The Quiet Road

Yesterday an article appeared in The Independent over in the UK with the title, Where’s the rest of the oil? As is the case with so much written in the mainstream media about this subject, it’s yet another piece riddled with misunderstandings, factual errors and untenable conclusions by a business journalist with little or no insight into the oil industry. Not that everything in it is wrong, but there are enough basic mistakes and research failures to cause one to despair that this should have appeared in the “Analysis and Features” section. If this is the best analysis that The Independent can muster, it calls the entire publication into question.

The article begins thus:

When BP first formed an alliance with Rosneft in 1998 to develop the Sakhalin fields in the Pacific Ocean, the UK oil giant estimated Russia’s oil reserves at 56 billion barrels.

When BP agreed its share-swap with the Moscow-based energy group last weekend, the estimate was 75 billion barrels, and development of Rosneft’s licences inside the Arctic Circle could increase production enormously.

Such advances undermine the pessimists’ predictions that the world’s oil will imminently run out. In 1956, when the concept of “peak oil” — the point at which production starts falling — was formulated, US output was expected to fall from the late 1960s. But new discoveries have constantly pushed that date back. BP was estimating world oil reserves at 1 trillion barrels 20 years ago: now, despite record consumption, the estimate is 1.333 trillion.

Richard Northedge | Where’s the rest of the oil?

Three paragraphs in and already three problems; one glaring factual error, one obvious misinterpretation and one example of questionable judgment.

One example of questionable judgment

Firstly there’s the issue of Reserve Growth (first and second paragraphs plus the end of the third). Now, this is something I’ve covered several times before but it’s something that bears repeating as it cuts right to the heart of the oil depletion issue.

Every year BP publish their “Statistical Review of World Energy” (link to 2010 edition). This publication — or collection of publications — tends to get picked up by journalists and economists and taken at face value. This is a terrible mistake on their part and illustrates the “questionable judgment” I mentioned. It reveals a failure to investigate the methodology behind the Statistical Review of World Energy and a blind acceptance of data presumably by virtue of it having a corporate source. One wonders whether these journalists believe everything they see in advertising too… for instance, does Richard Northedge actually think BP have moved “Beyond Petroleum”?

For those who haven’t read my previous stuff on the Statistical Review of World Energy (Energy Review), let me explain why it’s not to be taken at face value. The data within the Energy Review is broken down by country. And it is generated not by some kind of geological analysis but simply by asking the governments of each country to state their oil reserves without any independent audit or verification. This might be an accurate enough method if countries had an incentive to be honest about their reserves, but in fact the opposite is true and the majority of oil producing countries have a massive incentive to inflate their stated reserves. This fact alone should make any journalist hesitate before basing their analysis on the BP Energy Review, even before they take the time to investigate the effect this incentive has had on the reporting of historical reserves.

In the early 1980s OPEC introduced production quotas based upon “proven reserves”. This sounds solid enough until you realise that “proven reserves” actually means “stated reserves” in countries that have not implemented an independent auditing system (i.e. most of them). In effect, the more oil an OPEC member claimed to have, the more it was permitted to sell and consequently the more money it made. If you download the historical reserve data (Excel Workbook) you can clearly see the result this had on the stated reserves of OPEC nations. Check out the page in the workbook entitled “Oil – proved reserves history” and pay particular attention to what happened in the 1980s just after the new quota system was introduced.

Some examples… in 1986 Iran’s reserves jumped from 59 billion barrels (bb) to 93bb. They then remained identical for the next 7 years (implying that Iran somehow managed to discover exactly the same amount of oil per annum as they were producing) before starting to creep up again. A couple of years later, Saudi Arabia’s oil reserves leapt from 170bb to 255bb and has remained pretty much constant ever since. The same pattern can be seen across most OPEC nations. Venezuela doubled its reserves in 1985. Yemen doubled in 1986 and again in 1987. In 1986 UAE trebled their reserve estimates. And in the subsequent 25 years, no OPEC nation has significantly revised their reserves downwards (in fact many of them, as with Iran, simply report identical reserves for years on end).

