Gulf Oil. How Important Is It, Anyway?

April 23rd, 2003 - by admin

by Daniel Yergin – San Francisco Chronicle

(April 13, 2003) — In the midst of the second world war, Franklin D. Roosevelt dispatched America’s most eminent geologist, Everette Lee DeGolyer, to the Middle East.

DeGolyer spoke with unique authority. As a young man at the beginning of the 20th century, he had discovered the huge well that inaugurated the “golden age” of Mexican oil; in the 1920s, he had been such a relentless promoter of the new seismic exploration technology that he was said to be “crazy with dynamite.”

Roosevelt wanted DeGolyer to answer a fundamental question: “How important are Persian Gulf oil reserves to the future of the world?” That same question is with us once again, starkly posed by the war in Iraq. It is all the more important because of the widespread belief that the Iraq crisis is not about weapons of mass destruction but, rather, in some murky way, about oil. Yet such assertions are often made in isolation, without an understanding of the overall world oil scene.

The question may have been the same, but the starting point for DeGolyer’s mission in 1943 was very different from today. It was only 16 years earlier, in 1927, that oil had been discovered in Iraq. Found near Kirkuk, in the Kurdish part of Iraq, it still counts as the first commercial find of oil in any Arab country, and it opened up the Arab world to petroleum development. It would take until 1938 for oil to be found in neighboring Saudi Arabia and Kuwait.

Then came the second world war. Exploration efforts were suspended and wells were capped in fear of a Nazi advance. As it turned out, Field Marshal Erwin Rommel and the Afrika Korps were stopped at the Battle of El Alamein in late 1942.

But the war left no doubt of the importance of oil. The U-boats had come very close to cutting the tanker pipeline from the United States to Europe. Hitler’s forces almost made it to Baku, on the Caspian Sea, the main source of Soviet oil. Japan, with its oil supplies dwindling, turned to kamikaze attacks which, among other things, did not require fuel for a return trip. Rommel had written what would prove to be the epitaph for the German oil position during the war: “Shortage of petrol! It’s enough to make one weep.”

America’s Liquid Arsenal

For his part, Roosevelt knew that the US was sitting on a great arsenal in the form of the nation’s own oil supplies. The US oil fields, particularly along the Gulf Coast and in the Southwest, were mobilized for the war effort, and they supplied six out of the seven billion barrels the Allies were to use in the war.

In the course of his 1943 trip, DeGolyer visited Saudi Arabia, Kuwait, Iraq and Iran to analyze their respective potentials. The conclusion he delivered when he returned to Washington was startling: “The center of gravity of world oil production is shifting from the Gulf-Caribbean area to the Middle East and the Persian Gulf area, is likely to continue to shift until it is firmly established in that area.” But even DeGolyer could not have imagined by how much. Today, the Persian Gulf supplies more than 20 million barrels a day — more than three times what the United States produces.

Diverse Global Production

That the Persian Gulf’s resources, among the cheapest to produce in the world, are of central importance to the health of the world economy can hardly be doubted. Altogether, the region provides more than a quarter of the world’s oil, most of it flowing to Europe and, increasingly, Asia.

Yet these resources exist in a much larger and more diverse network of global oil production. Losing sight of that is to lose sight of the context.

Some of today’s highly charged rhetoric would have one believe that Iraq is uniquely important to world oil supply. That simply is not true. It amounts to just 3 percent of total world supply, and technology is making available new supplies in ways that most people do not realize. Moreover, in terms of consumption, there are major regional differences. The US gets 70 percent of its crude supplies either from its own production or from neighboring countries in North and South America.

In contrast to today’s crisis, the 1990-91 Persian Gulf crisis was more directly about oil and Iraq’s drive to dominate the region. In 1990 Iraq invaded Kuwait and sought to annihilate it as an independent nation. Saddam’s objective was, as it had been when he invaded Iran a decade earlier, to control, directly or indirectly, a large part of Persian Gulf supplies and bend them to his political and military purposes.

The central focus this time is on weapons of mass destruction and Iraq’s failure to comply with 17 UN resolutions going back to 1991. There is an oil dimension but it is not about “oil protectorates.” It is about geopolitics and the security and the stability of the Gulf’s supplies. Certainly, a Saddam Hussein regime equipped with these weapons would have been in a position to intimidate the region and to manipulate supply and threaten the security of the world economy.

