Western Oil Supply

Western nations — the U.S., in particular — are now experiencing the bow wave of a profound change in the current and future availability of oil. According to recently published data, oil output from all major Western oil companies is on an ominous decline trend. Exxon Mobil, for example, announced that its average oil output has fallen by 614,000 barrels per day in 2008.

Western oil majors like Exxon are finding it harder than ever to identify new prospects and successfully complete new oil projects. This comes despite the fact that the oil industry is flush with profits from upstream operations, and is eager to expand.

BP’s Thunder Horse project in the Gulf of Mexico, for example, is finally coming online in 2008, with an anticipated output of nearly 250,000 barrels per day. But this one project has taken almost 20 years to complete, at a cost in excess of $6 billion.

And Chevron’s recent success with its Jack 2 project in the Gulf came at a cost of over $240 million for just one test well. And this prospect is still years away from being a successful oil-producing prospect.

These sorts of developments have implications far beyond the Peak Oil argument, as valid as that thesis may be.

One of the key reasons for the decline in oil output from major Western companies is world politics. In the 1990s, the key strategic development in the wake of the fall of the Berlin Wall and the decline of communism was the trend toward globalization. Much of the world opened up to the West figuratively, as well as literally. And the oil industry was one beneficiary, making significant investments in unexplored or underexplored regions from South America to the Caspian Sea.

But the key strategic development in the first decade of the 2000s has been, arguably, the concept of “resource nationalism.” That is, in the many nations that were formerly friendly toward Western companies, the attitudes toward foreign investment have fundamentally changed. Western oil companies have found themselves squeezed in resource-rich areas.

Western companies have experienced outright nationalizations, such as what occurred with Exxon Mobil and ConocoPhillips in Venezuela. Or Western companies have been shown the door through intimidation and bullying legal tactics under the guise of “tax laws” or “environmental enforcement,” such as what happened with Shell Oil Co. at its Sakhalin project in Russia.

Even Brazil has shown its nationalistic teeth to foreign investment. Recently, Brazil withdrew numerous areas from prospective lease sales after it became apparent that the odds of finding oil were quite good. Why not just save it for Petrobras?

Whatever the case might be, Western companies have been shunted aside or, in the best cases, forced to renegotiate contracts on less favorable terms. The traditional model of resource development, in which Western companies obtain legal title and control over oil and gas deposits in the ground, is fighting a losing battle. Assertive host governments are gaming the rules to favor their state-owned national oil companies (NOCs).

As recently as the late 1970s, Western oil companies controlled well over half of the world’s oil production. But now the NOCs — such as Saudi Aramco, National Iranian Oil Co., Kuwait Oil Co., Petroleos de Venezuela, Petroleos Mexicanos (Pemex), etc. — control over 85% of the world’s oil resources. Western majors control about 7% of the world’s oil resource base.

All the while, oil output from mature regions is in decline. From the North Sea to the Alaska North Slope, the Western oil companies are faced with lower volumes from existing oil holdings. And there is a much thinner book of potential business elsewhere in the world. According to Amy Myers Jaffe, who studies the oil business from her chair at Rice University, “This is an industry in crisis.”

This sense of crisis also helps explain why Western oil companies are fighting to expand their options for offshore drilling in the U.S., as well as to expand access to areas like northern Alaska. The U.S. offshore, and other frontier areas such as the Arctic National Wildlife Refuge (ANWR) are among the few options remaining for Western oil companies.

So one key point that the Western oil industry makes is that its resource base and reserves are in decline. And over the medium to long term, this means that the economic importance of the Western companies will erode. Despite any plans or efforts at conservation and efficiency, as well as a large-scale shift to alternative energy sources, the Western world will become increasingly dependent on NOCs for oil.

From the standpoint of energy and strategy, this will not be a good thing for the West.

Until we meet again…
Byron W. King
August 29, 2008

The Daily Reckoning