Primer: Peak Oil

The record run-up in oil prices over recent years is igniting fierce debate over the "peak oil" theory — that once the maximum rate of global crude production is reached, it begins a terminal, and possibly steep, decline.

It has become a high profile debate — Boone Pickens weighed in on it before Congress — that depends not just on whether one tends to see the barrel half empty or half full — it’s often a question of getting a good look at the barrel.

That’s certainly a debate swirling around OPEC countries — which produce about a third of the world's oil — which are widely believed to overstate their reserves. Just how much, no one knows.

The reason: cartel members' reserves are the basis for calculating quotas; the lower the reserves, the less oil they can sell. (Non-OPEC, oil-producing countries are more transparent on the subject because their respective international oil companies have to report estimated reserves to investors.)

So far, there is no definitive indication that production is headed southward, much less that any decline is permanent. Saudi Arabia, for instance, recently demonstrated its heft by bringing on excess capacity.

To be sure there are warning signs. Global production fell last year (by 0.2 percent), while consumption continued to grow (by 1.1 percent), and peak oil proponents (which includes an international association) say this squeeze will really bite by 2010.

Skeptics insist oil remains a cyclical business, where the question is always how much oil at a certain price. By this reckoning, today's high prices will eventually lead to more supply — through more exploration, enhanced recovery and development of "unconventional" oil.

Geological variables are just part of the supply equation. Human factors — politics, taxes, investment levels, and that 80 percent of the world’s oil is state-controlled — can be equally important.

It's no wonder, then, that passions can run high in the peak oil debate, sometimes to a pitch that makes it a challenge to bring rival camps to share a stage. That's where a cyber soapbox comes in handy. Here we present two opposing views from long-sparring rivals.

Mike Eliason

Matt Simmons

Matthew Simmons, who leads an independent, Houston-based investment bank,Simmons & Company,specializing in the energy industry, is the author of "Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy,"which popularized the theory of peak oil, and firmly believes production isn't going any higher.

Michael Lynch, president of Strategic Energy & Economic Consulting, has been a long-time peak oil skeptic.

How were you convinced (either way) about peak oil, and does the recent run-up in oil prices provide evidence confirming or contradicting peak oil?

Simmons: I’m a data nut. I don’t really care what people believe [about oil supplies]. I wrote my book after reading some 200 technical reports about the declining oil fields in Saudi Arabia.

You can line up upwards of 50 to 60 individual oil fields that are of significant size, and they all have that same trajectory. (For instance, Prudhoe Bay, the largest US oil field, maintained peak production — 1.5 million barrels per day — for 11 years but is now down to 200,000 bpd, and within five years will be at 50,000 bpd.) If you look at that, it becomes more and more clear that if we are not at peak oil, we are at a mesa.

Lynch: Peakists predict a peak and it comes and goes, and then they predict a new peak and keep insisting the method is correct. It’s just a little premature. But we see oil production going up and up over time. Over the last 10 to 15 years we have had a number of peaks and declines, followed by new increases in production.

I agree there is cause for concern. There is no question we have seen the worst non-OPEC performance, probably historically ... and this has gone on for about a decade. But I think a lot of that is explainedby the shift of investment money.

How thoroughly has the world been explored, and is it clear that there are very diminished prospects for finding giant elephant fields?

Simmons: The history of finding new basins has generally come towards the end of a very disappointing exploration program and somewhat as a surprise — that’s how we found West Siberia, the North Slope and the North Sea. It took a decade of poking around and then all of sudden — bingo! — they find a producible structure. The problem is that we have been poking around in all the known areas and we have not had a bingo event for a long time. The Saudis have been on a scavenger hunt for 45 years and have found nothing. The closest thing we have had in recent years was the deepwater of the Gulf of Mexico.

Lynch: Almost every year the industry has added about 5 million barrels a day, mostly to cover depletion, so it seems kind of invisible — but that's Ghawar (a Saudi giant field). We are not finding anything like Ghawar, but if you ask people where did you find 25 million in the last five years, most people would not be able identify a fraction of that.

What do you consider the most encouraging discoveries? For instance, how significant is the recent Brazilian off-shore oil find,and what about the US Geological Survey's assessment (shared by the Russian and others) that the Arctic is rich with hydrocarbons? And don’t new explorations advances make discoveries more likely?

Michael Lynch

Lynch: Twenty years ago, we did not have the technology to go into deepwater or sub-salt and now you are starting to see these new areas, in Brazil, off Indonesia and Malaysia and new finds in East Africa — these may not be elephants but ducks.

India and China have been run by state-owned companies for a long time, so until very recently they were way behind technologically, so you've got to expect there is a lot of potential. In Russia too, depending on the political situation. BP's joint venture had been saying they were going to increase 10 to 15 percent a year for a long time before their latest political problem. The Caspian [Sea] still has a long way too. In the Gulf of Mexico, the Jack discovery byChevron means there is going to be a bunch more — potentially 11 billion barrels in the whole basin.

Simmons: It is always possible we will find another North Sea, but it’s not within the realm of possibilities that we will find seven North Seas.

Petrobras is trying to corral 70 deep-water rigs by 2017, so it is my guess that it will be 2025 before we really have any idea whether the Santos basin could be anything remotely like the North Sea, which peaked (in 1999) at 6.1 million barrels before it went to half that seven later. In 40 years we have drilled 220 dry wells in the Arctic. So before we become too optimistic about Arctic oil, we better find some first.

In releasing its recent Statistical Review of World Energy, BP recently said there are 1.24 trillion barrels of oil left, (other estimates say the remaining global oil resource base is actually 3.74 trillion barrels) and that the supply limits are due less to geology than human factors. Do you agree with that?

Lynch: Geology matters, but so do taxes, politics and so forth. Mexico is an example. What happened there is a budgetary battle. Pemex [the national energy company] said our costs have gone up, we need a bigger budget or production will collapse and after a long delay the government is giving them more money; production should at least stabilize, perhaps rise in the next year or two.

Simmons: The optimists all say the only thing we have to fear are the above ground risks, and there are a surprising number of above-ground risks we need to be concerned about.

[But] we will all probably go to our graves wondering, had we actually had enough rigs, had we had enough people and had we spent enough money, or had we not drilled all those dry wells, we might have actually not ended up with oil being produced in ten years from now at 40 to 50 percent its current rate.

How important are Enhanced Oil Recovery (EOR) efforts in stanching depletion rates in oil friends?

Simmons: Human beings and oil fields have a remarkable number of similarities. When finally old people start rapidly aging, the quality of their life goes down and the cost of their life soars. That’s what EOR is all about, and it has been around for 50 years. We are just using it more. Towards the tail end you can actually do an enormous amount to extend production life for years, but it is extremely expensive and it basically only stabilizes at a low base.

If we have a decline rate [in flow rate] of 4.5 percent, (as a report from Cambridge Energy Research Associates maintains) that means we have to add a new Iran every year. The likelihood of that is impossible. I think the actual current decline rate is 8 to 10 percent.

Lynch: Reserve revisions, through a combination of new discoveries and growth in old fields, are basically holding up all over the world.

If a company in the North Sea adds 3 million barrels to its reserves by drilling an extra well in some field, you just don’t hear about it, and especially when prices are high, people are doing that all over the world and it adds up.

I recently heard when ... geologists working on three California fields that have been producing for 100 years were asked how much oil is left, they said they had no idea. People like Simmons ask how is that possible; well, it's down in the ground, you can’t really see it.