Tech Talk - Optimism is becoming harder to sustain

For some time the nations of OPEC have been suggesting that demand for their oil will remain relatively stable in the near future, as increased production from the non-OPEC nations is expected to more than meet demand increases. Thus, for example, in the May Monthly Oil Market Report OPEC anticipates that global oil demand will increase by 1.14 mbd this year, while non-OPEC production will increase by 1.38 mbd, allowing a slight reduction in the volumes OPEC market, which continues to fluctuate around 30 mbd. In the longer term, however, as previous annual oil company prognostications of future supply have emphasized, the MENA countries are going to be pulling an increased weight in supply. For example ExxonMobil has noted:

The Middle East is expected to have the largest absolute growth in liquids production over the Outlook period — an increase of more than 35 percent. This increase will be due to conventional oil developments in Iraq, as well as growth in NGLs and rising production of tight oil toward the latter half of the Outlook period.

At the same time BP pointed out that in just a couple of years demand for OPEC oil is likely to start to steadily increase.

Figure 1. BP view of the increased demands to be made on OPEC oil with time. (BP Energy Outlook 2035)

A large part of that increase has been expected to come from Iraq. With the end of the Iraq war, and the government encouraging development there were some claims that production might eventually rise to over 13 mbd (ahead of both Russia and Saudi Arabia). But those optimistic views had to be measured against the reality that the country has taken a long time to recover back to the 3 mbd levels of exports that it had achieved before conflict.

Figure 2. The fall and recovery of Iraq’s oil production. (EIA)

At present OPEC reports that Iraq was producing at 3.298 mbd in April, making it second only to Saudi Arabia (at 9.579 mbd) among the OPEC nations. There still seemed to be some chance that the country might be able to reach some lower target figures, such as those suggested in the OGJ.

Figure 3. Anticipated Iraqi exports and their market region (OGJ)

Regrettably violence is now significantly increasing in the country, with Mosul being over-run by Sunni militants. This puts them in charge of the main pipeline to Turkey, as well as giving them potential control of some of the adjacent oilfields.

Figure 3. Known Iraqi oilfields in 2010.

Euan Mearns has written of the potential for oil from the Kurdish regions and Turkey has just allowed a second tanker to sail from Ceyhan carrying oil from that region to the market, without Bagdad’s permission. The oil is being delivered through a new pipeline capable of carrying 100 kbd from Kurdistan into Turkey. The main pipeline (shown in Figure 3) can carry as much as 600 kbd and runs from Kirkuk and perilously close to Mosul. The new pipeline runs through Kurdish territory until it reaches Turkey.

The declining influence of the central government over the northern territories of Iraq does not bode well for future production gains. Conflicts are getting worse, and the country is approaching the point where it could well be partitioned, since the government forces seem unwilling to take on the insurgency. Violence has already spread to the Al-Bayji refinery some 130 miles north of the capital. This is the largest refinery in the country, and currently produces below its 300 kbd capacity, all of which is used for domestic consumption.

The problems that this reveals are unlikely to be resolved soon, it is much more likely that they will continue to escalate over the next months, if not years. The impact on Iraqi oil production should not be underestimated. While the oil in the Kurdish region can make its way through the smaller pipeline that is under Kurdish control, the greater flow rates needed to sustain future growth in supply cannot be met by that pipe.

In the South developments in the Mesopotamian region around Basra from the fields of Rumaila and Majnoon will likely continue, with production being shipped out from the new facility offshore, although this is already quite significantly behind schedule.

Figure 4. Oil fields of Southern Iraq (IEA )

One has only to look at the degrading situation in Libya, where production has fallen from 1.6 mbd to a current level of less than 200 kbd, with no path forward now evident for production levels to be restored. Those familiar with the region doubt that there will be much improvement in the situation this year, and if the country follows the Iraqi path (figure 1) then it is unlikely that the world will see significant Libyan production for this decade.

That loss of a million barrels a day is likely to become increasingly evident as world demand continues to grow at greater than that level each year. When this is combined with the increasingly inability of Iraq to increase production as it moves back into more vicious internal strife, then one has to ask from where can future gains in oil production be anticipated?

The major oil companies have urged complacency having bet on Iraq and OPEC coming through (and in the process assumed that Saudi Arabia would also increase production significantly above 10 mbd, something that they have consistently declined to commit to doing). As Libya and Iraq remove that surplus from the table then the question becomes where else can it come from?

It is increasingly unlikely that US increases in production can be sustained for long, given the very short high-level life of the new wells completed in shale, and as the sweet spots in the current fields are consumed. Thus within a couple of years we are now likely to see an increasingly desperate search for new reserves. But those reserves take years to find and develop (as well as large amounts of money), and if the crisis comes at a faster pace than most now expect, then $100 a barrel oil may seem an absurdly cheap price to have had to pay. It may even have an effect on the next Presidential election.