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When will oil run out of gas?
Suppliers are working hard to pump more crude, but that could take years. Meanwhile, prices havent risen enough to kill demand. How high would they have to go? Try $75.
By Jim Jubak
A year ago, a barrel of West Texas sweet crude sold for $37.05 on the spot market. On July 8, the price was $59.60, a 61% spike in price.
But don't worry. That rate of increase isn't sustainable forever. Eventually the good old laws of supply and demand will combine to slow the meteoric rise in oil prices.
Unfortunately, in the near term, those laws are taking their sweet time to go to work. There's certainly a good chance that, over the next few days or weeks, oil prices will retrace part of their recent run to $60 from $48 as speculators take profits. But the trend for the rest of this year, and for 2006, is still up. I'd say we're likely to test $75 oil before the laws of supply and demand kick in to 1) at least put a damper on the rate of price increases and 2) maybe even send the price back toward $50 a barrel for a while.
Let me show you why that's the most likely scenario now.
It takes a long time, it turns out, to increase supply even when oil is selling for $60 a barrel. Take the ambitious plans from the Royal Dutch/Shell Group to expand production to 5 million barrels of oil equivalent a day by 2015 from 3.8 million barrels a day now. That's an impressive increase of 32%. Put aside all doubts about whether the company can really find the 10 huge new sources of oil required, by its own estimates, to get this production increase. Instead just look at the company's timetable: Almost all that new production will come on line after 2009. The total increase in production from 2005 to 2009 is about 5%.
Out of shape
And this isn't just a problem at Royal Dutch/Shell Group. After a decade, or more, of underinvestment in everything from refineries to oil field maintenance to engineering expertise, the global oil industry isn't in any shape to increase production overnight.
For example, in the Persian Gulf nation of Qatar, Marathon Oil (MRO, news, msgs), ConocoPhillips (COP, news, msgs) and Chevron (CVX, news, msgs) have signed agreements to build three natural gas-to-liquid fuel (GTL) plants to exploit that nation's huge reserves of natural gas. But the projects were recently delayed for at least three years because of a shortage of engineers to design the plants and because a shortage of construction materials had driven up costs. So much for the third-largest natural gas reserves in the world providing a quick shot to global supply.
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The shortage of engineers may be the toughest supply-side problem to fix. The United States is still the leading global source for petroleum engineering expertise, but the number of petroleum engineers here has tumbled by 50% since the 1980s. A survey by the American Petroleum Institute (of less than 20% of the U.S. oil industry) projects a need for more than 5,000 engineers in the next two years. Total enrollment in petroleum engineering programs in the U.S. was just 1,500 in 2003, 85% below the 1985 peak.
The engineering shortage might not be so bad if so many of the proposals to increase supply weren't so engineering-heavy. For example, Royal Dutch/Shell Group along with oil companies such as Imperial Oil (IMO, news, msgs) and Canadian Natural Resource (CNQ, news, msgs) sees Alberta's huge deposits of oil sands as a major source of new oil. Getting that oil involves digging up the sand, moving it in bulk to the plants that cook the oil out of the sand and then running the oil through refineries that turn the extremely heavy oil produced from these deposits into grades that can be refined using conventional methods. Each stage requires complex technology that hasn't been completely debugged.
A long process
The sands may indeed contain as much or more oil than sits under Saudi Arabia. But these companies are just now in the process of ramping up production from relatively modest daily flows, and even if everything goes right, that process takes a long time.
You can get a sense of the time scale from the Horizon oil sands project at Canadian Natural Resource. The potential is huge: 3.3 billion barrels of recoverable bitumen reserves. But the project, estimated to cost $11 billion (Canadian), will go into production over the next eight years. Synthetic oil product is scheduled to begin in the second half of 2008 at 110,000 barrels of oil a day. In 2010, Phase Two kicks in and production jumps to 155,000 barrels a day. Phase Three, due in 2012, increases total production to 232,000 barrels a day. That's a significant addition to global oil supply, especially when you remember that Canadian Natural Resource isn't the only company wringing oil out of Canadian sands. Royal Dutch/Shell Group, for example, has a goal of 500,000 barrels a day from these same deposits.
It's striking how many of the supply-side solutions to the current explosion in oil prices are engineering-heavy, rely on new, and in some cases, untested technologies and face the prospect of strong local political opposition. Liquefied natural gas, which requires the construction of plants to cool the natural gas into liquid and then special terminals to load and unload the liquid onto special LNG tankers, fits that profile. So does the attempt to revive nuclear power in the U.S. envisioned by the energy bill that recently passed the Senate. The same is true for the new refineries needed to turn the heavier grades of oil that Saudi Arabia is pumping into petroleum products such as gasoline.
Slow to respond
It makes immediate sense that oil supply will expand relatively slowly, for all these reasons, despite higher oil prices.
What's harder to understand is why the run to $60-a-barrel oil hasn't reduced demand.
Demand for oil and gasoline, the key product refined from oil, has kept rising as oil has become more expensive. For example, U.S. petroleum demand grew at an annualized 3.3% rate in May, about double the February growth rate. The Energy Department shows that total distillate demand, which includes jet fuel, heating oil, diesel fuel and gasoline, was 7% higher in the most recent four-week period than it was a year ago. U.S. gasoline consumption climbed 2.5% in the four weeks ended June 17 from the same period in 2004. This came despite the fact that the average price of a gallon of unleaded gasoline was $2.23 in the week ending July 4, up 13 cents since the end of May.
And the phenomenon of rising demand in the face of rising prices isn't limited to the U.S.: The International Energy Agency has upped its forecast for world oil demand growth to 2.2% from 1.8%.
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