Past Over-Production And A $100 Oil Norm For The Future

A Hubbert curve has proven to be about the most accurate way of estimating a production peak time frame for any resource extracted by a consistent method over the life of the resource. But there is one thing that rarely gets considered in Hubbert projections. In 1956, geologists ran the oil fields of the world. A conventional reservoir has an oil/water interface where pressurized water forces the oil up through the wells. Once the water migrates past this interface, as happens with faster rates of production, the drive mechanism for the reservoir is reduced. Oil gets stranded and can only be recovered by secondary methods at much lower net energy levels. Some water encroachment happens no matter what the recovery method over the life of the field, but geologists know just the right production rates to keep the drive at the optimal level through the field's life. Hubbert based his neat, symmetrical logistic curves on this in the peaceful 1950s.

But then we had geopolitical mayhem take over the oil fields. Saudi Arabia was the big swing producer (the Fed of oil) and, most of all, we had a cold war with oil financed expansion of the Soviet bloc, and an oil price war in the '80s and '90s between these two mega-players. It was a political soap opera, but suffice it to say that Russian centric geopoliticians began running the elephant oil fields of the earth. And they were not good geologists. This aspect of our present day energy markets is very rarely discussed or even considered. But its ramifications could be enormous. It is likely there was much over-production of the major fields with permanent reservoir damage.

No one can say just how much over-production and damage was done, and the secretive governments involved have never volunteered this information. The Wikipedia account for "Oil Reserves in Saudi Arabia" mentions Matt Simmons and his criticism of field management and noted:

"Simmons also argued that the Saudis may have irretrievably damaged their large oil fields by over-pumping salt water into the fields in an effort to maintain the fields' pressure and boost short-term oil extraction"

As I mentioned in this article, the decisive weapon deployed against Russia in the cold war was the Saudis' big production ramp and price war starting in the mid 1980s. There are those that claim this was in blatant partnership with Reagan, as this piece in the Telegraph details, with the main witness being none other than Michael Reagan, the president's son.

As for the massive Russian fields, well some say that, in the Soviet era, they were run as a military funding unit. They had no vibrant economy, so their massive oil fields were their prime treasury supply to build their empire, so they badly over-produced with poor technology. Russia is one of the most complicated oil cases on the planet, and opinions and future projections are all over the map.

But I want to present one scenario that would greatly alter oil price projections and energy investing out five years plus. I also should point out that over-production was not just a Russian thing, but they may be the biggest case of it. I should also point out how critical the Russian elephant fields are to the global production picture. The simple fact is that global crude has peaked and come off the plateau except for two players:

In the U.S. it is only the frantic shale boom diverging away from this peaking process. That's another story. As for Russia, it could be said that they are the most critical country in the world now for future oil pricing. This is because their production is over twice that of the U.S. shale and its future perhaps even shakier.

The following graph depicts the general effect of over-production:

The blue line is the kind of geologically sound curve Hubbert generated for the recovery of a large body of oil with just a little, maybe accidental over-production. The red line shows the effect of severe over-production, and has the effect of steepening the climb on the upside, but also steepening the decline rate an even greater amount after the peak with a greatly damaged field. 

As you can see from the graph, the price paid for all the added oil extracted pre-peak is a lot of oil that gets left in the damaged field. The peak time frame is about the same, thus Hubbert's peak time accuracy, and the total oil extracted is roughly the same. So how does our actual oil production history look so far?

This is a logistic fit of crude consumption done by Graham Zabel in 2007 and shows a couple interesting things. First, it's logistic, so it should be in accordance with Hubbert methods for peak projection. It is not Hubbert's method, but does show how well our production history so far is falling into line with typical, sound geology. It includes about 10 mb/d of the usual add-ons to conventional crude, but it does show the 2005 arrival at a bumpy plateau we've been on with conventional oil ever since.

Second, it shows us just where the over and under production areas are on the natural curve. From the late 1930s to the mid 1960s we had mild under-production, due in part to an economy emerging from the Depression. Then we had a booming economy and a historic surge in the principle use of oil, U.S. driving, amounting to over a doubling of miles driven from 1962 to 1977. This sent oil into mild over-production. Then a dramatic improvement in average gas mileage (and other oil uses) induced by the Arab oil shocks sent mileage up from 13 mpg in 1975 to 22 mpg in 1985. We also had a big slowing in the climb of miles driven. All this dipped the oil production curve back to mild under-production. Overall, as can be seen in the above chart, what was soundly produced and consumed followed market forces pretty closely.

So how did the dynamic duo of field mismanagement, Russia and Saudi Arabia, respond to all this?

