A 10-Year Retrospective Shows Unwarranted Optimism on Oil Supply

– Jeremy Grantham, Co-founder, Chief Investment Strategist, GMO

Ten years ago this month the Oil & Gas Journal published a story from CERAWeek—an annual elite conference for the oil industry put on by Cambridge Energy Research Associates—that bears revisiting.Why go back?  Three reasons.  First, CERA arguably has maintained the highest profile of any oil industry analytical shop since at least the turn of the century, thanks in large part to founder Daniel Yergin’s reputation.  Every time there is a surprise in world oil supply, he’s the media’s go-to guru.  When the National Petroleum Council convenes a world oil study, you can bet the ranch that CERA will play a lead role.  When the US Senate or House convenes a committee hearing on oil, CERA often sits on the panel; they also deliver some of their key research papers free of charge to all US lawmakers.  Their policy-oriented footprint is large and their strategic media outreach effective.Second, at the time CERA’s 2004 forecast of seven years of history-breaking sustained growth in world oil production capacity struck many players as being an unreasonably if not outrageously optimistic headline.  How does it look 10 years later?  Way off base.Third, if CERA’s oil forecast was that off base a decade ago, should we believe the current abundant-oil storyline that CERA jump-started in the fall of 2011 and that has been embraced by the press and policy makers alike?  So let’s look back.

On CERA’s lead panel in February 2004, Robert W. Esser, senior consultant and director on global oil resources, predicted global oil production capacity would expand by 20 million barrels/day from 2004 through 2010.  (CERA doesn’t forecast production; they forecast production capacity, which is essentially unverifiable.)   That’s nearly 3 million b/d of capacity growth every year for seven straight years from 2004 onwards. It didn’t happen.

Per Figure 1, actual production of global petroleum liquids grew by 5.7 million b/d (BP data) during that period.  Then consider the 4 million b/d of spare OPEC capacity that the US EIA shows for 2010; except there were also at least 2 million b/d of spare OPEC capacity in January 2004, at the start of the forecast period.  So net, CERA missed their forecast by well over two thirds.

Figure 1: Source for the actual production growth figure is BP’s Statistical Review of World Energy. Note that by CERA’s definition production capacity “…eliminates economic or political factors and temporary interruptions such as weather or labor strikes.”  Note too that unused productive capacity is never intentionally present among non-OPEC nations, and unused and undamaged production capacity among OPEC nations was primarily limited to Saudi Arabia, Kuwait and United Arab Emirates during 2010. Why did CERA stumble so badly?First and foremost, CERA underestimated decline rates from existing oil fields.  About the time of its 2004 conference, an oil industry analyst who knew Daniel Yergin asked him, during an elevator discussion, what decline rate for producing fields CERA used when calculating growth in world oil supply in their major studies.  Mr. Yergin replied, “oh, in the 1% to 2% range.”Chalk that up as a fatal flaw.  Over seven years, a decline rate of 1.5% would mean having to replace only 8+ million b/d of production capacity.  It’s ironic that by late 2007, in what CERA called a ground-breaking study, they calculated the actual decline rate from 811 of the world’s major oil fields at 4.5 percent per year.  Over those same 7 years, using their 4.5 percent decline rate would require 23 million b/d of capacity just to keep production flat.  IEA estimates for decline rates rank even higher than CERA’s.

On the production side, CERA spoke optimistically about projected gains from the Gulf of Mexico, West Africa, Brazil, the Caspian area, Canada, Venezuela, Iraq, Nigeria, Algeria, Ecuador, Sudan and Russia.  Indeed, production increased in 11 of those 13 nations for a net gain of 6.7 million b/d.  But on the bad news front, the rest of the world lost 1 million b/d of oil production during CERA’s forecast period, hence the 5.7 million b/d net gain.  Declines badly undercut forecast gains.

On the demand side, CERA actually worried that “should this spurt in output exceed projections of a very large increase in world oil demand this decade, then persistent downward pressure on oil prices might result.”  For the record, when CERA made that comment, oil prices were upwards of $30.  But while nearly everyone was wrong about oil prices a decade ago, CERA was also wrong about the key demand driver: China.  CERA forecast that China’s demand growth for oil would slow to 5 percent in 2004, compared to what eventually occurred: record-breaking growth of nearly 17 percent.  And while CERA talked about volatility in Chinese demand going forward, China’s record-setting growth rate for oil demand continued throughout CERA’s 2004-10 forecast period.

If this was a personal forecast which I had blown this badly (and I’ve blown a couple), no one would notice.  But this enormously flawed vision was widely circulated.  CERA gets press coverage, but the press isn’t checking CERA’s track record, and this 2004 prediction is just the tip of the iceberg.

In 2005, CERA dialed back their optimism only slightly.  They projected world oil supply capacity still growing 16.4 million b/d from 2004 through 2010—a reduction of 3.6 million b/d from their original forecast.  They projected world demand in 2010 at 94 million b/d, leaving 7.5 million b/d of idle capacity.  Note this comment about related impacts on prices:  “We generally expect supply to further outpace demand growth in the next few years, which could result in oil price weakness around 2007-08 or thereafter.”

In 2006, CERA projected potential world oil capacity growth of 21.3 million b/d—from 88.7 million b/d in 2006 to 110 million b/d 2015.  We’re less than two years away from year-end 2015, yet total petroleum liquids production will likely run in the 90 million b/d range.  Clearly, CERA’s was an exceedingly pollyanish view, rather like a best case in a perfect world.

Now square CERA’s long-standing optimism bias on future world oil supplies with the recent spate of sobering news from Wall Street on the financial travails of the large investor-owned super-majors.  Mark Lewis has done a nice job highlighting the near tripling of oil and gas capacity expansion costs since 2000—from $250 vs. $700 billion; three quarters of that was spent on oil, yet oil supply rose only a modest 15% (BP data).  Increasingly blunt reports from analyst shops like Sanford Bernstein add to the growing contrarian chatter.  Solid coverage in the UK of Richard Miller’s recent paperThe Future of World Oil Production opened a few eyes about limits.  But those voices still have a steep hill to climb.

That’s in part because, starting in September 2011, CERA went on the offensive as chief cheerleader of an overly optimistic, US-led oil abundance storyline. It features the US’s record-breaking shale oil bonanza—an amazingly successful yet term-limited reality. Viewed at the global level, for the last few years the brouhaha about our shale oil bonanza has been the tail wagging the world oil supply dialogue.

CERA’s oil supply predictions should have earned deep skepticism from the press and policy makers.  That hasn’t happened yet.  It’s overdue.

But please keep the larger backdrop in mind: Without a serious revisiting of the questionable optimism that dominates any dialogue related to longer-term world oil supplies, without a harshly realistic scrub of the facts, we face unnecessarily large energy policy risks.

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Steve Andrews is a retired energy consultant and a contributing editor for Peak Oil Review. He can be reached at [email protected] .

Bibliography:–“CERA: World oil supply to rise by 20 million b/d by 2010,” The Oil & Gas Journal, 2/16/04–“Finding the Critical Numbers: What Are the Real Decline Rates for Global Oil Production,” CERA Private Report, 2007–“Worldwide Liquids Capacity Outlook to 2010: Tight Supply or Excess of Riches?” CERA Private Report, May 2005

–“World Oil & Liquids Production Capacity to Grow Significantly through at least 2015: CERA Update,” CERA Private Report, August 2006

–“The future of oil supply,” Richard G. Miller et al, Philosophical Transactions of the Royal Society, 12/15/13