Professional Documents
Culture Documents
2006 Watkins Oil Scarcity PDF
2006 Watkins Oil Scarcity PDF
2006 Watkins Oil Scarcity PDF
Abstract
Oil shortages have been predicted over the past 30 years. In fact, oil is more plentiful now in an economic sense than in 1973. The
reason for such misconceptions lies mainly in reliance on analytical techniques that do not comprehend oil as an economic commodity.
r 2005 Published by Elsevier Ltd.
Table 1
Salient oil reserves and production data
until abandonment, when reserves will have equalled shortage.3 Reserve additions have more than offset
production. Another peculiarity of the oil industry is that depletion.
its inventory level—represented by its reserves—instead of Reserves in the Middle East remain predominant.
lasting for a few weeks or months must be large enough to Reserves in non-OPEC countries, even though the rate at
last for several years. which they were being produced greatly exceeded that in
Other things equal, investment per unit of reserves would the Middle East, nevertheless increased by some 30 billion
be expected to increase as exploration proceeds from more barrels by 2003, compared to 1973. The noticeable jump in
attractive to poorer prospects, although any strict sequen- world reserves between 1983 and 1993 was less a result of
tial upward ratcheting over time seldom holds (low cost new investment adding supply, and more a reassessment of
deposits are not necessarily found first). Correspondingly, reserves by OPEC countries, especially those in the Middle
prices would progressively increase over time until demand East, not the least encouraged by competition among them
would be choked off. Yet, unit costs—albeit more difficult for OPEC quotas.
to track down of late with inferior information—generally In 1973, OPEC production accounted for 53% of the
have been in denial of any such secular trend. Other things world total, but expectations that its share would expand
have not been equal: the data reviewed below suggest that further have been squashed: in 2003, OPEC production
overall new knowledge has offset expected declining yields was slightly smaller absolutely than in 1973 and its market
as exploration in areas under cultivation became more share has been dramatically cut to around 40%. Produc-
intense, and new horizons have continued to emerge. This tion by Middle East OPEC members was the same in 2003
picture is consistent with a stand-off for what Adelman has as in 1973. In 2003, the majority of the oil market was
called the ‘‘endless tug-of-war between diminishing returns
3
and increasing knowledge’’ (Adelman (1990, p. 3)). Reserves are proved reserves, ‘‘ythose quantities that geological and
engineering information indicates with reasonable certainty can be
recovered in the future from reservoirs under existing economic and
operating conditions’’ (BP Statistical Review, 2004, p. 4). ‘Oil’ here
3. Evidence from salient supply data includes crude oil, oil sands and natural gas liquids (NGLs). However,
Canadian oil sands reserves are confined to those serving projects under
Table 1 shows key data on oil supply for 10-year active development; these reserves thus exclude the great bulk of the 175
intervals, starting in 1973. It might have been equally billion barrels of remaining bitumen reserves which Alberta regards as
entitled ‘Confounding Cassandra’. Proven reserves of established. The quality of much of the reserve data outside of North
America (excluding Mexico) and the North Sea is not good and has tended
crude oil remaining in the world rose by some 500 billion to deteriorate further after the mid-1980s. Note, there may be some
barrels, 2003 over 1973, notwithstanding total production inconsistency between reserve definitions in 1973 and those for other
of about 730 billion barrels over this period: some years.
ARTICLE IN PRESS
510 G.C. Watkins / Energy Policy 34 (2006) 508–514
supplied by non-OPEC countries, at about 60% of world 4. Evidence from reserve prices
production, in contrast to 47% in 1973.
Proven reserves are equivalent to warehouse inventory. Price and costs trends are economic indicators of
A prudent profit sensitive producer operating in a scarcity. Ostensibly, prices of flowing oil (wellhead prices)
competitive market would operate with an R/P ratio of cover user cost—the impact on future net profits of current
10–15 years.4 The non-OPEC countries’ aggregate R/P production—and extraction cost, but they can be mislead-
ratio now approaches this level, declining from 23 years in ing. For example, price levels in the first quarter of 2004
1973. In short, non-OPEC is producing at a mature R/P have been heavily influenced by OPEC’s restraints on
ratio, one where production is not subject to restraint from output to keep the oil price in a desired range—hardly a
either policy measures or insufficient installed capacity. By yardstick for measuring scarcity.6 Indeed, the need for this
way of contrast, OPEC’s R/P ratio of currently about 80 kind of action indicates excess rather than tight supply. A
years illustrates the degree of excess commercial reserves better scarcity measure is provided by trends in the in-
held by these countries; and while the accuracy of OPEC’s ground value of reserves; these cast a longer shadow than
reserve estimates is questionable, it would take a very wellhead prices. Moreover, if there was a competitive
major error to alter this picture of a substantial reserve market in reserves, the reserve price less development
surplus. investment incurred represents the market value of an
If OPEC’s installed capacity matched a lower R/P ratio, undeveloped reserve. In turn, this equals user cost, the
oil would flood the market, prices would plummet and the value of the undeveloped asset in the ground relinquished
more expensive non-OPEC production would be stranded. by its sale (Adelman (1991)).
