How 5% of the global oil supply has suddenly vanished

The respected oil industry newsletter Petroleum Intelligence Weekly says that Kuwait has only half the oil that official estimates have claimed. That would mean that 5% of the global oil supply has vanished overnight, says Byron King in Whiskey & Gunpowder. But this might be just the tip of the iceberg - Saudi Arabia may well be facing the same problem...

By MoneyWeek

published 19 May 2006

in Features

Word just came out that Kuwait, long regarded as home to some of the world's largest reserves of petroleum, may possess only half the amount of oil reserves that it officially has been stating for many years.

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The PIW report is based upon data circulating within the top echelons of the Kuwait Oil Co. (KOC). KOC is the upstream arm of state-owned Kuwait Petroleum Corp. KOC has primary responsibility for conducting exploration, drilling and production from Kuwait's oil fields. The PIW report claims that Kuwait's remaining proven and nonproven oil reserves total about 48 billion barrels, or 51 billion fewer barrels than previously advertised.

Yet another way of stating the matter, and in a macro sense, the amount of estimated world oil reserves just fell by 5%. This 5% drop in reserves is the equivalent of almost 20 months worth of total cumulative worldwide oil production and consumption, based on the current world oil use of about 84 million barrels per day. From the standpoint of the world reaching the absolute Peak Oil point, we now live in August 2007, not January 2006.

According to the PIW report, the official public Kuwaiti figures do not distinguish between what are known as 'proven,' 'probable' and 'possible' reserves. The PIW report stated that the Kuwaiti data indicate that, of the current remaining 48 billion barrels of proven and nonproven reserves, only about 24 billion barrels are so far fully proven (That is, slightly more reserves than in the States).

Burgan is known in the trade as a 'super giant' oil field and has been pumping oil for almost 60 years. Burgan accounts for most of Kuwait's oil production and exports. You may remember the images of burning oil wells that came out of the Gulf War of 1991. Almost all of these were wells in Burgan, blown up and set afire by retreating Iraqi troops. (Under international law, oh, by the way, this type of intentional destruction of Kuwait's national patrimony and natural resource base was a war crime of the first magnitude.) The oil was just roaring straight up out of the holes in the ground, propelled by its own underground reservoirs, and feeding the conflagrations. It took many months of truly heroic effort to control the fires. And many of the Burgan wells, and portions of the producing rock formations, were irreparably damaged.

In the fall of 2005, KOC chairman Farouk Al-Zanki admitted that, in the future, the sustained output of the Burgan oil field will be around 1.7 million barrels of oil per day. This amount is significantly less than the 2 million barrels per day of production for the rest of the field's estimated 30-40 remaining years of life that were forecast as recently as mid-2005. In a recent experiment, Kuwaiti oil engineers tried to obtain 1.9 million barrels of oil production per day from Burgan, but the level was not sustainable. The engineers determined that the higher rate of production was causing pressure drops, water intrusion, and other formation damage to the underground reservoirs. Thus, according to KOC, 1.7 million barrels per day is considered to be the optimum rate.

Kuwait has announced plans to spend upward of $3 billion per year into the future to boost output and exports from other fields. There are three consortia, led by BP, Chevron and ExxonMobil, presently pursuing a contract to win something called Project Kuwait. Project Kuwait is intended to be a 20-year operating service agreement with the government of Kuwait to raise crude capacity at four relatively unexplored oil fields in the north of the country, near the border with Iraq. (That is another problem, but we will not go there just now.)

The competition for Project Kuwait is still open. However, I should note that one of the competitors, Chevron, has a long history in that relatively small nation. Gulf Oil Corp., which became part of Chevron in 1984, discovered the super giant Burgan oil field in Kuwait in 1938. In what was perhaps an omen of things to come, the first oil well drilled into Burgan hit pressures that were so high as to blow out the wellhead valves and turn the first Kuwaiti oil well into an uncontrolled gusher. Additional drilling and large-scale development, however, was interrupted by World War II.

The long-term impact of the Burgan discovery went beyond simply drilling wells into high-pressure zones and helped to change the geopolitics of the Middle East. In 1946, Kuwait began exporting oil, and has remained a net oil exporter ever since, except during the time of its military occupation by Iraq, in 1990-1991. After the first tankers started sailing from its ports, Kuwait rapidly became a wealthy nation. To its credit, and through its comparatively prudent stewardship of its oil revenues over the years, Kuwait has become a world-class financial power.

Burgan gusher or not, however, for many oil analysts, the reports that Kuwaiti reserves are significantly less than claimed are not news. For many years, there have been analyses along the lines that the Kuwaitis, and many other oil-producing countries whose reserves are state controlled, have been misstating the size of their reserves. In essence, the officially stated oil reserves of Kuwait have for many years been little more than an illusion, based on nothing more than wishful thinking and economic fiddling. The attitude seemed to be, 'Oh, yes. Burgan is a big field. Lots of oil there. No problem.'