Per this study by Political Economist, these two mega producers, making about 1/4th the world's supply, severely over-produced in response to the driving demand ups and downs, but the Soviet cold war financing over-production went on long after the driving demand dropped in the mid '70s. This went on until the Saudi ramp-up drove the Soviet oil industry to ruin in the '90s. Things have since settled back to typical Hubbert dynamics (red curves) as calculated here by Political Economist. But was there field damage?

I again refer you to the opinion of Matthew Simmons. He was an oil investment banker in the industry since 1973, was an oil advisor to the president and a member of the Council On Foreign Relations. He went through a mountain of SPE papers (Society of Petroleum Engineers) to write Twilight In The Desert in 2005. There was massive damage according to Simmons. He claims significant damage in Saudi Arabia, but also had this to say on Russia:

"The oligarchs who own and operate most of Russia's oilfields are aggressively tapping into the myriad pockets of bypassed oil ... This performance demonstrates the steps that can be taken to boost production after a field has been reduced to pockets of bypassed oil that water sweeps leave behind. These practices have accounted for most of Russia's surprising production rebound. But they are temporary, one-time remedies ... all oil fields have their rate sensitivities . Ignoring this concept and over-producing jeopardizes future production for any field, even in such prolific oil provinces as Western Siberia and Saudi Arabia." Twilight In The Desert, Matthew Simmons, p.307

One could look at the Hubbert curves above and say that Russia and Saudi Arabia aren't due to peak until clear out to beyond 2030. But there is serious doubt among Hubbert mathematicians whether the classic single curve is appropriate for these two cases. You could consider the curves shown above as "what should have been". Generating a Hubbert curve is based on the production physics staying about the same. When there are two vastly different ways of producing a large body of oil, like a country, sometimes a double curve is generated to better project the future. The very prolonged and severe over-production of the Soviet era could be considered a whole separate set of physics, and would justify a double math treatment for Russia, and by extension, to Saudi Arabia as well:

Sam Foucher, an oil analyst, presented the above in 2007 as his best Hubbert fit of what's to happen with Russian oil. I have added the data points through 2015. It has proven to be pretty accurate so far almost 10 years later. Russian production continued the rapid rise to just below the former peak and has been struggling to climb much higher in a similar plateau top as the '80s. If this projection plays out, it means Russian oil will soon turn into the same king of fast decline as the fast upside of the '60s and '70s and the fast decline of the '90s.

This view of Russia's oil future is from mathematicians viewing public data available on a secretive government from the outside. What do the Russian's themselves foresee? Russia projects their own oil future with a couple of Russian think tanks in "Global And Russian Energy Outlook to 2040". In that work, they conclude :

"Conventional oil (excluding NGL) production will drop to 3.1 billion tonnes by 2040 from the current 3.4 billion tonnes, and the long-discussed 'conventional oil peak' will occur in the period from 2015 to 2020. The drop in its extraction will be due to the gradual working-out of reserves of the largest existing fields." (p35) "Exports of petroleum products will peak in 2015 and will then gradually decrease ..."(p111)

Note they say here exports will peak in 2015 - that's the end of their contribution to the staving off of global decline for anyone living outside of Russia. This would leave just the U.S. shale prop in the global picture. Here is how the Russians see their crude in the years ahead:

"From old" means the oil they see coming from their existing aging elephant fields, so named because they can't be missed in exploration, and 99% of this oil globally has been found for over 30 years. This chart is based on two very optimistic items. First, it displays a 4.5% annual decline rate from the old fields, the "standard" rate applied to global post-peak fields. If these fields were greatly damaged as Simmons says, the decline rate will be much greater than that. Second, the blue parts of the bars are presenting the finding and exploitation of many more elephant equivalents. Good luck with that.

To give you an idea of how differing the explanations are on Russia, consider this fly in the ointment with the Simmons view above. A poster at The Oil Drum claims to have this simple explanation of the '90s rebound in Russian production:

About a month ago, I had the pleasure of spending 5 hours with the Chairman Emeritus of the most prestigious petroleum engineering consulting firm in the world as part of the SPE Distinguished Lecturer program. His firm has done reserve/ engineering studies in every major producing area of the world. He spent a lot of time in Russia over the past 12 years. He told me I wouldn't believe the principal reason for the Russian production increase from 1995 to 2005. They didn't have well tubing that had the tensile strength to run below 1,000'!!! As a result, the bottomhole pumps were set to 1,000' or shallower in all their wells. When they started tubing them deeper and pumping them down, here came the oil.