Hence OPEC’s policy of production restraint to keep prices Over the past decade or so, Morris Adelman and I have
in a target range well above marginal costs of Middle East had a go at putting together a price series for reserves in the
sources does not displease governments of those non- ground using North American data. Initially, we relied on
OPEC countries, e.g., the United States, with sizeable, a fairly small sample of proven reserve sale and purchase
high-cost domestic production. data (see Adelman and Watkins (1995)). Later, we have
Prices in 2003 were close to nine times higher than those had access to a more extensive database of US reserve
in 1973 in money-of-day terms, in real terms they were transactions (e.g., Adelman and Watkins (1997)).
about double; in 1983, the corresponding numbers in We pursued this research for three main purposes: to
relation to 1973 were over seven times and over three times. provide information about national income and wealth,
Note that 1973 prices in turn approached double those which includes oil and gas reserves; because in-ground
prevailing in the Middle East in 1970. Extending the values (compared with replacement costs) are crucial in
perspective to 1970 would make the price increases more assessing industry trends; and reserve values have impor-
pronounced.5 tant implications for the basic theory of mineral resources,
In large measure, the strong performance of non-OPEC including testing propositions such as the Hotelling
production over the past 30 years was a classic response to Valuation Principle. Our most recent exhibit is Adelman
opportunities created by the umbrella of higher prices and Watkins (2003), where inter alia, we estimated a US oil
sustained by OPEC, although the umbrella leaked when and natural gas reserve price series from 1982 to 2002. We
OPEC quota discipline was especially lax or when the have now extended the series to include 2003 (Adelman and
burden of output adjustment devolved mainly on one Watkins (2005)).
OPEC country (Saudi Arabia). Actual transaction data reflect appraisals by teams of
To recapitulate, the physical quantity of proven reserves engineers, geologists, bankers, economists and investors.
is a measure of scarcity, though not a particularly good The forecasts of prices, production and costs embedded in
one, since proven reserves are in the nature of working their calculations may be refuted, but values at which
inventory and do not represent eventual supply. Yet, the reserves actually change hands merit serious attention.
world inventory of reserves has markedly increased over Money is being put on the line.
three decades even though production has risen strongly. At first glance, evidence based on US transactions might
This runs counter to the opinion anticipating emerging seem parochial. However, deregulation of US oil prices in
shortages. 1981 effectively plugged the US market into the world
market; non-US corporations search for and develop oil in
4 the US, and US corporations have long gone abroad.
An analogy with reserve deliverability requirements for natural gas is
useful here. In the 1980s, typical long-term contracts in North America Hence, information on the competitive US market
called for a rate of 1 mmcf/d/7.3 bcf of reserves, implying an R/P ratio of implicitly provides a window on reserve prices in all
20 years. With the elimination of spare capacity in the 1990s, current regions open to new investment in oil resources. This
contracts—of which few are long term—call more for corporate includes most non-OPEC countries, and a few OPEC
warranties than specific deliverability standards, and the implicit R/P countries.
ratio is about 10 years, matching the aggregate North American natural
gas industry ratio.
5 6
The posted price of Arabian light ex Ras Tanura in 1970 was $1.80/b On the problems of using the current price as scarcity measure, also see
(BP Statistical Review, 2004, p. 4). discussion in Krautkraemer (1998, p. 2089).
ARTICLE IN PRESS
G.C. Watkins / Energy Policy 34 (2006) 508–514 511
Table 2 12.00
Nominal Prices Real Prices (With US PPI)
Estimates of in-ground crude oil price, United States, 1982–2003
New
Prospects, always be plentiful? That is more than anyone could
Resource Technological pretend to know. Some day the balance may shift. The
Depletion Improvement
great majority of giant conventional fields—many would
P
say all—may well have been found. Perhaps, the impact on
oil demand of economic development, especially in Asia
SD (India and China), is a harbinger. This degree of
uncertainty encourages agnosticism about whether tech-
nology and new knowledge will continue to keep the forces
S
SA of depletion at bay.16 At the same time, a generous
‘backstop’ of non-conventional oil supplies (oil sands,
Reserve Additions/unit of time
heavy oils, oil shales) looms once returns become
Fig. 3. Oil reserve supply curves. sufficiently attractive.
