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Sunday, February 05, 2006


In his State of the Union address last week, President Bush pledged to reduce oil imports from the Middle East by 75 percent by 2025. Never mind the fact that the pledge is politically peculiar because the two countries from whence the U.S. gets 90 percent of its Middle Eastern oil –Iraq and Saudi Arabia—are also fundamental to the war on terrorism; even if we didn’t buy their oil, we would still be crucially concerned about Saudi and Iraqi politics. The current U.S. concern about Iran, from whom we purchase no oil, makes that point abundantly clear. Nevertheless, supposing that not buying Middle Eastern oil were a worthy aim, how would we replace the 2.5 million barrels per day the region supplies us?


The answer at first glance depends upon the price of oil in the years between now and 2025. If oil prices were to fall back significantly from current levels to the historically more normal $20 to $28 per barrel range, oil from the Middle East will capture more of the market because production costs in the Middle East are so low. Alternatively, if prices remain in the $45 to$ 60 barrel range over the long term, supply from regions where production is more costly will compete with Middle Eastern production and capture more of the market.

The Energy Information Administration (EIA) forecasts production out to 2025 according to three price scenarios: a low price case of $21 per barrel, a high price case of $48 per barrel, and a reference case in between at $35 at per barrel. In the low price case, total world demand is projected to be higher, reflecting the higher growth rates that would result from the lower cost of oil. In the high price case, total world demand is expected to be lower given the softer growth that would result from higher energy prices. The reference case, of course, projects world economic growth and oil demand somewhere in between.

In the EIA’s low price case, demand for oil in 2025 is robust at 135.2 million barrels per day, up from the current demand of 84 million barrels per day. In that scenario, production from the Persian Gulf countries is expected to increase 142 percent to 50 million barrels per day, while non-Persian Gulf production is expected to increase only 44 percent to 85.2 million barrels per day. Persian Gulf oil would thus make up 37 percent of world supply, with other sources contributing 63 percent. In that case, it would be difficult for the U.S. to replace its Middle Eastern oil.

In the reference case, demand is still strong at 122.2 barrels per day. In this scenario, production from Persian Gulf countries is expected to increase 90 percent to 39.3 million barrels per day, while other sources will increase production by 40 percent to 82.9 million barrels per day. The percentage of the world’s oil coming from the Persian Gulf would increase to only 32 percent, with the remaining 68 percent coming from non-Persian Gulf sources. It would still tough to avoid Middle Eastern oil, but possible.

In the high price case, demand comes in at only 115.5 barrels per day. In this scenario, Persian Gulf production increases by only 34 percent to 27.8 million barrels per day, while non-Persian Gulf sources increase production 48% to 87.7 million barrels per day. If that happens, non-Persian Gulf sources would capture 76 percent of the market, while the Persian Gulf would supply only 24 percent of the market, about 2 percent less than it supplies today. Clearly then, high prices would help the U.S. if it wished above all to avoid Middle East oil.

So, which price case seems most likely? Once one digs in to the numbers, the picture becomes a little less clear. In the low price scenario, the EIA projects Saudi Arabia at a whopping 20.4 million barrels per day in 2025, a 94 percent increase over their already world-leading 10.5 million barrels per day. However, even the oft boastful Saudi’s themselves have never suggested that they could produce more than 15 million barrels per day. Most of their oil comes from aging super-giant fields that will increasingly demand expensive secondary recovery techniques to maintain production. While Saudi Arabia has smaller undeveloped fields it can bring on line, new projects come with smaller economies of scale and increased marginal production costs. The EIA does not give detailed estimates on production costs from the various producers under the alternative scenarios, but it could hardly be in the Saudi’s interest to produce 20 million barrels per day at $21 per barrel. And since Saudi Arabia, as the anchor producer in OPEC, has some control over prices, it seems highly unlikely that it would ever produce enough oil to hit the low price scenario described by the EIA.


Given the Saudi numbers and the two dozen or so other reasons why oil will not settle again in the $21 per barrel range, it seems safe to dispense with the low price case presented by the EIA. However, the EIA’s reference price scenario also yields some peculiar country and region level details. The major production boosts in this case are expected from Saudi Arabia, the former Soviet Union (FSU), Iraq, Kuwait, and Africa. The Saudis here are projected to increase production to 16.3 million barrels per day. This figure is probably too high for the same reasons as the 20.4 million barrels per day was too high, but it is at least plausible at $35 per barrel.

However, the reference case also has the FSU coming in at 17.6 million barrels per day. This figure is much harder to fathom. Russia’s primary producing region, its giant West Siberian basin, is well along in years and losing production capacity at around 3 percent to five percent per year. To make up for that amount, Russia is producing increasingly smaller West Siberian fields at ever increasing production costs. One recent study suggested that Western Siberia is expected to remain Russia's main production base, with crude output climbing there, but only until 2010-15 when it will level out at about 6 million barrels per day.

New oil production in Russia will have to come from several large projects, such as the Timan-Pechora basin, Russia’s Caspian Sea reserves, and its Sakhalin Island projects. The Timan Pechora basin holds an estimated 4 billion barrels of reserves, but it is still early in its development. The largest and most developed project there, the ‘Polar Lights’ project, is expected to yield only 440,000-460,000 barrels per day by 2015. Furthermore, Russia’s Caspian Sea reserves, once a source of great hope, have yielded a disappointingly high gas to oil ratio thus far. An optimistic projection puts Russian Caspian production at 500,000 barrels between 2010 and 2020. The Sakhalin Island projects too have been fraught with challenges and disappointments. Development of the frigid Island has been slower and much more expensive than had been expected and only two of the six production sites there are anywhere near market viable production. Output at the most advanced Sakhalin project is expected to be only 250,000 barrels per day in 2010.