90 Millions Barrels a Day

Such a threat would have become all the more critical when one realizes that world demand continues to grow. A decade from now the world will probably be consuming 20 percent more oil than today. What this means is that today’s 77 million barrels a day will become more than 90 million barrels a day by 2013.

The main growth will come from the developing world and, in particular, China and India. As China continues on its remarkable course of economic growth, so its oil consumption continues to increase. Today it uses twice as much oil as it did a decade ago. It’s the third largest consumer after Japan, and soon will overtake Japan to become the second largest in the world.

For decades, China, inspired by “the heroic spirit” of the workers in its great oil field at Daqing, in Manchuria, was committed to self-sufficiency. That changed in 1993 in what turns out, in oil terms, to have been a very significant year. For that was the year that China — no matter how heroic the spirit — simply could not do it on its own any more, not with an economy that was growing 8 percent a year. It became a net importer. And its imports have continued to grow.

Walk into the headquarters in Beijing of any of China’s three national oil companies and you will see how China is responding.

Share Prices Flashing

In the lobbies of PetroChina, Sinopec and CNOOC — three companies created to reform, make more efficient and partially privatize China’s oil industry — there are flashing signs that tell you each company’s share price on the world stock market at that moment. This is not exactly what you would expect to see in what used to be known as a centrally planned economy. These scenes vividly capture the shift from state control to markets. Breaking up the old state monopoly and subjecting the newly born oil companies to the discipline of capital markets is one of the most important ways that China has sought to cope with the country’s growing oil demand.

But where will the new supplies come from?

That brings us back to the Persian Gulf. After all, the region has been credited with holding two-thirds of the world’s total oil reserves. But reserves are not necessarily a guide to production.

Iran, hobbled by technological and organizational problems and by political discord, has seen its production decline by 35 percent over the past 25 years. Iraq’s capacity has declined by 20 percent over the past 10 years, and it is now estimated that it will take two to three years, and up to $5 billion, to get back to where Iraq was a decade ago and several years more to begin to significantly ramp up production beyond that.

This contrasts starkly with Saudi Arabia, which has kept itself at the forefront of technology. It usually produces about 8 million barrels per day. It also maintains at least an additional 2.5 million barrels per day of “spare” capacity that it can bring into production as a stabilizer, as it has been doing, first in the face of the disruption of Venezuelan supply and now to meet the shut-down of Iraqi production.

But what is striking is the diversification of supply sources on a global basis. In 1975, the Persian Gulf produced 40 percent of world output of 52 million barrels per day. Today, world consumption is 77 million barrels per day. Yet the Persian Gulf’s output has grown only slightly, with the result that its output has declined to less than 30 percent of total world output.

New Sources of Supply

Over the years, many new supply sources have come in, beginning with the North Sea and the Alaskan North Slope after the 1973 oil crisis. It’s never easy. Every year, oil companies spend tens of billions of dollars to find and develop new reserves to replace the barrels they have produced in previous years.

Much of this work is governed by the “law of long lead times”; it can take up to a decade to bring a major new oil field into operation. For the companies, it always seems an uphill struggle.

Right now, the most dramatic expansion is unfolding in the Russian oil industry, in what my colleague Thane Gustafson calls “the miracle in the Russian oil fields.” Over the past three years, Russian output has increased 25 percent. Today Russia is the world’s second largest exporter, exceeded only by Saudi Arabia.

The 1990s collapse in output that resulted from the implosion of the Soviet Union has been reversed. There are many reasons: a reformed industry, largely privatized, working toward world standards, introducing new technology. But the heart of the matter was summed up a few weeks ago by Mikhail Khodorkovsky, CEO of the Russian oil major, Yukos: “We now apply an economic test to every stage of what we do.”

Joint Venture

A signal of the change was the announcement last month by BP and one of the other Russian oil majors, TNK, that they are establishing a multibillion dollar joint venture to accelerate development of Russian production. The thing to look for over the next year or two is the firming up of plans by Moscow for new pipelines that will carry Russian oil to China or elsewhere in Asia and, even more dramatically, to Murmansk, the ice-free port on the Arctic Ocean.

During the second world war, Murmansk is where the American freighters delivered the Lend-Lease goods that supported the Soviet battle against Hitler.

