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June 01, 2007

Another Inconvenient Truth!
by Puru Saxena

THE BIG PICTURE - Let's face it, our planet is facing an energy crisis. If nothing is done to reduce our dependence on crude oil and if the human race is unable to find a viable alternative source of energy, the 1970's oil-shocks will look like a picnic! Most people remain oblivious to the fact that the supply of oil is struggling to keep up with rising global demand. And when you factor in the reality that over 60% of the world's top oil-producing nations are already past their peak output, the picture starts to cause some alarm. Now, I am not saying that our world is going to run out of oil tomorrow. Far from it! However, the rate at which we pump this stuff out from the ground is likely to enter an irreversible decline.

When painting a rosy outlook for the world's energy situation, the governments always like to talk about the huge amounts of oil reserves supposedly present in the Middle-East. Whether these "reserves" are there at all or if they have been over-stated, is highly debatable. However, what the officials forget is that reserves are not worth much if they cannot deliver oil fast enough. For example, I may claim that I have discovered a trillion barrels of oil under my backyard, but how helpful is this reserve in solving the world's energy problem if it only produces say a hundred thousand barrels of oil per day? In a world where the global demand for oil is running at 84.5 million barrels per day and supply is extremely tight (Figure 1), rather than taking comfort from the Middle-Eastern oil-reserves, we must focus on the amount of oil that we can actually bring to the market.

Figure 1: Can supply continue to expand?

Source: Dr. Ed Yardeni

Moreover, in order to grasp the world's oil supply dynamics, it is crucial to understand that every oil-field or oil-province on the planet is governed by the laws of geology. In other words, once you have extracted more than 50% of the oil present in any given field, the rate of production peaks and thereafter enters a decline. This is what geologists refer to as "Peak Oil". Now, some would argue that this is a conspiracy, but a quick look at some historical data proves that "peak oil" is a reality; an inconvenient truth!

There can be no disputing the fact that the United States' oil production peaked in the early 1970's and today its output is roughly 50% below its record-high. In other words, despite all the amazing technology at its disposal, the world's most "developed" nation, has failed to ramp up its oil-production and now imports roughly 65% of its oil. So, if "Peak Oil" is indeed a myth or a conspiracy and if new forms of technology will surely help us find and produce an unlimited quantity of oil, why then, has the most technologically advanced nation failed in this "easy and simple" task? Simply, it does not exist.

Next, let us turn to Saudi Arabia. It is interesting to note that despite their highly- advertised reserves of 270 billion barrels, Saudi oil production has in fact fallen since 2004 and is still below the record-output achieved in 1981 (Figure 2). It is not as if the Saudis do not have an incentive to produce oil when it is trading above $60 per barrel. So, you have to wonder why the Saudi's have failed to maintain let alone increase their oil production.

Figure 2: Saudi Arabia's production in decline!

Source: Dr. Ed Yardeni

It is no secret that all of the "super-giant" oil-fields in Saudi Arabia were discovered several decades ago and are very mature. Some geologists claim that these oil-fields are now in a permanent state of decline and the national oil company (Saudi Aramco) is taking desperate measures (injecting massive quantities of water) in order to maintain the pressure in their oil-fields. If this assessment proves to be correct, we are in trouble.

Over in Mexico, the news is also ominous. It was recently announced that its largest oil-field (Cantarell) peaked in 2004 at 2.15 million barrels per day and since then 600,000 barrels of oil per day has been lost due to the inevitable "peak". Today, Cantarell (the world's second largest oil field) produces only 1.5 million barrels of oil per day; a sharp fall in a short period of time! Over the coming year or two, Mexico expects to lose another 500,000 barrels per day of oil production as Cantarell's decline accelerates.

In Asia, the picture also looks gloomy. DaQing, China's largest oil-field is also past its peak output, which means that the world's most populated nation will have to import even more oil in the future.

Declining production from existing oil-fields in different parts of the world would not have been worrisome if we were still discovering gigantic oil-fields in new frontiers. However, it is my observation that over the past 35 years, only a single gigantic oil-field has been discovered anywhere in the world (Kashagan Oil-field discovery in 2000). Furthermore, it is worth noting that due to rising costs and technological difficulties, its production will only commence in 2009 and peak output may reach 1.5 million barrels per day - a drop in the ocean.

So, the point I am making is that even if we were to discover a world-class oil-field today, the supply from that will probably not reach the market for another decade and we will need to find many oil-fields to feed the rapidly rising global demand. To complicate matters further, over the coming years, it is expected that more and more existing oil-fields will enter a decline. So, rather than adding to the global supply in any meaningful manner, additional supplies from new fields may only just about compensate for the decline in the older fields. This is a sobering thought often overlooked by many oil-analysts and economists.

In any market, it is pointless to only look at supply without examining demand, so let us review some of the trends in this area. Despite elevated prices, the global demand for oil is at a record-high. So far, "high" prices have not had any impact on curbing demand. Although demand from the industrialised nations has declined somewhat, the emerging-world, led by China and India, has continued to consume ever-larger quantities of oil. Going forwards, it is expected that roughly 500 million Asians will migrate areas to urban centres over the coming decade and this will continue to increase the demand for crude oil.

Today, the average American uses roughly 25 barrels of oil per annum, whereas the average Chinese uses a miniscule 2 barrels per annum and the average Indian burns less than a barrel per year! Some of the more developed Asian nations such as Hong Kong, South Korea and Japan consume roughly 17 barrels of oil on a per-capita basis. It is worth noting that despite extremely low per-capita consumption levels, today China and India combined, consume 11% of the world's crude oil versus 6% at the start of the decade! If current growth rates continue over the next decade, we would require an additional Saudi Arabia to fulfill this demand.

Now, my research has convinced me that there is no other Saudi Arabia waiting in the ranks to meet the rising Chinese and Indian demand. Moreover, if my assessment is correct and the global supply of oil is unable to appreciate by much from the current levels (84.5 million barrels per day), we will see a significantly higher price of crude oil. Ultimately, if nothing is done to solve this problem, we may see shortages and rationing of the world's most important natural resource.

The above is an excerpt from Money Matters, a monthly economic publication, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly reports, subscribers also benefit from timely and concise "Email Updates", which are sent out when an important development in the capital markets warrants immediate attention. Subscribe Today!

Puru Saxena
www.purusaxena.com

Puru Saxena publishes Money Matters, a monthly economic report, which highlights extraordinary investment opportunities in all major markets. In addition to the monthly report, subscribers also receive "Weekly Updates" covering the recent market action. Money Matters is available by subscription from www.purusaxena.com.

An investment adviser based in Hong Kong, he is a regular guest on CNBC, BBC, Bloomberg, NDTV Profit and writes for several newspapers and financial journals.

Copyright © 2005-2009 Puru Saxena Limited. All rights reserved

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