The other major challenge Russia will face if it is able to significantly increase production is getting its new oil from remote production sites to market. The Russian pipeline system is currently operating at full capacity and new capacity to remote locations will be slow and expensive to build. Given the entanglement of the Russian oil industry with Russian politics, it seems unlikely that the most efficient path possible will be traveled to boost the production and transportation projects that will be necessary if Russia is to get anywhere near EIA’s expectations for the country.

The same transport problems dog the FSUs other primary oil producer, Kazakhstan, especially because much of its oil exports go through Russia. New pipelines from the Caspian Sea to Turkey in the West and from Kazakhstan to China in the east will help, but not nearly enough to account for the massive production increases surmised by the EIA report. While nineteen years seems like a long time to reach the EIA goal, it is not such a long time in oil years. Production and transport infrastructure of this magnitude would require tens of billions of dollars and geopolitically dicey international involvement to build, and neither Russia nor Kazakhstan has been a place in which international oil companies have felt particularly safe in recent years.

The EIA reference price case has Iraq producing 6.6 million barrels per day in 2025, up from its current level of around 2 million barrels per day. While that very well could be the case, it seems by no means certain or even likely. Wars and revolutions have a funny way of interfering with oil production. Iran is a good case in point. Before the Iranian revolution, the country produced 6 million barrels of oil per day. It has struggled in the 25 years since then to climb back above 4 million barrels per day. Even once the situation in Iraq is stabilized, it will take massive amounts of foreign investment to bring Iraq’s dilapidated oil infrastructure back to life, let alone accomplish the 230 percent increase envisioned in the EIA’s reference price case.

Kuwait is projected by the EIA in this scenario to increase production 148 percent to 5.2 million barrels per day. Kuwait indeed has big plans, dubbed “Project Kuwait” to permit foreign oil companies to invest in upstream production, though only with "incentivised buy-back” arrangements, wherein the Kuwaiti government will retain full ownership of oil reserves, control over oil production levels, and strategic management of the ventures. Foreign firms are to be paid a "per barrel" fee, along with allowances for capital recovery. While not as attractive as production-sharing arrangements, the Kuwaiti plan should generate significant international interest. The problem with regard to the EIA projection, however, is that Kuwait itself plans for the project to top off at 4 million barrels per day, a good bit short of the 5.2 million assumed by the EIA.

Africa, finally, is projected by the EIA reference case to increase production by 119%, from 3.1 million barrels per day to 6.8 million barrels per day. However, the EIA does not include in this figure Africa’s three most prolific oil producers, Algeria, Nigeria, and Libya, which it tallies separately with OPEC. This leaves Angola, Gabon, Equatorial Guinea, and Sudan to carry the load. With the exception of Angola, none of these producers have ever produced anywhere close to a million barrels per day, and in most of these countries production has been falling. While China has been a major foreign investor in several of these countries, political instability and corruption will make EIA investment and production targets extremely difficult to meet.


In the EIA’s high price case, even higher figures are given for the FSU and Africa. If the reference case estimates for those two regions seemed unrealistic, the high price scenario estimates of 20.4 million barrels per day from Russia and 8.1 million barrels per day from Africa seem out of the question. However, in the high price case, Saudi Arabia is projected to supply only 11 million barrels per day, hardly more than they now produce. Should Russia or Africa fall short of their lofty targets, it does not seem unrealistic to imagine 15 million barrels per day coming from Saudi Arabia. The high price case also estimates 121 percent increase from Canada to 6.4 million barrels per day. That seems reasonable given the abundant but high cost reserves in Alberta’s Athabasca oil sands region. At $48 per barrel, those reserves become economically viable.

The most peculiar figures in the EIA report, however, concern Venezuela, which also has abundant oil sands reserves. In the low price case, the EIA has Venezuela producing 7.3 million barrels per day, a 135% increase over recent levels. However, at increasingly higher prices, the EIA estimates a lower output from Venezuela. In the reference case, it projects 5.6 million barrels from th country, and in the high price scenario just 3.9 million barrels per day. Despite having reserves similar to Canada’s and a comparable infrastructure connecting it to the world’s largest oil consumer, the EIA’s production projections for Venezuela and Canada are almost precisely inversed.


Political pledges and oil production projections are similar in one regard: they are often made and almost never borne out by subsequent events. The combination of the two hardly leaves one with anything to stand on. The good news for Bush is that if the EIA is right in its high price scenario –and it seems reasonable to think that prices will stay high—the world will be awash in Russian, Iraqi, African, and Canadian oil come 2025. The bad news for Bush is that it is hard to imagine given the political and economic characteristics of Russia, Iraq and Africa that the EIA is right. If such high production targets are to be reached, massive investment and international involvement will have to begin soon and be sustained for the next 15 years. While Venezuela might make up for some of a shortfall in any of those countries, it will be Saudi crude that makes up most of the difference. So much for reducing dependence on Middle East oil.


At 7:31 AM, Blogger David Amulet said...

It's good to see someone crunching these numbers. It seems like to achieve the goal of reduced dependence on the region, we should root for ... higher prices! Now THAT's an unexpected finding.

-- david


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