Oil Supply: The Crunch Has Arrived!!

Brian J Fleay
2000 13 March


In December 1997 the Asian Financial Meltdown began to bite, ending over 20 years of high economic growth there. The Organisation of Petroleum Exporting Countries (OPEC) also increased their production quotas, responding to the high consumption growth during 1996-97, and the UN Security Council increased Iraq's so-called oil-for-food quota. The 1997-98 northern hemisphere winter was mild and demand for heating oil was low. Consequently 1998 saw a fall in Asian oil consumption ending two decades of high growth with no increase in world consumption, while production expanded.

Oil prices fell from US$23 a barrel in December 1997 to US$10 a barrel in February 1999, equalling in real terms the lowest prices ever. OPEC countries faced severe financial crises with the threat of political unrest. Falling cash flow forced western oil companies to cut back exploration and development work and shed experienced staff, weakening even further their capacity to operate in upstream oil. In many areas, production costs exceeded the price of oil, wells were shut down with some never to be turned on again, especially 'stripper wells' in the USA. Many of the investment cut-backs were for development work to counter falling output from ageing oil fields. Running fast just to stand still became running backwards.

To counter this financial disaster, the OPEC cartel in March 1999 further reduced its production "quotas" to a total cut back of 4.32 million barrels per day (m.bbls/d). Oil prices began to rise in April and most oil analysts predicted OPEC discipline would not hold and forecast low prices to continue for at least three years. The more perceptive analysts predicted the opposite, being aware of the tight supply position and of the looming spectre of depletion.

Why Were The Analysts Wrong?

Consumption rebounds
Firstly, OPEC quota discipline held at around 90% through 1999. Prices continued to rise and were over US$20 a barrel by August.

Asian Recovery
Secondly, from mid-1999 Asian economies began to recover sooner and more quickly than everyone expected, and with it their oil consumption. Oil was the principal fuel powering the "Asian Tigers" economic growth. A booming US economy was also fuelling higher oil consumption, and both impacts resonated around the world. Oil consumption rose by 1.6% to 75.2 m.bbls/d in 1999 with the increase gathering pace as the year progressed.

By October consumption was exceeding supply, according to the International Energy Agency (IEA). Stock draw downs were 0.7 m.bbls/d in October, 1.6 m.bbls/d in November, 4.7 m.bbls/d in December, 0.5 m.bbls/d in January and continued into February while OPEC quota compliance fell to 75%. In other words the OPEC "shut-in" production is down to about 3.2-3.3 m.bbls/d. The falling inventories of crude and petroleum products are starting to encroach upon the requirements for secure operation of the supply system which is becoming increasingly vulnerable to minor disturbances. Oil prices have risen to over US$30 a barrel.

Non-Persian Gulf oil is peaking
Thirdly, there is a growing consensus in the oil industry and among other analysts that oil production outside the Persian Gulf will peak in 2000 through 2001. North Sea oil will peak this year according to the London-based Petroleum Review of February 2000. Mexico's largest oil field, offshore Cantarel, has a gigantic $1 billion nitrogen injection project about to be commissioned to re-pressurise the field to offset decline and requiring a further 12 year $9 billion investment to keep the pressure up. The enforced investment cut backs of 1998-99 are now showing up as production declines in North America, the North Sea and possibly Venezuela which faces a similar situation to Mexico. African producers and China face similar problems.

Non-Persian Gulf oil will peak at about 55-56 m.bbls/d with about 10 m.bbls/d of this coming from OPEC producers. The IEA forecasts consumption of 77 m.bbls/d in 2000, an increase of 2.4% on 1999 with consumption in successive four quarters of 77.2, 75.4, 76.6 and 78.8 m.bbls/d respectively. That means Persian Gulf producers have to supply an average 21-22 m.bbls/d for the year and 22.8 m.bbls/d in the fourth quarter. Their output in 4Q 1999 was 19 m.bbls/d and their maximum is about 23 m.bbls/d. However, it is not possible to operate such a supply system at or near 100% capacity all the time; there are always supply hiccups.

The second quarter is normally the time stocks are replenished following the northern hemisphere winter peak and in preparation for the summer driving season and following winter peak. However, in the absence of an increase in OPEC production this will be extremely difficult. OPEC meets in March to review quotas and from media reports it seems that quotas may be partially lifted. There are signs that OPEC members are looking backwards at the price falls that have accompanied past quota rises and will be wary about ending them. It would be June before increases could be effective as it takes two months for oil to move from the exporter's shipping terminal to the petrol bowser.

