In our continuing debate about the outlook for energy securities, we all agree that the price of crude oil (and natural gas) will be the largest and least-predictive variable. Those favoring a conservative view cite the near certainty of rising North American liquids production, and declining demand for petroleum products throughout much of the industrialized world, as evidence that supply may exceed demand, leading to lower oil prices. While we know this can occur, I offer a different viewpoint based on two less-discussed topics; the likelihood of declining oil exports from Saudi Arabia and that country’s need to maintain high prices to fund its daunting social spending.
One thing most of us can agree upon is that Saudi Aramco (the Saudi Arabian National Oil Company) has been, and will continue to be, the #1 swing producer, raising or lowering output to meet global demand. Having spent over forty years studying geology and politics of the Kingdom of Saudi Arabia (KSA), I remain surprised at how little this is understood by many oil analysts and the degree to which they may be missing evidence of that country’s rapidly maturing export capability.
Let’s begin with a few accepted facts:
- Saudi Aramco production peaked in 2009 at nearly 12 Million barrels per day (bpd).
- Production is now closer to 9.6 Million bpd as an accommodation for weak global demand and rising non-OPEC output from the United States and Canada.
- The Kingdom also produces about 2.0 Million bpd of natural gas liquids used, primarily, as feedstock for its huge petrochemical industry.
- Claimed “proven reserves” remain at 265 billion barrels, the same figure for about the past thirty years.
- As KSA has averaged 7 Million bpd over this time frame, they would have produced 77Billion of these 265 Billion barrels.
- Domestic oil consumption has been rising rapidly. From 1.6 Million bpd in 2000, it is now closer to 3.0 Million bpd and rising at an accelerating rate.
- Natural decline rates in its existing fields remain a hotly debated topic. The Ministry of Petroleum and Mineral Resources claims it is about 3%/year. My years of research, including interviews with dozens of drilling engineers and foreign service companies, suggests the number is larger – possibly closer to 7%/year.
Given these apparent “facts”, what does all this mean for the global oil industry? It raises several vital questions, each of which will have meaningful impact on future supply/demand balances;
- Has Saudi Aramco really replaced the estimated 77 Billion barrels produced since 1983? While aware of several important new discoveries (Safaniya, Khurais, Shaybah and Manifa), only two of these are Arab Light crude while the other two are much lower grade, high sulfur Arab Heavy which is less attractive to Eastern Hemisphere refiners. Likewise these fields were developed at high cost in order to replace the Kingdom’s ultra-low cost, 70 Billion barrel Ghawar field that produces 5 million of their 9.6Million bpd.
- Domestic consumption is the largest “wild card” for projecting KSA export potential. As noted earlier, this figure has nearly doubled to 3.0 Million bpd in the past decade. Up to one-third of this is used as fuel for their electric utilities where demand growth is soaring to support new industrial plants and water desalination. Given internal demand rising much faster than production, Aramco’s CEO, Khalid al-Falih, warns that domestic consumption may double again by 2020 unless replaced either by natural gas or unwelcomed economizing. The implication of this statement is significant. Assuming, as I believe one should, that Saudi Arabia remains at 9.5 Million bpd by 2020, but raises consumption to 6 Million bpd, that leaves 3.5 Million for export versus a current 6.5 Million bpd. This reduction of 3.0 Million bpd would be a very convenient “accommodation” for the United States and Canada where production may rise by a comparable amount.
- The obvious best alternative for Saudis would be to expand natural gas production for use as industrial fuel and electricity generation. The country is actively exploring for such reserves with a clear shift away from oil to Natural Gas targets, employing global service giants like Schlumberger, Halliburton and Baker Hughes. While meeting with some success, it must offset declines in production of “associated gas” (that produced with crude oil) which represents nearly 60% of their 3.6 Trillion Cubic Feet of annual output. As a country with the fifth largest gas reserves in the world (behind Russia, Iran, Qatar and United States), we can foresee rising dry gas production but potentially significant loss of associated gas. One might ask the logical question; “why not import gas from Qatar, its next door neighbor?” Here is where geopolitics comes forward. You only need to spend time in these two countries to measure their enmity for each other, including Wahhabi Sunni versus Shiite bitterness, to understand why economic logic can be overwhelmed by personal/religious rivalries. It appears that politics surpasses logic, leading Saudi Aramco to spend billions annually to become a major natural gas producer despite having the world’s largest natural gas deposit (Qatar’s North field) right next door where gas is converted to Liquid Natural Gas rather than being piped to the giant oilfields and petrochemical plants of its next door neighbor.
The “bottom line” of this discussion, quite simply, is that energy investors should increasingly focus on Saudi Arabia’s likely declining crude oil exports in coming years, both due to their rising internal consumption and need to make room for rising North American output. The other reason why this will happen is the country’s huge “social contract” with its population that is about 90% Sunni and 10% Shiite. That latter 10% represent key workers in their large Eastern Province oilfields. Were they to become restive, as they have in the past, the Kingdom’s stability would be threatened as has happened with the Arab Spring throughout North Africa, Syria and another neighbor – Bahrain. While subject to some debate over definitions, it is my belief that Saudi needs about $110/barrel for its Arab Light crude just to meet budgetary commitments that include huge subsidies for all citizens. This is one other reason that, despite its occasional accommodative comments about supporting “fair prices” for oil, to support struggling world economies, they will make every effort to keep global prices well above $100/barrel. That implies domestic (West Texas Intermediate) should remain above $90/barrel in coming years, assuming no economic collapse or military conflicts.
The above scenario makes our outlook for oil exploration and services reasonably positive in the next few years.
Paul Mecray, Managing Director 610-260-2227