The recession has taken the oil industry out of mind, so we are over due for a refresher course on the subject. The problem is very simple. We are technically unable to fully replace the oil resources we are consuming and this appears to be largely price insensitive.

We are discovering and perfecting ways to do a lot, but that will be not enough. We simply consume way too much because several mega fields empowered a global expansion of consumption over the past five decades. Their general decline must contract supply. The only mega field in existence with the ability to replace a part of the pending production decline is the Canadian Tarsands under THAI production provided it succeeds.

As Nelder comments, the change that has taken place is the silencing of the dream spinners. As I have posted several times, it is most probable that industry production will decline over several years by as much as forty percent, Over the past two years we have watched conditions deteriorate with a few discovery announcements fueled by the natural uptick in drilling.

The industry can sustain production levels at about half present rates for a long time, certainly decades. It is the pending loss of the mega fields that is the problem. I personally think that a great deal of expensive conventional oil exists but it is mostly behind political barriers and will as a result tend to trickle out. I am not so sure that is not a good thing.

As I have also posted, we are about ready to transition from oil to electric transportation. This alone will nicely offset the drop in supply.

The Next Oil Crisis Is Just Ahead

By Chris Nelder Friday, October 16th, 2009

I have just returned from the annual conference sponsored by the U.S. contingent of the Association for the Study of Peak Oil (ASPO-USA) with a wealth of new information and perspective to share, so this will be the first of a series of reports.

I look forward to the ASPO-USA conferences all year, because they consistently deliver good, solid data on the state of energy and afford an opportunity for vigorous and stimulating discussion with some of smartest and up-to-date experts in the world-particularly over dinner and drinks late into the night. This year was typically outstanding.

I begin with some high-level updates on the key aspects of the peak oil study.

Past the Peak?

Perhaps the thing that struck me most was how much the outlook on peak oil has changed since the first conference in 2005.

Those who thought conventional oil had probably peaked back then were considered extremely pessimistic, where the consensus view saw the peak another 5-10 years off, and the optimists put it 20 years away or more. Some thought the peak rate of "all liquids" would be around 100 million barrels per day (mbpd), up from 85 mbpd at the time. Most thought non-OPEC production would increase up through 2010. Biofuel boosters were sunny about their future.

Four years later, the view on oil and biofuel has grown considerably worse.

We now know that conventional crude did in fact hit its peak-plateau in 2005, having remained around the 74 mbpd level ever since. The expected growth from non-OPEC mostly failed to materialize, as depletion of mature fields took its toll and the cost of new projects soared—especially for deepwater and production from marginal sources. More pessimistic observers now think the 87 mbpd all liquids peak recorded at the height of the 2008 boom was the peak, and the more optimistic ones have cut their expectations to under 100 mbpd, with 90 mbpd looking more likely.

Biofuels now have a black eye from the corn ethanol frenzy of 2007-2008, which has all but collapsed. Ethanol from algae and cellulose still looks about as far in the distance as it did in 2005, as no one has figured out how to produce either one at commercial scale or with an acceptable net energy return. And biodiesel has remained a minor player, with little expectation for it to scale up any time soon.

But the most surprising change has been the outlook for North American natural gas. In 2005, the majority of observers seemed to think it had peaked for good, and saw gas prices remaining in a high range of $11-15/Mcf. I don't think any of them expected the recent boom in North American shale gas, and there was certainly no suggestion that gas prices would crash to nearly $2 this year.

In fact the main worry about gas now seems to be that the shale gas boom will prove to be short-lived, and sucker us into building more vehicles and infrastructure to use it just as it sputters out. We only have a couple of years of data to work with on shale gas wells, and the only good data is from the Barnett Shale.

Running down the depletion numbers on shale gas, analyst Arthur Berman found that in the first year of production decline rates have been in excess of 50% for Barnett wells, and 90-95% for Haynesville Shale wells. The average well in the Fayetteville Shale is "profoundly non-commercial" he said, and predicted that most shale gas wells will be abandoned in less than five years after their first production because the output will be so low.

There is also a fear, which I have articulated previously, that with an average production cost of $7-8/Mcf for shale gas and prices through most of 2009 staying around $4 or less, new wells simply haven't been getting drilled. The effects of that lapse should show up next year and cause our "glut" to disappear quickly, taking prices much higher.

Supply Decline Rates

With the end of growth in the rate of global oil production now either in the past or looming in the next few years, attention is progressively focused on the depletion rates of mature oil fields and the rate and date of overall decline.

Most observers believe the globally averaged depletion rate has risen from 4.5% per year in 2007 to about 5 - 5.5% now, which will accelerate to around 6.5% per year by 2014. This is more or less in line with the average rates from IEA's report last year. Petroleum geologist Chris Skrebowski pointed out that a 5% per year decline rate means a loss of 4 mbpd per year, equivalent to all the volume of biofuels, tar sands and heavy oil combined, or losing the entire North Sea in about 14 months, and that it would be a huge challenge to replace those lost volumes.