So this expert is saying the poor Soviet materials they had limited the wells to 1000' or less when clear back in the 1950s, average well depths were four times that. They were just scratching the surface in Russia!

But this explanation flies in the face of most expert opinion on Russia. It could be that they were just exploiting the top layer of oil fields and bungling that with over-production, putting a damaged cap on a lot of stranded oil to be recovered later with secondary recovery at lower production rates and low net energy levels. In my comments on the above cited article, I said this back in 2007:

Russia's very big part in the global peak can not be considered apart from the very large impact of the very large Soviet Union. The Russian production chart isn't a case of a single peak per Hubbert's theory, but what is going to be a twin peak ... One interesting article is this one written by an Air Force major in Air University Review in 1980. Way back then, he sounded just like Simmons today only talking about Soviet fields and predicting a production collapse by the mid '80s (which, in fact, did happen) ... He points out that Russia ambitiously directed over half of their oil exports to Eastern Europe and other parts of the expanding empire, and other geopolitical factors that led to serious overproduction where "...rewards for exceeding goals are given without regard to productivity over the long term ...The consequences are...overproduction of existing fields using low productivity techniques that reduce the total amount of recoverable oil." The major was thus accurately predicting the first Russian peak (a Twilight on the Tundra).

The Russian over-production was apparently bad enough to be a military cause for concern in 1980, just before the production collapse of the mid '80s, which was about it for the primary recovery of conventional crude according to Simmons. But as I said earlier, we mustn't just blame Russia for a possible field damaging production spree in years past. Any country with the elephants and an urgent need for oil revenue was about equally to blame:

Venezuela's chart looks even worse. In fact, the study by Political Economist cited in these charts looks at the top 11 mega producers, and all but Canada, US, China, and UAE have been severe over-producers. I'll give Iraq a pass on this since its erratic chart from political instability can't tell us much. Did everybody in the oil business over-produce. The study gives a chart for global production without these top 11:

Note that it is dropping off sharply from the 2005 peak.Clearly, not everybody over-produced. It was the large field owners that stepped in to the driving demand excess 45 years ago that were also playing all the political fun and games.  The geologists weren't in charge as they were elsewhere. The vast majority of the earth's fields were run sensibly. But here's the thing - The big 11 producers account for over 70% of the projected global peak production. They have done their deeds to the earth's elephant fields, the irreplaceable ones that have been mostly exploited. This soon may come back to haunt us.

Governments running oilfields is still a problem, as this article "Oil's Dark Secret" details. About 90% of the post-peak half is owned by state-run companies. Because they are not good at exploiting what they've got, "oil production will be even more concentrated in the hands of the national firms of Russia and the Persian Gulf."

All this is not good news for those of us stuck on the post-peak side of conventional oil's foreign affairs fun and games. Energy planners and forecasters tend toward an existing field post peak average decline rate of about 4%. But consider this. The Cantarell elephant field of Mexico, as recently as 2004, was the biggest producer in the world except for the Saudis' Ghawar field. It was over-produced in its later stages and has declined now to just 12% of its peak production, a 14% annual decline rate as opposed to the widely assumed 4% for existing production.

All fields behave differently, but if we are underestimating over-production damage to our elephants, we could all be in for a surprising oil production decline rate from damaged fields. Without the policies and infrastructure built needed to get us off the high net energy of conventional oil, with such things as The Pickens Plan, we may be left with a net energy crisis a few short years down the road.

This all sounds very gloomy. But there is a lot of high cost oil out there yet to be drawn into the market by high prices. We found that out when oil was at $105 and climbing in 2012, which drew a flash of American shale oil out of the rock. I'm writing an article on what's really out there in shale, and it shows that the U.S. shale experience is not easily replicated globally. But it will be replicated! Due to several factors, global shale oil will be slower to ponce on high oil, and may be more expensive. And I think oil will be cheap for a while before global shale supply is activated. But we are going toward a global secondary recovery cost norm (think bypassed oil, shale and other "dreg" oil). It's expensive but there is a lot of it. We think of the break-even cost for shale as about $60. But Art Berman believes that counting the typical total balance sheet tendencies of these aggressive companies, it's more like $100 for the "going concern" oil price. Oil at $200 will mean serious demand destruction and belated switch-over to natural gas. So I see oil modulated at $100 or a little more for a long time, if we can keep net energy from falling over the math cliff, as I discussed in this article- a big if.

We (Marketocracy) are publishing an article at Forbes online this week about an investing strategy for all this and a discussion of one stock in particular. The tentative article title is "Russia, Saudi Oilfield Mismanagement" in interview format with Ken Kam as the contributor. You can google to read it, probably later this week.