Today's Analysis: Report: Saudi Arabia Oil Production Tapped Out

Secret government papers are raising concerns about Saudi Arabia's ability to increase oil production significantly, raising the danger of perpetually high oil prices and the potential for frequent shortages.

According to the New York Times: "doubts about Saudi Arabia's assurances of how much it can expand capacity - and for how long - have been raised in a secret intelligence report and in a separate analysis by a leading government oil adviser."

The Times added the following: "a senior intelligence official, who insisted on remaining anonymous because he was not permitted to speak publicly on the issue, said that the Saudi plans to increase production by nearly 14 percent in the next four years were not enough to meet global demand. Even the Energy Information Administration recently scaled back its expectations of how much more oil the Saudis could pump in 20 years."

According to the Times, the Bush administration has relied on the Saudi government to provide crisis management of oil supplies, and the Saudis, until recently, before huge demand from Asia, had been able to meet expectations. But, now, things have changed: "Saudi Arabia's capacity now stands at about 11 million barrels a day. The Saudis pump about 9.5 million barrels, leaving a cushion of about 1.5 million barrels, mostly of heavier grades not very usable in the West.

There is virtually no other global spare capacity. "

Aside from Matthew Simmon's book "Twilight In the Desert," a literature review which concludes that Saudi oil reserves are running out, there are others, with inside knowledge of the Saudi infrastructure, who assert doubt about the kingdom's oil promises. According to the New York Times: "there are doubts about the Saudi assertions about how much oil they have. Data about reserves is tightly guarded, and the Saudis dismiss skeptics as uninformed. But they do not dismiss Edward O. Price Jr., the former head of exploration for Saudi Aramco and an adviser to the United States government on Persian Gulf oil during both Iraq wars. He questioned future reliance on Saudi capacity in an article in The New York Times last year and wanted to know from his former colleagues how they reached their estimate of more than 150 billion barrels of extra oil. Twenty years ago, a detailed study by geologists from four large American oil companies then in partnership with Aramco found little in the way of undiscovered oil resources, he said."

According to the Times, Price met with Dr. Nansen G. Saleri, the head of Reservoir Management for Saudi Aramco, the Saudi national oil company, in the United States, last year. Saudi Aramco declined to discuss the meeting, but the Times reported Mr. Price said in an interview that "Mr. Saleri told him that the basis for the higher oil figures was a global study in 2000 by the United States Geological Survey estimating Saudi Arabia's undiscovered resources at 87 billion barrels."

Price questions the validity of the U.S. Geological Survey study, and is not alone. According to the Times: "Questions about Saudi Arabia's long-term estimates were also raised last year in a report by the National Intelligence Council, an advisory panel that produces the government's most authoritative intelligence estimates, according to a government official who insisted on not being identified because the report was classified. In addition to Saudi Arabia, the Bush administration has viewed the United Arab Emirates as a supplier with excess capacity. In 2001, the emirates planned to increase capacity to 3 million barrels a day by 2005 from 2.5 million barrels a day then. But capacity has not grown in four years, which one administration official attributes to a lack of urgency by emirates officials and a lack of high-level attention by American officials."

Finally, according to the Times, the United Arab Emirates, long expected to increase its output, has failed to do so, along with Iraq, whose production, due to "improper management of the reservoirs," has actually decreased since the war started.

Conclusion

This is yet another article, by a presumably credible source, the New York Times, about the increasingly tight world oil supply.

The centerpiece is Saudi Arabia, long the world's swing producer, and at least strategically, a U.S. ally, presently, given all available information.

There have been rebuttals of "Twilight In the Desert." Most of them suggest that the author Matthew Simmons is an investment banker and analyst, and doesn't understand the science of oil.

A perfect example recently appeared in the Saudi daily, Dar Al Hayat, which attempt to throw ice on the growing notion that peak oil is here. According to the Saudi daily, the notion of peak oil is "complex," and "is a mere scientific issue, just like all scientific issues, that only experts in the field of petroleum geology know of, follow up on, and are proficient at. More importantly, the world oil reserves are affected by many factors, the most important of which is the oil exploration and extraction technique. For instance, the average oil quantity that can be extracted from fields on a global level can roughly reach 40% of available petroleum quantity in the ambush of these fields. Once the petroleum extraction technique is developed, this shall increase the reserve quantity that can be produced. If this increase reaches 1%, this represents what the world consumes in a whole year."