Analysts using the Megaprojects database (of large oil projects started up after 2005) generally agree that production will peak in the 2009 - 2010 time frame. Net new supply each year is expect to begin declining around 2014 - 2015 as depletion overwhelms new projects. Supply may reach as high as 92 mbpd in 2010, then plateau to around 89 mbpd in 2014, then decline to 84 mbpd in 2020 and 78 mbpd in 2030.

That view was generally in line with comments from oil consultant and former head of exploration and production for Saudi Aramco, Sadad al-Husseini, in a video interview clip. Seeing insufficient large new projects in the next 5 - 6 years to compensate for decline rates of 6.5% in non-OPEC and 3 - 4.5% for OPEC, he expects a shortage of capacity in the next 2 - 3 years.

The poster child for decline rates is, of course, Mexico with its crashing Cantarell field. Matthew Simmons projected that its decline would end Mexico's long era as an oil exporter in 18 - 36 months. David Shields, an author and expert on Mexican oil production, delivered a devastating indictment of the country's political leaders and its oil company Pemex, asserting that Pemex officials knew exactly what Cantarell was going to do as far back as 2002, but said exactly the opposite in public. A chart that Pemex shared with the Mexican Senate showed that production from its largest fields would fall to 1 mbpd by 2017, a full 1.8 mbpd lower than the official forecast of about 3 mbpd. If political manipulation is distorting the public impression of Mexico's near-term oil potential (and I believe Shields on this point) then it could be very bad news for the U.S., for which Mexico is the #3 source of oil imports.

Demand Growth Rates

On the whole, I would say there is now a strong consensus (at least among analysts who prefer data to faith) that global oil production will begin to decline in the 2012 - 2015 time frame. The later-dated estimate is based on the notion that the global recession of the last two years has probably given us that much longer before terminal decline sets in.

Peak oil deniers who have projected continued growth for many decades hence and ultimate peak rates of 120 mbpd or more have obliquely capitulated in the face of the recent evidence and switched to a "peak demand" argument: It's not that supply couldn't keep up for geological reasons, it's that demand wasn't strong enough to support high enough prices to raise supply further.

It's a classic tactic to try to change the game if you can't win it, but the peakers aren't buying it. As Skrebowski pointed out, the peak demand argument only really holds for the OECD, where demand is off a few percent from the peak.

The real demand story is shifting quickly to the developing world, particularly China. Analyst Steven Koptis projected that China would overtake the U.S. as the top consumer of oil by 2018, and if supply is available, would double U.S. consumption by 2025.

Indeed, as petroleum geologist Jeffrey Brown pointed out in his presentation of the Export Land Model, the U.S. has already been outbid by Kenya for oil. According to the model he developed with Dr. Samuel Foucher, the top five oil exporters in 2005 will in aggregate reach zero net exports by 2032, and most of that will be shipped early on. In just three years, they shipped 1/5 of their total expected net exports after 2005.

Petrobras' Promise

As a counterpoint to the generally gloomy data on global oil supply and demand, a razzle-dazzle keynote was given by Dr. Marcio Rocha Mello, president of HRT Petroleum and a 24-year veteran of Brazil's oil company Petrobras (NYSE: PBR). He asserted that the recent pre-salt finds in very deep formations off the shore of Brazil, like the much-hyped Tupi field, indicated that there was a great deal more oil in the pre-salt layers—we just need to drill deeper.

In an extremely animated presentation that at times seemed more like a carnival sideshow than a serious analysis, Dr. Mello served up combination of stratigraphic charts and contrarian theory to make the case that between the pre-salt of Brazil, West Africa, the Congo basin and the Gulf of Mexico, there are another 500 billion barrels yet to find.

While entertaining and humorous, I don't think Dr. Mello made too many converts in the room. As former BP oil exploration chief Jeremy Gilbert pointed out the following morning, none of the alleged pre-salt oil is yet proved, and in fact he'd be surprised if there were 5 billion barrels of proved oil there. "Don't confuse passion with precision" he warned, and noted that it would take 20 - 30 years to prove the resource. In short, it doesn't change the peak oil story at all. By the time pre-salt barrels come online, we'll be well down the back side of the production curve. Rising resource nationalism in Brazil also bodes poorly for very many of those new barrels to make it to foreign markets.

I'll conclude this report with a brief comment on oil prices. As I mentioned in my update three weeks ago, the outlook for oil prices has been murky for months as they traded in a $60 to $75 range. I was long oil but cautiously bearish, and watching for signs of a new signal. This week, that signal came as oil breached the $75 level and touched $78 this morning. It's a decidedly bullish move and I think it portends higher prices to come, at least in the near term.

I took the opportunity to beef up my oil exposure with positions in EOG Resources (NYSE: EOG) and, naturally, Petrobras. Even if Dr. Mello is wrong about the pre-salt, Petrobras is one of the most sophisticated and aggressive oil companies in the developing world, and they are positioned better than most to mint money for years to come. And if he's right...well, it will be a great position to hold long term.

Stay tuned to this space for much, much more from the cutting edge of peak oil analysis in the coming weeks.

Until next time,

Chris Nelder

Energy and Capital