A persistent change in the return to holding oil in the
ground, with a definite upward trend emerging in reserve
contracting: less would be found at a given price.14 Note a prices, would provide an early warning system. Indeed, the
leftward shift in a supply function does not mean reserves recent upward trend validates OPEC’s success in meeting
will not continue to be added. Rather, it indicates that its price targets, and beyond those levels, as demand
returns from further exploration have started to diminish— presses on aggregate world installed capacity. However,
returns not offset sufficiently by technological or efficiency recent wellhead price levels of over $50/bbl register
improvements, or by opportunities to exploit new plays. contrived not actual scarcity—a shortage price without a
Supply conditions in OPEC countries could not be shortage of in-ground resources.
depicted by the interaction of conventional supply func- Techniques to analyse oil supply should pay less heed to
tions with price; OPEC output restraint entails a rather Hubbert and more to the economic framework. Oil as a
different model specification. resource is a gift of nature. In-ground recoverable reserves
Smith and Paddock (1984) estimated economic oil are an economic commodity. They need to be treated as
supply functions divided into two stages: a discovery such.
model and a production model. The discovery process
described the physical returns to exploration. The produc- Acknowledgements
tion model specified the economic costs of bringing new
fields on stream and likely production rates. In both stages, I acknowledge helpful comments from Morris Adelman,
the negative influence of resource depletion was modelled Jeffrey Krautkraemer, Roland Priddle and James Smith—
explicitly. The models were applied to data for 37 the usual disclaimer applies.
individual regions around the world, from a 1978
perspective. The discovery model disclosed a large poten-
tial for new fields in most areas. References
There have been other efforts. The pity is that they have
Adelman, M.A., 1990. Mineral depletion with special reference to
been so few and far between. petroleum. Review of Economics and Statistics 72 (1), 1–10.
Adelman, M.A., 1991. User cost in oil production (with Harindar De Silva
and Michael F. Koehn). Resources and Energy 13.
6. Concluding remarks Adelman, M.A., Watkins, G.C., 1995. Reserve asset values and the
Hotelling Valuation Principle: further evidence. Southern Economic
Three decades beyond 1973, oil reserves increased by Journal 61 (3).
Adelman, M.A., Watkins, G.C., 1997. The value of United States oil and
80% even though production has continually increased. gas reserves: estimation and application. In: Moroney, M.J. (Ed.),
There has been less, not more, reliance on OPEC. Advances in the Economics of Energy and Resources, Energy Supply
Indicators of resource scarcity do not provide evidence and Demand, vol. 10. JAI Press Inc.
that oil has been becoming scarcer.15 Instead, new plays, Adelman, M.A., Watkins, G.C., 2003. Oil and natural gas reserve prices
1982–2002: implications for depletion and investment cost. Working
more intense development of existing plays, allied with cost
Paper 03-016, MIT Center for Energy and Environmental Policy,
saving and innovative technology, have offset resource October.
depletion. In short, Nature as Scrooge has to date met its Adelman, M.A., Watkins, G.C., 2005. Addendum to CEEPR WP 03-016
match in Knowledge’s Lady Bountiful. with results for 2003. MIT Center for Energy and Environmental
Policy Research, forthcoming.
14
For a list of the 41 countries, see Watkins and Streifel (1998, p. 35); for Cleveland, C.J., Kaufman, R.K., 1991. Forecasting ultimate oil recovery
a list of the ‘contractionary’ and ‘expansionary’ groups, see Watkins and and its rate of production: incorporating economic forces into the
Streifel (1998, p. 45). models of M. King Hubbert. Energy Journal 12 (2), 17–46.
15
Krautkraemer (1998) reached a parallel conclusion in a more general
16
mineral industry context, not just for oil. Tilton (2003) takes a similar position.
ARTICLE IN PRESS
514 G.C. Watkins / Energy Policy 34 (2006) 508–514
Hotelling, H., 1931. The economics of exhaustible resources. Journal of Resources for the Future, Sam, S., et al., 1979. Energy in America’s
Political Economy 39, 137–175. Future: The Choice Before Us. Washington, DC, USA.
Hubbert, M.K., 1962. Energy resources. A Report to the Committee on Ryan, J., 2003. Hubbert’s peak: déjà vu all over again. IAEE Newsletter,
Natural Resources, National Academy of Sciences, Government 2nd Quarter.
Printing Office, Publication No. 1000D. Smith, J.L., Paddock, J.L., 1984. Regional modelling of oil discovery and
Krautkraemer, J.A., 1998. Nonrenewable resource scarcity. Journal of production. Energy Economics.
Economic Literature 36 (4), 2065–2107. Tilton, J., 2003. On Borrowed Time? Assessing the Threat of Mineral
Lynch, M.C., 2002. Forecasting oil supply: theory and practice. Quarterly Depletion. Resources for the Future, Washington.
Review of Economics and Finance 42(2); In: Smith, J.L. (Ed.), Oil and Watkins, G.C., 1992. The Hotelling Principle: Autobahn or Cul de Sac?
the Economy: Recent Developments in Historical Perspective (Special Energy Journal 13 (1).
Issue). Watkins, G.C., Streifel, S., 1998. World crude oil supply: evidence from
Parra, F., 2004. Oil Politics–a Modern History of Petroleum. estimating supply functions by country. Journal of Energy Finance
I.B.Tauris. and Development 3 (1).