Energy Production
Committee
Understanding the Petroleum Industry
Price Overview | Demand |
Supply | Trade and
Imports | Refining | Stocks
What's Hot: Demand | Supply
| Trade and Imports | Refining
| Stocks
Supply
- World oil production has been on
a roller coaster ride over the last 25 years (see Graph). The higher prices that
followed the first oil price shock dramatically improved the economics of finding and
producing oil, so world oil production initially rose steadily. However, it peaked at 62.7
million B/D in 1979. and by the mid-1980’s it had given up almost all these gains,
undermined both by the production shut-ins that stemmed from the Iranian Revolution and
then the Iran-Iraq war, and by the demand slump that was the unsurprising response to the
further leap in prices. After prices collapsed in late 1985/early 1986, demand growth
returned and production started to increase steadily again. Despite prices remaining low,
world oil production had exceeded its prior peak by 1996 and is still rising today.
- World production has not fully followed the normal rules of economics for
good reason. It has been under the influence of a cartel: OPEC, the Organization of Petroleum
Exporting Countries (see What's Hot).
- OPEC’s grab for power in late 1993 initially led it to stagnating
production and a modestly declining market share, but soaring revenues, thanks to the
strong prices. Then, between 1979 and 1985, OPEC tried to defend an increasingly untenable
price level in the face of rising supply from newly-profitable non-OPEC areas and slumping
demand. Its production collapsed from 30 million B/D to 16 million B/D and its market
share fell from 48% to 30%. Since abandoning that defense, OPEC’s production has
bounced back to 28 million B/D and its share to 43%, making it the main beneficiary of the
recovery in world oil production.
- The brunt of OPEC’s volume collapse was borne by Saudi Arabia, the
world’s largest oil producer, exporter and owner of reserves. However, in mid-1985,
with its production a quarter of its 1980 peak of nearly 10 million B/D, and its exports
heading into oblivion, Saudi Arabia permanently abandoned its swing producer role. Since
then, Saudi Arabia has grabbed the lion’s share of OPEC’s volume growth, helped
by Iraq’s exports having been severely constrained by United Nations sanctions since Iraq invaded Kuwait in 1990 (See What's
Hot).
- In contrast to OPEC’s production surge, non-OPEC production was
almost the same in 1997 as in 1986, when prices collapsed. This blandness masks two
important but offsetting trends: an unprecedented collapse in production in the Former
Soviet Union (FSU) and growth in most of the world’s other producing regions, outside
of the U.S.
- Before its economic and political collapse in 1990, the FSU’s oil
production was determined by the combined needs of the government for hard currency and
the domestic market for what was essentially a free good. The move away from communism
exposed the uneconomic nature of much of the FSU’s oil production under the old
system, but the failure to introduce all the necessary legislation and institutions has
undermined the transition to a market-driven system. As a result, production has dropped
by 45% from its 1987/88 peak of 12.6 million B/D, and the FSU has barely hung onto its No.
3 spot in the world production rankings, behind the OPEC-dominated Middle East and
U.S.-dominated North America. (Nonetheless, the central Asian republics of the FSU
are home to one of the hottest prospects for future development, the Caspian Sea.)
- As the FSU collapsed, production in the rest of non-OPEC entered a period
of increasingly rapid growth. Both the industry and the producing countries contributed to
this, motivated by a common need to improve their financial situations, which had been
badly hurt by the price collapse and which looked increasingly unlikely to be rescued by a
return to high prices. Their actions have led to a more efficient use of capital upstream.
Put another way, the amount of development and production at a given price has increased.
- Industry’s main focus was on lowering costs through the active
pursuit of new technology and new operating
practices (see What's Hot). The North Sea (see What's Hot) was in the vanguard of many of
these moves. As a result, it has become the world’s 4th largest producing
region and, despite persistent predictions over the last decade to the contrary,
production there has yet to reach its peak.
- Governments focused more directly on volume push. Realizing that they
couldn’t achieve this unaided, the governments started competing for the
international money and for the skills and technology of the international companies. Not
only did they improve their contract terms but they also removed many of the barriers to
entry into their exploration and production sectors – collectively known as the
upstream.
- U.S. oil production (see graph)
has been declining since the early 1970’s from an 11.3 million B/D peak, despite the
temporary relief provided by the 1977 start-up of Alaskan North Slope production, which is
centered on the 12 billion barrel Prudhoe Bay field, the largest field ever found in the
U.S.
- The decline has occurred because the U.S. is one of the oldest, and
certainly the most densely explored, producing region in the world: there have been over 3
million wells drilled in the U.S. since the first one, in Pennsylvania in 1859. Such
maturity typically means higher costs. As the rest of the world has increasingly opened up
to upstream activity, it has provided more attractive investment opportunities, and the
U.S. has been de-emphasized by many companies, especially the major integrated companies.
- However, with total oil production (crude oil and natural gas liquids)
still averaging 8.3 million B/D, the U.S. remains a world leader, second only to Saudi
Arabia.
- The U.S. produces significant volumes of heavy crudes and crudes from wells with very low flow
rates (see What's Hot), both of which have low relative cash flow. In the former case,
this is because they receive lower prices than higher quality, more readily usable crudes
like WTI while at the same time costing more to produce, because they need to be heated to
flow to the surface. In the latter case, it is because there are so few barrels to spread
the overheads across.
- Consequently, the U.S. is more vulnerable on a supply economics basis to
a price drop, such as the one that has occurred in 1998, than other large producers.
However, many of these, like Saudi Arabia or even Venezuela and Mexico, have experienced
even larger reductions in production because the governments have participated in the
coordinated, producing country cutbacks.
- Because oil resources in the U.S., as in the world, are not distributed
evenly, neither is production. The Gulf Coast accounts for over half and the West Coast
for almost a third of the total. The largest producing state is Texas. Texas overtook
California in the 1920’s and has remained No. 1 ever since, shaking off a strong
challenge from Alaska in the mid-1980’s, when its production had already gone into an
extended decline but Alaska’s was reaching its 2 million B/D peak.
- Alaska’s 35% decline since its 1998 peak has actually been less than
was expected. Alaskan production may confound expectations even more dramatically in the
near future by flattening out or even rising modestly. It has been a prime beneficiary of
the industry’s new technology and has also gained from the state’s decision in
the early 1990’s to encourage additional production through making its contractual
and fiscal terms more competitive. This reflected the state government’s conclusion
that this, rather than treating the then flowing oil as a captive cash cow, would maximize
its oil-based revenues over time.
- Alaska could consequently overtake Texas in the producer stakes after
all, but it will not win the No. 1 spot. Top rank is certain to go to the Gulf of Mexico (see What's
Hot), the only part of the Federal offshore where leasing is still active.
Technology-driven, new production plays in world record water depths of a mile or more
have achieved world-scale single well flow rates of up to 30,000 b/d, making the area a
magnet for the large, international players that place the rest of the U.S. Lower-48 well
down their rankings.
- California, now No. 4 in the producing area rankings after the Gulf of
Mexico as well as Texas and Alaska, is the only other area where production from the
Federal offshore is allowed. However, it is unable to share in the boom being experienced
in the Gulf because new leasing is banned. California is also, thanks to geological
happenstance, by far the largest U.S. producer of heavy crudes. Technology had stemmed the
long-term slide in California’s production in recent years, but the low prices will
renew it.
For more info, go to What's Hot in Supply:
To see graphs, go to Supply Graphs
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