By Murray Duffin, July 16, 2000

Dear Friends,

I am writing this letter because I believe the general public is not being kept informed on a very important subject, and this may be one way to remedy that situation. The current obvious symptom of the issue is high gasoline prices. The causes are more complex and long term than we are being told, and the remedies proposed so far by various politicians are short term palliatives at best.

I can understand the reluctance of politicians to tell us the unpalatable truth in an election year, but the near silence of the media is less easily explained. Perhaps it is simply the impossibility of telling the whole story in a 30 second sound bite. Also, there are two sharply opposed points of view and perhaps they don't know which to choose.

As you know, I am not an alarmist, and I am not given to writing this kind of letter. I have spent many months and many tens of hours researching both sides of this issue, trying to separate the wheat from the chaff, and reaching my own conclusions on what appears to be nearest to the truth. To keep this letter fairly brief, I am providing only a little of the explanation and the key conclusions. For those of you who wish to do your own research, I have attached a much longer and more detailed explanation, and a bunch of references.

There are two aspects of the story - near term price related, and longer term strategic.

Price related The problem derives from three issues; - limits to the supply of oil, recent relative under-investment in oil field development, and the current economic boom. It is exacerbated by our profligacy in using energy, which is, in itself, another fairly complex subject. Let me touch briefly on the three issues:

Approaching limits. There is a phenomenon, well-known to the oil industry, but not publicized, that when an oil field has been depleted by about 50% of its initial total content, the rate of extraction begins to decline, while the cost of extraction begins to rise. In 1956 a Geophysicist named M. King Hubbert applied this concept to the entire known and conjectured reserves of the lower 48 states, and predicted that American production would peak in 1970 and then begin a long decline. He was reviled at the time, but proved to be right on for the lower 48. (The Alaskan North Slope was not known at that time). The phenomenon is now called the Hubbert Peak.

A consulting firm in Geneva (Petroconsult) has created what is considered to be the most complete computerized data-base of world oil exploration results, has done a Hubbert peak analysis, and has concluded that the world Hubbert Peak will arrive shortly; in the pessimistic case between 2000 and 2003, in the optimistic case between 2007 and 2010. After the peak, production declines and costs of production rise, regardless of new investment.

Recent years have seen consistent under-investment in the development of known oil reserves, especially OPEC reserves, because low oil prices did not provide enough income for OPEC member economies, and large non-OPEC oil companies were excluded. Most non-OPEC major finds are at or past their Hubbert peaks. The former Soviet Union (FSU) has not even kept up with maintenance needs in their fields. As a result, regardless of oil reserves, present world wide demand is very near the limit of productive capacity.

The only place there are major reserves that can be brought on stream quickly is in the Middle East. Even there, developing additional productive capacity will require billions of dollars of investment. Development will be quickest if non-OPEC major oil companies are allowed to participate. Given the time to negotiate participation, get investment and equipment in place, and get the oil flowing, we are looking at early 2003 before there is any real increase in availability.

In 1997/98 the Asian economic crises caused world oil demand to drop briefly, causing a temporary glut (more on paper than real), and a precipitous price decline. In response world production was cut back, and even production capacity was reduced slightly. The Asian recovery has been earlier and stronger than expected, leading to a major demand recovery, just as the supply reductions were taking hold. The result you saw was a very quick tripling of oil prices, from a totally unrealistic low. The result you didn't see was a major emptying of the total production pipeline.

The April OPEC increase of 500,000 bbl/day couldn't both bring supply back up to demand, and refill the pipeline. The additional 700,000 bbl/day agreed in June should restore the balance, but won't provide an excess that would lower prices much. Saudi Arabia `s recent announcement of a further increase of 500,000 bbl/day mainly offsets recent production problems in Kuwait and Iraq. It makes the Saudi's look good, but doesn't do much to change the balance.

From about 1988 to 1998, world oil consumption grew 1.25%/year on average, including the Asian crisis. Since 1998 demand is growing at greater than 2% per year. With no production problems anywhere, peak world production capacity is estimated to be about 78 to 79M bbl/day. Actual production at any point in time will be somewhat less. Peak demand this summer is expected to be near 78M bbl/day, and by 2002 average demand is expected to be 80M bbl/day.

Given all of the above there are two questions we should ask, and a few conclusions we can reach. - Why would OPEC increase production another 1 or 2% only to see their prices decline 20 or 30%, especially to satisfy SUV driving Americans? - Even if there were a compelling reason, could they do it? - There is unlikely to be a single Hubbert Peak, but rather a series of lower peaks spread over 10 or 15 years.The first peak was probably in 1997. We may see another about 2003, with some temporary price relief, which may precipitate another cycle and another peak in perhaps 2008. - Except for brief respites of a few weeks to a few months, gasoline prices are unlikely to go down, and in fact have probably started on a gradual but inexorable uptrend. We had better get used to it. - Tax roll-backs to alleviate the price (as in Illinois) are temporary palliatives. They won't help much and won't last. Governments don't give up established revenue sources for long. - Depleting the strategic reserves to ease price pressure is a dumb decision. Any relief will be temporary, the nation's security is reduced and the reserves will ultimately be restored, at higher prices, which we pay.

In 1973, at the time of the first oil-shock, OPEC supplied 38% of the world's oil. In subsequent years, with energy economies and development of North Slope and North Sea fields, OPEC share dropped below 20%, and they lost control of prices. They are now back above 30% and by sometime in 2003 they will be again above 38%, given present trends. Before 2007, they are likely to be above 50%.