If you believe that every OPEC nation somehow managed to discover as much new oil as they already possessed in a two year period in the 1980s just at the precise moment they gained a huge financial incentive to overstate their reserves, then may I suggest a certain level of naivety on your part. Particularly as there’s no actual evidence for a massive series of discoveries at the time and no parallel discoveries outside the OPEC nations.

As well as the OPEC nations, in recent years Russia has also found itself with an incentive to overstate reserves in the form of inward investment in oil and gas infrastructure that naturally increases in direct relationship with their claimed reserves. Tellingly, there is also no official independent auditing of Russian reserves.

What this means is that while I cannot say with any certainty that Saudi reserves (for example) are significantly lower than those stated in the BP Energy Review, I can state with confidence that relying on the accuracy the BP Energy Review is a very foolish thing to do. When Richard Northedge says that “BP was estimating world oil reserves at 1 trillion barrels 20 years ago: now, despite record consumption, the estimate is 1.333 trillion” it’s not a revelation of growing reserves but of the complete nonsense of reserve reporting.

An examination of the reporting of those nations with transparent reserve auditing procedures reveals a telling contrast. Norway’s reserves grew gradually in the 1980s, hit a peak in the year 2001 and then entered decline. This completely tallies with what we would expect given a basic understanding of petroleum geology. There are no sudden doublings and treblings of reserves. No decade-long periods of unchanging reserves. Just a gradual rise, a peak and a gradual decline. Only two weeks ago, in fact, Norway announced a further reduction in reserves based upon falls in new discoveries and a downgrading of existing fields. The fact that every nation with transparent reserve accounting demonstrates this behaviour, while nations that lack independent auditing and have financial reasons to lie demonstrate the complete opposite should surely ring alarm bells for any half-decent journalist or analyst.

One obvious misinterpretation

In the third paragraph Richard Northedge writes of “pessimists’ predictions that the world’s oil will imminently run out”. I’d challenge him to provide one example of a serious analyst who makes such a prediction. In reality no such analyst exists. The claim that we are approaching peak oil is not a claim that we are about to run out of oil. The clue is in the name… peak oil. To suggest that those of us who have been banging on about peak oil for the past 14 years are predicting “the world’s oil will imminently run out” is a complete failure to understand what peak oil means.

Peak oil is quite simply the point at which oil production peaks and enters terminal decline (see, I told you the clue was in the name). What’s interesting is that it actually occurs at around the point that half the oil has been extracted from a given well, field, nation or planet. So when I say we have passed the peak of global oil production (which I believe probably happened about 4 years ago), I’m not saying we’ve run out of oil. I’m saying we’ve used up half of our oil.

The reason this is important is because once you reach the halfway point, the flow of oil drops off. This is down to the basic physics of oil reservoirs and there’s just not much that can be done about it. It’s also important because from that point forward, every barrel takes incrementally more energy to produce. This is one of the things that so many people fail to realise about “non-conventional oil sources” such as tar sands, oil shales, deepwater and polar oil reserves… just like crude oil from a post-peak well, they require far more energy to extract than the oil we get from a pre-peak conventional well.

Take, for example, a relatively young field in the Saudi desert. From extraction through to the refinery and beyond, we might get a hundred barrels out for every one barrel (energetically speaking) we put in. In energy terms this is known as EroI (Energy Return on Investment) or sometimes NER (Net Energy Ratio). Clearly as the ERoI of a given energy source falls, the less economically useful that source becomes. So peak oil not only means there is physically less oil available, but that more of the oil that is available is going back into producing oil (as opposed to fueling our cars, our factories and our farms).

Because oil is by far the most economically important fuel available to us (and not just in terms of fuel, but also as a raw material for a vast array of products), a reduction in available oil ultimately translates to a reduction in economic activity*.

Now, in fairness to Northedge he does correct this misinterpretation later in the article when he discusses the idea of peak oil in more depth, but the way he expresses himself in that third paragraph does a massive disservice to the entire debate around this vital issue and is sloppy at best, and at worst is biased. Even the word “pessimist” is value laden and has no real place in this discussion. There are low reserve estimates (usually produced by petroleum geologists) and there are high reserve estimates (usually produced by economists and politicians). To suggest that the low estimates are “pessimistic” is to imply that there isn’t a coherent methodology behind them, and that they are at least partly the result of personal disposition.

