the validity of official and corporate pronouncements.

Evaluating the oil industry's performance and future opportunities made him see the limits and recognise depletion. At first he thought only in financial terms but later, came to identify the underlying resource constraints. He became aware of the possibility of "peak oil" and decided to draw attention to its potentially monumental impact on mankind.

His words, therefore, carry credibility and authority, coming as they do from an establishment figure at the heart of the oil industry in Houston, Texas. His courage deserves commendation too, as it cannot be easy for someone in his position to be forthright in telling the truth when so many vested interests would prefer him not to.

Using the skills of a detective, Simmons has delved into historical records and obscure technical papers to uncover the real oil production position.

The result is a compelling wake-up call to oil consumers across the world.

Oil provides some 40 per cent of traded energy and more than 90 per cent of the transport fuel on which trade depends. Furthermore, it plays a critical role in agriculture. The world accordingly has a right to know how long it can continue to rely on its major suppliers, especially Saudi Arabia.

All oilfields decline during the second half of their lives, and Simmons's investigation finds that the Saudi oilfields obey the same immutable physical laws. It transpires that 90 per cent of Saudi production comes from just six giant fields, which are well into middle age. Other, yet-to-be developed fields are smaller by orders of magnitude, some with inferior reservoirs and poorer-quality oil. Furthermore, substantial exploration programmes over the past 30 years have tested the best remaining possibilities without notable outcome, meaning that future exploration cannot yield results comparable with those of the past.

The Saudi oil minister makes comforting statements to the effect that his country can lift production from today's 10.5 Mb/d (million barrels a day) to as much as 15 Mb/d, and maintain that level for 50 years. Simmons's book casts very serious doubt on the credibility of such assertions.

It is a popular delusion that the Middle-Eastern countries are using primitive technology and poor management to operate their oilfields, and that the entry of foreign companies would open a new floodgate in production. Simmons makes clear that this is certainly not the case in Saudi Arabia, where cutting-edge technology, involving highly deviated, multi-branch wells and various forms of stimulation to optimise recovery, is being applied. The carbonate reservoirs are particularly difficult, having pods of high porosity and permeability, which are separated one from another by tighter zones. A mat of tar below the eastern flank of the largest field, Ghawar, has inhibited the natural water drive, calling for a massive programme of water injection to sweep the oil towards the producing wells and maintain pressure. Evidently, lifting production is far from just a matter of opening a valve. The country has to run ever faster to stand still as it tries to offset the natural decline of its ageing fields.

Oil and politics are never far apart, and nowhere are they closer than in the Middle East. Oil is money, and money is power. And now these countries face increasing external military threats and pressures, as consumers vie for access to their oil. The countries themselves have become utterly dependent on oil revenues to meet even the minimal needs of their burgeoning populations in a barren landscape.

Had the international companies remained in control, they would have produced the relatively cheap, easy oil from this region before moving on.

But the expropriations of the 1970s, and before, forced them to turn elsewhere, bringing in new supplies from offshore and other hostile environments. The companies worked flat out, forcing the governments of oil-producing states in the Middle East to meet the competition by cutting their production to support prices through a system of quotas set by the Organisation of Petroleum-Exporting Countries (Opec), partly on reported reserves.

In 1985 Kuwait, no doubt wishing to raise its quota, overnight increased its reported reserves from 64 to 90 Gb (billion barrels), although nothing particular had changed in the oilfields. This move forced the other countries to react. Abu Dhabi, Iran and Iraq simply came in with new estimates close to that of Kuwait, whereas Saudi Arabia, which was already reporting more than Kuwait, waited until 1990 before announcing a massive increase from 170 to 258 Gb. Simmons is entirely justified in questioning the validity of these and later reported reserves, which have remained, implausibly, almost unchanged despite substantial subsequent production.

Although Opec is widely blamed for the present soaring oil prices, in reality it has almost lost its relevance as natural depletion does Opec's job for it.

The first half of the Oil Age has lasted 150 years and has seen the rapid expansion of industry, transport, trade, agriculture and financial capital, allowing the world's population to expand six-fold. During this period, banks lent more than they had on deposit, creating, so to speak, money out of thin air, but the system worked because confidence in tomorrow's expansion provided collateral for today's debt. Many people came to think that it was money that made the world go round, when in reality it was the underlying abundant supply of cheap, oil-based energy.

The second half of the Oil Age now dawns. It will be marked by the decline of oil, and all that depends on it. Logic suggests that this decline will reduce confidence in perpetual upward economic growth, which will in turn undermine the collateral for today's debt. It is hard to imagine a more serious subject. Should we speak of a second Great Depression?

Simmons's book is therefore essential reading for industry, government, the investment community and academia. It has a message for everyone. While it is concerned primarily with Saudi Arabia, the world's largest oil supplier, it goes deeper. The book would be worth reading just for the preface and final chapter outlining the general conclusions. But the intervening chapters are equally strong, offering a clearly written and comprehensible account of the history of Saudi Arabia and its oilfields.

However, Simmons is not a doomsayer. While he recognises the extreme gravity of the situation, he emerges confident that we can learn to live with the consequences, provided that governments and the general public recognise the situation for what it is and plan accordingly. His primary call is for more transparency in production and reserve data. With valid information, the need for action would become self-evident. There is an urgency needed, for the adjustment to declining oil supply will be neither easy nor quick to implement.

Colin Campbell is chairman of the Association for the Study of Peak Oil and Gas. He was formerly an exploration geologist and oil executive, and is the author of The Golden Century of Oil , The Coming Oil Crisis and Oil Crisis .

Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy

Author - Matthew R. Simmons
Publisher - Wiley
Pages - 422
Price - £15.99
ISBN - 0 471 73876 X

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