Michael Lynch: World Oil Reserves Suddenly Downgraded By 292 Barrels! Yawn.

This week, Rystad Energy announced the eye-popping finding that the world’s estimate of oil supplies had suddenly shrunk by 292 billion barrels. Needless to say, the announcement caused eyes to pop, as did the headline’s statement heralding the early onset of “peak oil” demand. Hopefully, oil industry executives understand the nuances of the report, and do not overreact. Sadly, many others will.

This represents a typical case of complex news that will terrify the uninitiated who think that 292 billion is a lot of oil. As Saudi Minister Abdulaziz bin Salman would probably say, “292 billion barrels here, 292 billion barrels there, pretty soon you talking about real amounts of oil.” (That’s from an old Everett Dirksen joke about the U.S. budget deficit, originally ‘a billion dollars here…’.)

The episode is somewhat reminiscent of the Shell reserve scandal from a decade and a half ago, which similarly shocked many and was interpreted by some as a sign that global oil reserves had been exaggerated by the industry more generally. Peak oil advocates predicted that many other companies would have to similarly restate reserves and the peak in global oil production was thought to be that much nearer and more obvious.

Nothing of the sort was true. The problem with Shell’s reserves was an accounting one, not a geological one; they had booked gas resources as being proved reserves despite lacking customers for them. The gas was there before and after, but without a buyer, the economic value could not be estimated.

Similarly, Rystad is not restating the existence of the oil resource, but merely re-estimating how much is economically recoverable under current circumstances, that is, ‘low’ oil prices. Petroleum resources’ economics are a continuum, from cheap to prohibitively expensive, except that the prohibitively expensive resource is not considered ‘recoverable’ and is therefore usually excluded from estimates.

Does this matter? Consider that resource estimates from more than a decade ago rarely included shale oil (though many included oil shales, or kerogen, a solid substance that requires expensive processing to be converted into conventional liquids). Wells in the Bakken shale might produce a barrel of oil—if they were unfractured vertical wells, and so oil in Bakken shales would be disregarded by geologists estimating global resources. Enter George Mitchell and his team’s discovery that shales which were hydraulically fractured could, at a three or five-fold increase in cost, would produce a hundred times more oil. Voila, the prohibitively expense resource has gone from invisible to part of the supply curve.

This is illustrated by the figure below, from the IEA’s 2008 World Energy Outlook, which provides an estimate of the global oil resource by production cost. Shale oil is not included (the amount for ‘oil shales’ is a reference to kerogen) but would be off to the right hand side of the curve as the most expensive resource considered. After fracking, hundreds of billions of barrels have been added to the curve roughly in the middle, extending the period when oil prices will remain moderate.

Because some of the peak oilers were geologists who argued that economics was irrelevant to oil supply (‘oil either is there or it isn’t’), they were loathe to acknowledge that changes in price affected the amount of the resource that was recoverable. The reality is that there is a broad continuum of oil resources rated by production costs, not the step functions that most simplistic supply curves show. And each category in the supply curve moves independently as a result of different conditions.

Depletion has little impact on short-term costs in areas like the Arabian peninsula, where the extraction rate is very low, or in the Canadian oil sands, where the resource is produced at a slow and constant rate. Conventional oil in places like the Gulf of Mexico or Argentina, where the depletion rate is relatively high, experience more upward cost pressure as a result.

But all resources are subject to downward pressure from improved knowledge and technology: the seismic and production technologies of today are much advanced over those of fifty years ago—and will be much advanced fifty years from now. As a result, massive amounts of oil now prohibitively expensive to produce will become economically viable in the future, as the ‘easy’ oil is used up. Oil resources that are not ignored for costing $75 per barrel to produce, might cost $50 in a couple of decades and thus become part of the (ever-expanding) oil resource.

Ultimately, then, estimates of the currently recoverable resource (and Rystad’s work appears quite sound) are primarily of academic, not operational, interest and tell us little about the near-term availability of oil supply—or its price. Easing of sanctions against Iran, more drilling in U.S. shale basins, and similar factors are the best indicators of where the market will go in the next three to five years. Sadly, those elements remain exceedingly difficult to predict (although this is good for the consulting industry).

Forbes