As Oil Price Continues to Rise, Saudis Will Recede Into Insignificance

The popular image of Saudi Arabia is synonymous with oil, its vast swathes of desert home to virtually limitless supplies of oil. Indeed, the Saudis have consistently reassured the world that their giant oil fields contain hundreds of billions of proven reserves that can continue to produce at rates from 10 million to 15 million barrels per day for another two generations. And with its commitment to open the world’s oil spigots to avert any serious economic crisis, Saudi Arabia has always exerted a gentle calming force on the world oil markets.

As reassuring as this scenario is, none of it is true — at least according to Texas based oil man Matthew R. Simmons. Author of "Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy." Simmons’ book seeks to shatter the popular view of Saudi Arabia as a virtually bottomless oil well — and leaves even the biggest skeptics with plenty to ponder.

Today’s King of Oil

Only 35 years ago, the U.S. was the world’s No. 1 oil producer, pumping out 10 million barrels of oil per day. Today, Saudi Aramco — the Saudi state-owned oil company — produces about 7 million to 8 million barrels per day. That’s more than any oil producing country and twice as much oil as the next largest individual oil corporation.

Popular images notwithstanding, Saudi Arabia does not sit on an ocean of oil. Its oil production has always been concentrated in a remarkably small area about the size of Utah. Ninety percent of Saudi oil production has come from seven rapidly aging giant and super giant oil fields, with one field Ghawar, the greatest oil field the world has ever known. The Saudi’s three most important oil fields have been producing at very high rates for more than 50 years. Peak production of the two biggest oil fields occurred 25 years ago, in 1981. Almost all of Saudi Arabia’s oil production comes from fields that have been on stream for over 40 years, and that have been producing below their capacity for most of that time.

History of Saudi Oil Production

Saudi Arabia achieved remarkable successes from 1940 through 1968, relying on primitive technology. Since then, the successes have dried up. Over the next three decades Saudi Aramco has used the best technology around to try to bulk up the portfolio of its world class oil fields. Despite Saudi Aramco’s best efforts, no significant oil fields have been discovered since 1968. Few of the 80-90 newer fields Saudi Aramco has discovered since then have produced oil in any significant amounts.

Despite this, official reserve estimates have gone the other way. Saudi Arabia raised its estimates from the 100 billion level to 150 billion barrels at the end of 1979. Its proven reserves then jumped to 250 billion in 1988 — in the absence of any large discoveries. Not only has this number remained mysteriously unchanged, the Saudis keep upping the ante. In 2004, Saudi Arabia’s petroleum minister announced that the kingdom could increase reserves by 77%, to top 461 billion barrels through a combination of new discoveries and increased recovery from new deposits. If this were true, Saudi Arabia could theoretically produce at a rate of 9 million barrels a day for another 140 years.

Simmons argues that Saudi claims are hot air — none of it supported by his examination of over 200 technical SPE (Society of Petroleum Engineers) papers. He argues that Saudi Aramco has maintained its oil output by using advanced drilling and completion technologies in its mature giant fields. And the surest way to bring any oil fields to a premature end is by overproducing it. Yet that is exactly what the Saudis have done. That also means that the drop off in oil production will be steeper than predicted.

The bottom line? Unless the Saudis discover a new generation of giant and oil gas fields, Saudi Aramco will have enough trouble just maintaining production levels at 7 million to 8 million barrels per day, let alone increasing its production during times of crisis.

"Predictions are hard. Especially about the future." — Yogi Berra

Yet even if the Saudi oil fields are today’s Potemkin Village, it may not lead to the "oil shock," Simmons predicts. Nobel Prize winning economist Gary Becker addressed this issue at a recent speech I attended in London. Becker pointed out that the price of oil only reached record levels in real terms when it hit $72 dollars per barrel. Why has this not put the global economy into a tailspin as it did in the 1970s? The world is much less dependent on oil than it was 25 years ago. Becker’s only prediction was that oil will not reach $200 in his lifetime (Becker is 76). The reason? As the price rises, demand for oil will fall. It will also increase the supply of oil substitutes and alternative sources of energy.

That gives us a clue about the future. No one can revoke the law of supply and demand. As the price of oil rises, the world will gradually wean itself from oil, making other sources of energy more viable. Becker argued that safe nuclear power will make a comeback. Automobiles will gradually shift to non-gasoline power. Sudden interruptions in oil supply — such as a conflict in the Middle East — may send economies into a temporary tizzy. But the world economy will adjust as it always has.

The only lasting effect? The economic influence of oil-rich countries will recede gradually into insignificance. And for countries like Saudi Arabia, that may be the greatest shock of all.