Shell's World of Energy - A Zone of Extraordinary Opportunity or Misery?

Now that seemingly endless increases in the price of oil are starting to make 2011 look like 2008 all over again, the mainstream media is covering the oil market on page one rather than somewhere back near the obituaries and the personals.  One story in particular caught my attention.

In early March 2011, the Telegraph carried a news item quoting the Chief Executive of Royal Dutch Shell Peter Voser who stated that the lack of investment by the oil industry over the past two to three years will be a big driver of higher oil prices.  Here's a quote:

"We may face a situation at one stage where supply cannot meet demand.  That's where OPEC spare capacity will help but we have to replace significant barrels because of natural decline over time."

Mr. Voser goes on to state that he has confidence that OPEC can supply the market with the 1 million barrels of oil per day that have been lost to the world's market due to the uprising in Libya.

"I think as OPEC has highlighted there is enough spare capacity to actually replace the shortage of oil out of Libya and it will over time balance itself again....once the Middle East calms down, the oil price will be in the area where it is determined by supply and demand."

These are most interesting words from the CEO of Europe's largest oil company.  They are particularly interesting when taken into context with Shell's "Signals & Signposts - Shell Energy Scenarios to 2050" publication released in mid-February 2011.

In this publication, Shell outlines energy scenarios that address the challenges facing the world both from an energy and a financial standpoint over the next four decades.  In particular, Shell examines how the Great Recession of 2008 - 2009 affected the world's energy markets now and in future decades.

The publication notes that the key driver for the world's economy and energy markets lies in world population growth.  As the populations of developing, non-OECD nations (think China and India who together make up about 43 percent of the world's total population) escape poverty, their demands for both energy and goods is increasing rapidly on both an individual and on a countrywide basis.  This is most likely going to lead to tensions in the world's energy supply systems.  Shell projects that the underlying global demand for energy could triple between the years 2000 and 2050 if the economies of developing nations follow energy use intensities that conform to historical patterns.  Shell also projects that technological innovation could reduce the demand for energy through greater efficiency by about 20 percent over the 50 year period and that rates of growth for the supply of energy could boost energy production by about 50 percent.  The projected difference between the somewhat diminished growth in demand and the increased growth in supply still leaves the world's energy market with a supply gap of around 400 EJ per year or about the size of the world's entire energy industry in the year 2000.  Shell terms this the "Zone of Uncertainty" or the "Zone of Extraordinary Opportunity or Extraordinary Misery".  To me, it sounds like the making of yet another Mad Max movie.

Here is Shell's graphic showing the Zone of Uncertainty:

The first issue facing the world's energy industry is volatility in the world's financial system.  Massive sovereign debt loads amongst western nations and concurrent rapid economic expansion amongst developing nations has put the world's fiscal situation on a tightrope.  This has led to the occurrence of both inflationary pressures and deflationary pressures at the same time, a rare phenomenon which makes central bank fiscal policy difficult and has increased volatility in the world's financial markets.  This has impacted credit to businesses which is having an impact on consumer spending and ultimately on GDP growth rates.  In 2008 - 2009, it was that fiscal uncertainty that led to a completely unexpected collapse in energy prices and a significant drop in the world's oil demand.  This uncertainty also led to a complete drying up of the world's corporate credit market making it very difficult for corporations to raise capital and expand their operations around the world.

On the demand side of the ledger, the contrast between the economies of the world's OECD nations and the world's developing non-OECD nations can also be seen in their current and projected energy use.  Demand for energy by the mature economies of the OECD nations is projected to dip by 2030 whereas demand by non-OECD nations is expected to nearly triple in that same time frame as their economies mature and they pass through their energy-intensive phase of development as shown here:

On the supply side, Shell projects that non-OPEC supply will likely decline over the coming years, but that new discoveries may offset natural production declines in mature fields.  Here is a graph showing the projected world oil supply picture to 2015:

In maturing non-OPEC fields, the use of new and expensive technologies to increase field productivity could come into play if prices stay high for prolonged periods of time.  Nonetheless, a given field can only produce for so long before production declines to non-economic levels.  Shell holds out great hope that Iraq will become a key player in supplying oil to fill the world's declining production profile.  Shell states that partnerships between national and multinational oil companies could double Iraq's output to between 5 to 6 million BOPD over the next decade and they state that Iraq claims that it can do even better, with Iraq forecasting that they could produce as much as 10 to 12 million BOPD.  While the thought is nice, the target has proven to be an illusion since the invasion in March 2003 in light of the ongoing sectarian violence and political instability in the country.  The report states that the key to price volatility will be OPEC's ability to bring its spare capacity online as prices ramp up to eliminate the perception of market supply - demand tightness.  Again. the thought is nice but, from this report by the United States Department of State shows, it appears that the Saudi's ability to act as the world's swing producer may be limited.

  

In closing, let's take a look at two of the world's largest new(ish) discoveries in Brazil's offshore.  The first, Tupi, the world's largest new oil discovery since 2000, is located 160 miles offshore in 6600 feet of water.  To put that water depth into context, the infamous BP Macondo field in the Gulf of Mexico was in 5023 feet of water.  Here is a map showing the location of the Tupi field:

The Tupi field is expected to produce between 5 and 8 billion barrels of oil and the overall cost to bring the field to commercial production ranges between $50 and $100 billion; the initial exploration well alone is estimated to have cost over $240 million!  A second discovery located in the same geologic basin 50 miles from Tupi, the Carioca/SugarLoaf discovery, could contain even more oil with rumoured recoverable oil reserves of up to 30 billion unconfirmed barrels.  Now, let's look at Tupi in terms of the world's daily oil consumption.  Conservatively assuming the entire world consumes 80 million barrels of oil per day, if the Tupi field were the only producing oil field on earth, it would have a production life of only 100 days.  From this you can see that to maintain production and consumption balance in the world's oil markets takes both huge amounts of capital investment during the highly risky exploration phase and even larger amounts of capital during the somewhat less risky development and production phases, in large part because the environments where "elephants" are still awaiting discovery are very hostile.  If the Great Recession Part 2 where to rear its ugly and unwelcome head, raising capital to develop a $100 billion oil field could become very complicated.

As Shell states, we are facing a "zone of extraordinary opportunity or misery".  Only time will tell us what path the world will take.