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CHEAP OIL — ENJOY WHILE IT LASTS

by Howard Banks, 06/15/98

 

NOT THIS YEAR, nor the next, but maybe as soon as five years hence, oil prices will start to rise, says Franco Bernab, chief executive of the Italian oil company ENISpA. Well before 2010, he believes, the world will be vulnerable to 1970s-style oil shocks.

Speaking to FORBES in London in early May, he says, “There is a great deal of complacency among politicians and economists that the oil problem is over. But despite today’s low prices, in the long term we will be back to a high-price scenario in the oil sector.”

It sounds unlikely, at a time when crude prices have sagged below $15 a barrel. In real inflation-adjusted terms, that’s not much above the price level just before OPECsandbagged the world with $30 oil in the mid-1970s. In short, on balance, the price of oil has gone nowhere in a quarter of a century. However, Bernab — who is a former economics professor and in the 1970s was a senior economist at the Paris-based Organization for Economic Cooperation & Development — puts forward a well-argued case that oil will be a lot dearer in the 21st century than it is in the 20th.

What about technology? Haven’t things like horizontal drilling greatly increased the yield from existing fields in recent years? Sure, says Bernab, but there’s not a lot more scope to increase recoverable reserves this way.

Today’s conventional view is that prices will remain low for the foreseeable future because reserves of oil have been increasing, especially with the discoveries of oil outside the OPEC countries (the North Sea, Alaska’s North Slope). On paper, the world’s declared reserves, when related to production, are one-fifth higher than pre-1973.

“Actually, the exact opposite has happened,” Bernab says. Most of the increase in world reserves has been within OPEC, and occurred in 1987 and to a lesser extent in 1989. These were years with low oil prices. “OPEC countries boosted their reserve figures as a way [under their calculation method] to increase their shares of OPEC production through the quota system.” A negotiating ploy to boost earnings to pay for their rising debt? “It was simply a trick,” he says. Either the newfound oil existed only on paper, or it had been there all along but the owners hadn’t declared it. In either case, not new oil.

Another region claiming growing reserves is the former Soviet Union.

“These countries, too, overstate their reserves, in this case because they use the concept of geological reserves [everything that might be in the ground] rather than the West’s concept of economically producible reserves,” he explains.

Bernab’s key concern is the reserve-to-production ratio the ratio of proven economically producible reserves to actual output of the non-OPEC oil companies. He looks at the world’s 200 largest oil companies that are not owned by an oil-producing country, eliminating from his list such national companies as Saudi Arabia’s Aramco and the Iraq National Oil Co. (a group which accounts for over 60% of the world’s oil reserves). For his list of 200, Bernab says, new reserves are failing to keep up with growing output. “From 1980 to 1997, their reserve-to- production ratio declined from 18 years to 12 years.” Bernab thinks the figure will continue to decline. “Even to maintain this ratio at today’s 2.5% annual increase in world production, this group would need to replace 140% of their reserves over the next five years,” he says. This simply isn’t in the cards.

“The amount of new discoveries in the world has dropped from a peak of 41 billion bbl. a year in 1962 to 5 billion to 6 billion bbl. a year now,” he says. The peak of new discoveries was in the 1960s, with just half a dozen major fields found since then.

“The only really major new basin recently has been Africa’s Gulf of Guinea, off Angola, Congo, Gabon and Nigeria. Even the new North Slope field in Alaska contains less oil than was once hoped.

“For the U.S. as a whole, the industry is spending 15% more than five years ago on upstream capital expenditure, but without seeing an increase in reserves,” he says.

“The North Sea has accounted for over half of increased production in the last 15 years. But output there will start to decline in the next 2 to 3 years.”

Bernab points to what has been happening in the Norwegian sector.

“They have announced that their planned increase in natural gas production to 100 billion cubic meters a year from 2000 to 2010 will now be trimmed to 80 billion cubic meters. The reason is that they can only keep oil production up by injecting gas into their wells,” says Bernab.

The new field west of the Shetland Islands is also proving to be much harder to produce from than predicted.

“My forecast is that between 2000 and 2005 the world will be reaching peak production from our known fields, and after that, output will decline.” But demand will keep growing, slowly but inexorably.

Does this mean that oil prices will stay down well after the turn of the millennium and then start to go up? Not necessarily. Once the markets recognize that production has peaked while demand continues to grow, prices could move up in advance of any actual shortages.

If Bernab is right, oil and oil shares should be good investments for those who can take a genuinely long-range point of view. But there are other, more dire implications. “It will shift the power in the oil market back to the Gulf region,” he points out. More than ever, the Middle East will become a potential powder keg for war.

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