Hubbert’s Peak Oil theory was famous amongst previous generations of oilmen because, apart from positing that there was only a finite amount of recoverable crude oil and that, therefore, there was a real risk of “running out”, it fostered the conviction that the future value of oil in the ground was likely to be worth more than oil for immediate production. This meant that the hunt for reserves and reserve replacement ratios of over 100% were fundamental to an O&G company’s raison d’etre.
However, while one can argue logically that the world’s hydrocarbon resources are ultimately finite, recent experience of development of new reserves (such as US “tight” oil), the continuing relatively low level of nominal oil prices, and the unveiling of a number of new scenarios for supply vs. demand, are now causing concerns that perhaps not all those reserves will be worth as much as has long been assumed.
This shift in opinion raises a number of important questions:
– For example, should a company, or a country (such as Saudi Arabia), seek to pump oil at maximum capacity in order to monetize its reserves, but thereby run the risk of driving down at least spot prices?
– What if rational carbon-pricing policies are implemented, resulting in taxes or levies that currently are largely absent from many jurisdictions?
– Will the long-assumed steady increase in demand for oil and oil products from rising populations in the developing world, seeking to emulate the living standards and use of resources in the developed world, be overwhelmed by changes in technology or more efficient forms of existing alternatives such a wind or solar?
– Is natural gas production more defensible in terms of future demand and use than crude oil?
If it turns out that demand will gradually taper off and drop below projected production levels, and that prices will remain low in both nominal and real terms, the implications both for the industry and for the global economy will be profound.
Producers will have to change their focus from a “customized” approach to one that amounts to systematized “manufacturing”- similar to what is already visible in the operations of the most efficient US “shale oil” producers- in which repetitive, low-cost solutions will be essential; while “petro-states” will have to take meaningful steps to diversify their economies rather than assume that “eventually” prices will rebound because demand “always” ultimately outstrips supply. This is also likely to engender more standardization across all levels of the industry, as the need to focus on costs will become inexorable.
All this requires a change in the way in which one analyzes any O&G related risk, because assumptions that even 5 years ago would have seemed almost axiomatic (e.g., reserve replacement ratios should be above 100%, or that over time the price curve usually has a contango) may no longer be so. Of course, the history of the industry is also littered with the carcasses of those who made the wrong call!
At Awbury, our approach is to avoid “assuming” that something is so or will be so unless we can also analyze the probability of the key assumptions no longer proving to be valid- and what the consequences of that may be in the context of the overall risk.
As one of our colleagues states: “The Stone Age did not come to an end because the World ran out of stones…” The Hydrocarbon Age seems unlikely to end because of “Peak Oil”.
The Awbury Team