No problem? Using a method called 'Hubbert linearization,' some analysts have previously estimated that Kuwait's ultimate recoverable reserves would be far less than what the government statistics forecast. One authoritative estimate has placed Kuwaiti reserves ultimately at 76 billion barrels, of which about 36 billion have already been produced. This would leave remaining Kuwaiti reserves at about 40 billion barrels, and that is assuming that there is massive effort at additional drilling, new discovery, and production in the years to come. This linearized estimate is in general agreement with the range of oil reserves, 48 billion barrels, based on the internal KOC information that PIW recently reported.

The numbers suggest that Kuwait is at about 47% of its ultimate oil recovery, or, for all intent and purpose, at the halfway point of ultimate oil recovery. Future depletion rates are cheerfully, if not hopefully, estimated to be in the magnitude of about 4% per year. However, the Kuwaitis have in recent years adopted the latest approaches to using new technology to maximize short-term oil production and recovery. That is, they are drilling horizontal wells and using what are called multiple lateral completion techniques. This does not really find 'new' oil; it just drains the existing oil faster.

Thus, in this case, it is not possible to rule out the possibility that Kuwaiti oil production will suddenly go into steep decline. This would be similar to what we have seen in other oil provinces that have benefited from application of 'new technology,' like in the North Sea or Mexico's Cantarell. Instead of the estimated annual 4% depletion rate, we might see a North Sea-like depletion rate of 10% or more per year. Thus, until the decline rate becomes apparent, and given the age of and production history of Burgan, it will not be possible to make a refined estimate of future production trends.

The news out of Kuwait highlights the point that most, if not all, of the estimates published by member nations of the Organization of Petroleum Exporting Countries (OPEC) are similarly without merit. In all likelihood, all of the OPEC member nations have chronically overstated their reserves. The ominous implication is that we are confronting the reality that the world has a lot less oil than we thought and that a peak in global oil output must occur sooner than even some of the most pessimistic predictions.

The news about the Burgan oil field lends credence to the opinions of investment banker Matthew Simmons, who has made a career working with the companies that form the industrial backbone of the oil industry. For the specific arguments of Simmons, you should read his exceptionally well-written book Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy, published in June 2005. In preparing and writing his book, Simmons reviewed hundreds of technical papers written about the Saudi oil fields, interviewed many people with firsthand knowledge of Saudi oil production, and visited a number of important oil sites in Saudi Arabia. Based on this, Simmons makes a solid case that Saudi Arabia faces an imminent downturn in oil production. And because Saudi Arabia has always been considered the 'swing producer' to the world, and thus the price-setting supplier to the world's oil-based economy, any production shortfalls would have severe and immediate economic, political, and military impacts.

Using the 'Hubbert linearization' method on publicly available reserve data and production figures for Saudi Arabia, it appears that the Saudis have produced 105 billion barrels of oil out of an ultimately recoverable reserve base of about 180 billion barrels. Much of this production came out of the ground in the past 25 years. Thus, the Saudis are now at about 55-60% of their ultimate recovery and a state of irreversible decline cannot be very far behind.

The implications for the global economy of a decline in Kuwaiti oil exports, let alone Saudi production, are indeed serious. If the world oil supply fails to expand proportionally to the increasing demands of China and India, as well as to growing demand from the West and Japan, then the upward pressure on oil prices will be inexorable. As we have said so many times before in Whiskey & Gunpowder, we can expect to see the price of oil climb.

Oil-consuming nations and societies will face major energy and financial crises. Governments and central banks will try to 'inflate' their way out of it, as has been the case in America over the past few years. Eventually, however, the combination of high prices, depreciating currency, and absolute shortages of oil will lead to profound dislocations in society. Things may approach a state of what author James Kunstler calls The Long Emergency, the title of his book published last year.

And what are the political, economic, and cultural leaders of most nations doing about this profound and precarious situation? Very little, sad to say. At the recent Detroit Auto Show, the biggest press coverage was reserved for new versions of 1960s muscle cars, recreations of such famous old names as the Chevy Camaro and the Dodge Challenger. The U.S. economy is still utterly dependent, and growing more and more so, on over-the-road trucking for most freight hauling, at an average fuel burn of about 4 miles per gallon. And every U.S. politician of any significance has a well-honed 'position' on the virtues, or not, of Roe v. Wade. But ask that politician about Peak Oil and, with a few notable exceptions, you will get a blank stare, or at best a silly answer, that betrays little understanding.

And what are you doing about all of this, dear readers? Do you really believe that, as the notion goes, 'technology will save us'? (OK, technology will help, but you had better get out in front of it.) Or do you believe that 'the politicians will do something'? (Wow. Call your doctor. Get that closed-head injury examined.) Or do you subscribe to the 'abiotic theory' of oil formation? (I call it 'abiotic snake oil.' It offers nothing but utterly false hope.)

MoneyWeek is written by a team of experienced and award-winning journalists, plus expert columnists. As well as daily digital news and features, MoneyWeek also publishes a weekly magazine, covering investing and personal finance. From share tips, pensions, gold to practical investment tips - we provide a round-up to help you make money and keep it.