If the IEA's consumption expectations are fulfilled, even with OPEC quotas lifted in March, supply will be extremely tight in the second half of 2000.

Post 2000 Supply Shortfall

Mid 1990's forecasts Oil supply analysts like Colin Campbell have for many years predicted that non-Persian Gulf oil would peak around 2000 and Persian Gulf production about 2011-12, preceded by the world as a whole between 2006-08. The latter predictions have always assumed that the needed investment in exploration and oil field development would occur in time on the scale required, especially in the Persian Gulf. What is the true position?

A series of articles in the US Oil & Gas Journal around 1994-96 discussed the prospects for both OPEC as a whole and the Persian Gulf producers to meet anticipated production in 2000 and 2005. Investment of over $100 billion was seen as necessary by 2005 with just under half in the Persian Gulf countries who would provide 75% of the net production increase, the only area in the world where significant increases are possible at low cost. Oil consumption in 2000 is at the higher end of these forecasts and non-Persian Gulf production a bit higher.

The bulk of non-Persian Gulf investment was required to sustain production from ageing oil fields - with 60% of the Persian Gulf investment needed for the same purpose. There is a substantial backlog of such investments. Such investment is particularly needed in Iraq and Iran to refurbish oil infrastructure where the consequences of war and sanctions have taken their toll. Several countries' maximum production rate is now below levels attainable in the 1970's.

It is difficult to get reliable information on the physical status of these oil fields and the level of investment in recent years. But one thing is certain: there is a substantial backlog of Persian Gulf investment needed to meet expected post-2000 oil consumption growth, in the order of tens of billions of dollars. Once the barriers to such investment are removed it will take two to four years for this to translate into new oil production.

So it will be 2003-04 before meaningful expansion of world oil production beyond the 2000 level is possible!! By then non-Persian Gulf production falls will be very visible, particularly in the North Sea. The scale of investment required is now beyond the internal financial and technical resources of these countries. This may not have been the case if sustained investment had begun five years ago.

Barriers to Persian Gulf oil investment

What are the main obstacles to Persian Gulf oil investment?

Firstly there is a lack of awareness of the realities of oil depletion, over-optimistic expectations of the gains possible by new technology and inconsistencies in the statistics for production and reserves and their interpretation, factors that together create a false optimism and lack of awareness of how tight supply is becoming.

Secondly, low oil prices have inhibited investment as has the large excess of supply over consumption since the early 1980's which was mostly in the Persian Gulf. Growing populations and low oil prices have substantially reduced these countries' per capita income, and who now have to import food on a substantial scale. Along with welfare (for the elite as well as the masses) and high military outlays, little has been left in budgets for oil investment.

Thirdly, and the most important, are the political constraints to investment. Iraq and Iran have the most urgent need to upgrade infrastructure and US-inspired sanctions effectively prohibit this, sanctions that now seriously threaten the political and economic stability of the world. These are unlikely to be lifted before the US Presidential elections and what happens after that may depend on who is President and the composition of Congress.

The scale and speed of outside investment and technical support needed is a sensitive internal political issue for the countries concerned and where there is considerable criticism of the extravagances of the ruling elites compounded by a generation change. Iran has over 6o million people and over half are under the age of 25.

It is not in the long term interests of these countries to blow their oil quickly, but rather to ration it out at high prices, but not at a level that damages the world economy or provokes oil substitution.

The March and September 2000 meetings of OPEC will be critical in this regard as will the interactions with the US Presidential elections and six-monthly re-negotiating of the UN's so-called oil-for-food agreement with Iraq, due in May and November.


Only a significant fall in the IEA's expected world oil consumption for 2000 can reduce the risk of a supply shortfall later this year, and then only if OPEC substantially or completely lifts its production quotas in March.

Supply shortfalls are inevitable after 2000 to at least 2003 due to the lack of appropriate investment in the Persian Gulf countries. If the political obstacles to this investment are delayed unduly then the supply shortfalls will last longer.

Consequently the peaking of non-Persian Gulf oil production in 2000-01 will merge with the previously anticipated 2006-09 world peak into one decade long peaking event.

Australia's oil self-sufficiency is expected to deteriorate rapidly over the next decade. Oil imports were approximately A$1.2 billion in 1999 and could reach A$10 billion by 2010 at current oil prices and exchange rate for business-as-usual consumption, and half that by 2003. The annual trade deficit is under A$10 billion at present. Business will not be "as usual".

A better appreciation will be possible after 10 April when the IEA publishes its quarterly report on www.iea.org

updated 2000 March 15