The Saudis are raising the political card, accusing some in the U.S. of making "the issue of peak production" part of "personal and political goals." According to the paper "It seems that Mr. Simmons is part of this political campaign directed against the role of the Kingdom in industry and global petroleum markets. This campaign started to take a clear shape six or seven years ago, starting with articles by some US writers on petroleum issues, who are known for their defined political inclinations and not the objectivity of their analysis."

According to Dar Al Hayat: "In conclusion, in view of the ongoing changes in supply, demand, prices, and oil extraction technology, it is hard to identify a specific period to reach peak production. The studies also point out that the global oil supplies system is characterized by its intricacy and complexity. It lacks sufficient statistics allowing to accurately determine when the peak production will be reached. Most of the time, most advocates of the peak production theory lose their credibility because they try to foresee the specific date when global production will reach its peak, prior to a subsequent decline."

Our own view on peak oil remains unchanged. The easy oil has been found. What's left, whether plentiful or not, is hard to get at, and hard to get out of the ground, as much for political reasons, as for logistical and methodological limitations.

From a pragmatic point of view, it doesn't really matter whether peak oil is here or not. Oil is more expensive now, and it is likely to have been reset at a higher price that where it was 5 years ago. Whether that price is $40 or $60 is practically irrelevant from an investment point of view, since higher oil prices are starting to be factored into the logistics, and the price structures of all goods and services.

In a very real sense, as we noted in the conclusion of 2002's "Successful Energy Sector Investing," where we predicted that as long as President Bush and Vice President Cheney were in the White House, energy would be a central topic, that China would rise as a major oil player, that Venezuela would cause all kinds of energy related problems, that California's energy problems would continue, and that the days of cheap oil were over, "our world will never be the same."

Oil Market Summary: $60 Holds Again.

Supply data dropped prices slightly on 10-26, but worries about cold weather are keeping prices up.

At the core of the supply issue remain heating oil, and natural gas, with gas supply numbers due out later this morning. The $14 area is the key for natural gas prices.

This could be an interesting day in prices, though, because of the New York Times article, described above, on Saudi Arabia's oil supplies.

The amount of U.S. production capacity that is offline has remained fairly constant over the last two weeks, suggesting that little progress is being made, an especially important set of conditions as what could be a very long and cold winter hears.

Oil traders are keeping the market in a trading range as $59 has been the floor lately.

As we've noted, the scenario of a bounce in energy continues to build, and may get a boost when supply data is released. Lately, there has been a surprising large build in stocks, while the market has been expecting a series of draw downs. If stocks rise beyond expectations, though, we could see the $59 area give way.

Still the market is oversold. Oil has been falling for almost a month, and the bull market is now in question, as the price in the December contract is approaching the 200 day moving average, near $56. If this key level is taken out, we could see an acceleration of prices to the down side. But, if it holds, we could see some kind of a bounce.

It's that bounce, and the conditions, especially in the weather, that are present during the bounce, that should be of concern. When hurricane Wilma makes it up to New England, and runs into two other weather systems, as forecasters are expecting, what will happen? Will there be three feet of snow? And is there going to be a surge in demand for heating oil and natural gas, this early in the season?

On the charts, if prices break below $56 on the December crude contract, there could be move toward $50. $71 is key resistance.

The Philadelphia Oil Service Index (OSX) moved back above the 160 area.

Dr. Joe Duarte's Market IQ appears daily at Joe Duarte. Duarte is author of the upcoming book "Futures And Options For Dummies," due out in December 2005. His "Successful Energy Sector Investing" is available at the Rigzone bookstore.

In the Rigzone Store:

Successful Energy Sector Investing: Every Investor's Complete Guide

Dr. Duarte's book predicted many of the current developments in the economy and the energy markets, and provides an excellent set of benchmarks and trading lessons for what could be in store for the future.

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