Thursday, January 29, 2009

Peak Oil and OPEC's Oil Reserves

There is much uncertainty surrounding the future of global energy supply but the fact remains that crude oil is a finite natural resource and continued consumption will eventually lead to a reduction in the total proven oil reserves on this planet. Reduction in proven reserves will likely lead to a point where global oil production begins to permanently decline. This point is commonly referred to as “Peak Oil.” There is much debate over when peak oil will occur and many analysts believe that it has already happened.

One of the main factors in determining when Peak Oil occurs and how fast the subsequent decline will be is the amount of proven reserves. As shown below, around 80% of the world’s proven oil reserves are controlled by OPEC.


The control of the world’s oil reserves by OPEC means that most of the future oil supply will come from these countries. OPEC has traditionally tried to control prices by supposedly regulating the supply side of the supply/demand equation. However, over the last year we saw oil reach record highs followed by a steep drop in prices. OPEC’s attempts to stabilize prices by varying production were pretty much useless and it was clear that demand had a far greater influence on price during the price decline.

Does OPEC have the ability to produce more during periods of high demand??? Based on the amount of proven reserves, you would think that OPEC would have the ability to produce large amounts of oil and would do so during periods of high commodity prices such as we have seen in the last 5 years. The following graph depicts the ratio of reserves to production for several countries.

(BP Statistical Review of World Energy 2008)

You can see that the Middle East is producing relatively little oil compared to its total reserves. There are several potential reasons for this:

1) They treat there oil as a “national trust fund” and want to save some for the next generation (how thoughtful)
2) It takes a long time to bring new wells online (possible but some of these fields are over 50 years old and a 10,000’ well can be drilled in about 40 days)
3) They think that prices will increase further in coming decades (likely, but there is significant risk of demand destruction due to new technologies replacing oil)
4) The OPEC countries are inflating there reported reserves

It is likely that the first three points do play some role in the low production by OPEC. However, I think that it is very likely that OPEC is overstating their reserves and that this will become a huge problem as we get further past the peak. In the late 1980’s, many of the OPEC countries made huge step ups in their reserve bases. This was likely due to changes in the cartels production policy which allows countries with more reserves to produce more. This causes incentives for the members of OPEC to overstate their reserves in order to gain more power within the cartel. In addition, there is further motivation to overstate reserves to assuage global fears of about oil supply which may force nations to consider alternatives to oil.

Whatever the case may be, if OPEC countries are in fact overstating their reserves, we will likely see negative effects as this resource is continually depleted.


Som said...

A nice post on the politics of oil and its global implications. On a slightly different note, I'd like to point out that the rise in oil prices and its subsequent fall was not entirely governed by supply from OPEC or demand of the burgeoning third world economies. In fact, the Wall Street has greater control over oil prices than we are led to believe.

Oil is traded, and its prices determined, through oil futures contracts in the international oil exchanges in New York (Nymex) and London (ICE Futures). The Nymex is regulated by the Commodity Futures Trading Commission (CFTC), the watchdog, which ensures that speculation or price manipulation by investors don't drive the market. However, in 1999 the London Exchange (ICE Futures), which previously used to trade only in European energy commodities, obtained permission from CFTC to allow traders in the US to trade European commodities. And in 2006, it gained permission to trade in US crude oil futures through the London exchange. Interestingly, the ICE is outside the jurisdiction of CFTC. According to a US Senate report, in recent years, there has also been a spurt in energy commodity trading by large firms in unregulated OTC electronic exchanges [1]. The amount of money that was poured into the oil futures market by banks and hedge funds from wall street, in the run-up to the record prices, was staggering. Moreover, the trading process is so opaque that only a select group of major oil trading banks such as Goldman Sachs or Morgan Stanley have any idea who is buying and who selling oil futures.

This is a news report on it:
and here is a detailed description of the scenario:

[1] United States Senate Premanent Subcommittee on Investigations, 109th Congress 2nd Session, The Role of Market speculation in Rising Oil and Gas Prices: A Need to Put the Cop Back on the Beat; Staff Report, prepared by the Permanent Subcommittee on Investigations of the Committee on Homeland Security and Governmental Affairs, United States Senate, Washington D.C., June 27, 2006. p. 3.

Anonymous said...

This reminds of a report I saw on CBS, " The Oil Kingdom." Worth a watch:

abhishek gaurav said...

After this article I researched on OPEC, 1973 Oil Crisis and few realted links. One thing I can be sure about is OPEC in no way has a control over Oil Prices in the current times. And, actually OPEC after the 1973 oil crisis has the learnt the lesson of not being stupid anymore by restricitng it supplies to control the oil price.