This is not the case. Indeed the “coherent methodology” is all but denied by Northedge when he writes: In 1956, when the concept of “peak oil” — the point at which production starts falling — was formulated, US output was expected to fall from the late 1960s. But new discoveries have constantly pushed that date back.

One glaring factual error

The concept of “peak oil” was first proposed by M. King Hubbert in the 1950s. He was a respected petroleum geologist working for Shell Oil in Houston and his position gave him access to US oil reserve data. Hubbert first observed the rate of oil production for a specific oil well and graphed this data. This became known as the Hubbert curve and has been verified as accurate hundreds, if not thousands, of times with respect to individual wells. He then extended this model to a given oil field where it was also verified as accurate. Ultimately, taking the data from every US oil field (excluding Alaska) he extended the model to the entire continental United States. The curve predicted a peak in US oil production “around 1970” (there’s always a small margin for error when dealing with massive amounts of geological data).

What’s remarkable is just how small that margin for error actually was. US oil production in fact peaked in 1971/72 contrary to Northedge’s puzzling claim that “new discoveries have constantly pushed that date back”. That’s just plain wrong and is the sort of thing that any fact-checker should be able to find in a matter of minutes. In fact, US per annum oil production today is roughly half of what it was in 1971 despite the fact that entire new areas have been added (Alaskan and major off-shore fields) which were not part of Hubbert’s original calculation. And the decline has indeed been roughly in line with the Hubbert curve. It’s mind-boggling that a piece of analysis should appear in the business pages of a serious newspaper that contains such a blatant error.

And on it goes

The rest of the article is less contentious, but the tone has already been set. It points out that the current recession has resulted in a significant drop in oil consumption, though fails to acknowledge the high probability that the recession was partially** caused by high oil prices resulting from supply constraints. The article mentions the dramatic increase in reserves during the 80s, though fails to investigate why such a dramatic jump should have happened within OPEC and other nations without transparent reserve auditing, but nowhere else. Right when financial incentives were introduced in those countries to overstate reserves.

The article informs us that “Saudi Arabia has sufficient supplies to meet its needs for 66 years and Iraq has enough for 142 years” without really making it clear that these figures are essentially meaningless given that these nations are responsible for a fairly insignificant proportion of global consumption. In fairness, it does point out that “the US would run out [of oil] by 2018 if it did not import”.

But even that is dreadfully misleading. If the United States ceased importing oil, the economy would collapse immediately, not in 2018. You cannot simply divide reserves by time in this way. That fundamentally misunderstands the nature of oil production, which as I’ve said, occurs at a rate determined by the geological properties of the oil field. It’s not determined by demand. The United States currently consumes about 18 million barrels of oil per day. It produces about 7 million. What precisely would happen if you were to take 11 million barrels of oil per day out of the US economy? Anyone think it would keep ticking over until 2018?

This is why BP’s claim that we have enough oil left for 45 years is a recipe for dangerous complacency. Not only is that estimate based upon unreliable data, but it completely fails to acknowledge the physical constraints involved in oil production.

Then the article highlights recent oil discoveries. Now, there’s no question that 2009 and 2010 have been fantastic years in that regard. But they are anomalies. Spikes on a downward trend. In 2009 we discovered roughly half as much oil as we consumed. And that was the best year in a decade. In 2010, thanks to a major discovery near Brazil, we discovered even more. But it’s vital to get your head around the fact that not only were these bucking a clear trend, but they were largely offshore, deepwater discoveries. The ERoI of deepwater oil is nothing like as high as with the monster fields of the past. And I hope I’ve made it clear that ERoI is just as important as sheer volume.

Based upon these new discoveries, Richard Northedge finishes with the statement that “The day the world’s energy sources run dry is thus being pushed even further away…” It’s a shamelessly misleading conclusion and one that completely ignores the reality of the looming crisis we face as a result of falling oil production. A crisis that the Pentagon (that hotbed of fringe radicalism) suggests will be upon the world within the next 12 to 18 months.