A half-dozen years from now, the tankers may be sailing in the other direction.

A similar resurgence is taking place to the south, in the Caspian Sea and Central Asia. Output is increasing in Kazakstan and Azerbaijan. As with in Russia, the key is transportation. Railway tank cars will not suffice for the future volumes, and new pipelines are critical. Recently, Heidar Aliyev, the president of Azerbaijan, stood up in the ballroom of a hotel in Washington, D. C., to tell the story of how it has taken eight years to get plans to gel for a pipeline to transport Azeri and possibly Kazak oil to the world markets. But now one leg is built — and the Japanese-made pipe is being welded for the next segments of a huge pipeline that will move almost a million barrels a day from Baku through Georgia, down through Turkey to the Mediterranean port of Ceyhan, which is accessible to super tankers. This new Baku-Ceyhan pipeline will be one of the linchpins of world supply and energy security in the years ahead.

Another growing source of oil will be West Africa, which by 2006 will overtake the North Sea in terms of output. But the real competition for market share looks to be between Russia and the Caspian on one side, and the Middle East on the other. The race will be affected by everything from governments’ investment policies to local activism. At this point, it looks as though Russia and the Caspian will be about even with the Middle East, each adding 4 to 5 million barrels a day.

People sometimes seem to think of “reserves” as a fixed amount of oil, laid down by nature. In fact, “reserves” are a more elastic concept, determined not only by geology, but also by the interaction of economics, politics and technology.

After the first world war, fear of an “oil famine” gripped the world. But then fresh areas for exploration opened up, including the new nation of Iraq, which was cobbled together at the Versailles conferences out of the three eastern provinces of the old Ottoman Turkish Empire. During this time, the industry applied new technology. Building upon techniques used during the first world war for detecting enemy gun emplacements, it developed the seismic exploration championed by DeGolyer. This quickly became a critical tool for new oil exploration.

Today, a major technological revolution is unfolding, known as “DOFF” — the “digital oil field of the future.” This brings together a panoply of information and control technologies, remote sensing mechanisms, “intelligent drilling” and highly accurate measurement tools to make exploration and production far more exact and targeted. The consequence will be to substantially lower costs.

Economic Feasibility

As a result, physical supplies that were previously too expensive or too difficult to produce will now become economically feasible. The impact of DOFF will be enormous. Over a decade, DOFF could expand world oil reserves by 125 billion barrels — more than the known proved reserves of Iraq.

That is still in the future. In the meantime, although almost completely overlooked, something very important has just happened to supply. This past year saw the first major increase in world oil reserves since the mid-1980s.

The new increase is some 175 billion barrels. This is a lot of oil — 50 percent more than Iraq’s proven reserves and two-thirds that of Saudi Arabia’s.

These new reserves, however, are not in the Middle East but in Canada.

Advances in the technology for handling the oil sand deposits in the province of Alberta have, by cutting production costs almost in half, moved this enormous volume of potential supply into the economically recoverable “proven reserves” column. For the first time since Everette DeGolyer’s report to President Roosevelt, there has been a significant decline in the Persian Gulf’s share of total world oil reserves from 66 to 56 percent.

The point here is that world oil supplies are not some finite constant sum. Rather, the picture is dynamic and changing. The reserve picture will continue to shift. It’s altogether possible that if and when a “new” Iraq sorts out its arrangements and reintegrates into the world economy, new exploration will substantially increase its reserves, once again pushing up the Persian Gulf’s share of the total.

What DeGolyer foresaw 60 years ago is true — the resources of the Persian Gulf are a tremendous strategic asset for the world economy, one of the foundations for the standard of living in the developed world and a critical fuel for economic growth in the developing world. But what is also true is that if one is looking for oil, there are lots of other places to go.

How much from where?

That will be determined not just by nature’s endowment, but also by technology, economics and, more so than most recognize, by the political choices that countries make about how they want to develop their resources and what they want to earn from the world economy.

Daniel Yergin is author of the 1992 Pulitzer Prize-winning, “The Prize: The Epic Quest for Oil, Money, and Power.” He is chairman of Cambridge Energy Research Associates. His television series, “Commanding Heights: the Battle for the World Economy,” based on the book of the same name, will air nationally on PBS in May. A version of this piece ran in the Financial Times.