They now have far more data, far better models, and much more experience. It is very likely that this time they can maintain cohesion. Their obvious goal should be to gradually but surely raise prices, always giving us time to adjust our minds, but never precipitating a major crisis-type development of alternatives. (The boiled-frog syndrome.)

It has been said that "agriculture is a process by which we use soil to convert petroleum into food". The reference is not only to petroleum derived fertilizers, but also to fuel for farm machinery and transportation of food. The world already has trouble making ends meet food-wise. For several years now grain reserves, measured in months of consumption, have been declining. Population is still growing. Arable soil per capita is also declining. What happens when oil production also begins declining - in absolute terms? That point is probably less than ten years away.

At least in terms of large economic blocs, the world is on remarkably good terms, especially the majors, - USA, Europe and Japan. What happens when all three depend for more than 50% of their oil on OPEC, (or even maybe on OMPEC - Organization of Muslim Petroleum Exporting Countries), and growing demand permanently exceeds declining supply? Can we continue to be friends?

Perhaps you are now asking yourselves "what should I believe and what should I do?" A small group of very well-informed Petroleum Geologists tend to be a little more pessimistic than I am. A small group of outspoken economists is totally optimistic, concluding there will be no limit to cheap oil in the foreseeable future. In my opinion the geologists are analyzing available data as objectively as they can and extrapolating more on recent trends than long past history, but maybe discount technology too much. The economists present a future based on the best of the past, ignore the current and near term real situation and recent trends, and count too much on unspecified technological developments.

Politicians, of course, are more exposed to economists than geologists and for sure prefer optimism. They may also be influenced by petroleum lobbyists that don't want us to change our ways, and auto-industry lobbyists that want to keep on selling very profitable SUVs.

The Secretary of Energy has an advisory board that only has two members likely to be aware of the details, one is an economist and the other an oil company executive.

Even if we choose to be optimistic for the long term, we should face the most likely short term squarely, stop seeking someone to blame, and adjust ourselves to the end of cheap oil. People, (John Q. Public), if well-informed will adjust. To that end I have written this letter to you - to 20 personal friends and responsible citizens. I would ask each of you to send the letter to 20 more, and ask each of them to send it to 20 more, etc. If we all participate, the word will become known, regardless of politics and media.

I don't like to launch a "chain letter", but it is the only way I can see to use the power of the Internet. Thanks in advance for your cooperation and assistance, and best regards.

About the Author:

Murray Duffin is a recently retired executive of a leading microelectronics firm, having most recently held the position of VP Total Quality and Environmental Management. He has been heavily involved for the last few years in the improvement of energy efficiency in plant construction and operation for his firm. Therefore he has become very cognizant of issues related to global warming, atmospheric CO2 concentration and petroleum availability. As some indication of performance he notes that his employer was the first large multinational in the world to have all plants ISO14000 and EMAS qualified, and is the only company to have won the EQA, SQA, MBNQA at the level of the total local corporate entity, as well as the Malaysia QA, Morocco QA and MaltaQA at the local plant level.

Murray Duffin, July 2000

In this paper I will try to summarize & organize the salient information from a great many source papers, to make the key points readily accessible. First I will present conclusions, followed by definitions, data, commentary on the data and arguments. Finally the key source papers are referenced, with Internet addresses, for those who wish to dig deeper own their own. The following is derived from two years and many hours of research.

The end of the era of cheap oil is at hand. It began in 1999 with the resurgence of oil prices from a very uncharacteristic low, in essence a bottom. We are not running out of oil, in fact far from it. However, we are at the point where demand has caught up with supply, and given the huge investment required, it will be 2 - 3 years before slack supply is available again, if ever. We are only a few years away from the time when 50% of all of the originally recoverable conventional oil in the earth's crust will have been exhausted. After that point (termed the Hubbert Peak), supply will begin to decline, regardless of investment and the gap between supply and demand will open. OPEC is now, again, the world dominant supplier, and in a few years will control more than 50% of the world's oil supply. Given OPEC control and natural self interest, near term demand equal to or greater than supply, medium term demand growing while supply diminishes and no readily available alternatives, the price of oil is set to rise inexorably, possibly punctuated by a few brief respites. The next substantial price rise is likely to be as soon as Q4 2000. What will that do to the stock market and our economic boom? We must adjust to (temporary?) shortages with high and increasing prices immediately and to permanent shortages within a decade. No one is to blame. A finite source will eventually get harder to produce from and will yield at a lower rate. Less extravagant consumption could have delayed, but not prevented this outcome. The economists who reassure us that there is no foreseeable problem, and the politicians who listen to them have got it wrong. There is one other conclusion that I would like to note that is not directly related to nor derived from this research. There is a great deal we can do to reduce oil consumption, with only neutral or positive impact on the economy. The know-how and technology already exist. Unfortunately, without knowledge on the part of the people, and political will on the part of our leaders, we are unlikely to act until prices and shortages really bite. Dependence on oil could easily be cut by a factor of 4 per unit of GDP in less than 20 years, without economic or environmental sacrifice.

Several of the definitions are accompanied by necessary elaborations, so that the reader can understand the sources of disagreement and confusion relative to the subject of petroleum supply.

2.1 First - some relationships

a) - Cumulative production (total from the first oil recovery to the present)

b) - Reserves - oil that has been discovered, but not yet recovered

c) - Estimated Ultimately Recoverable (or Ultimate Recovery) EUR - how much will have been produced when no further recovery is possible.

d) - Discovered-to-date - a) + b) e) - Yet-to-find c) - d) f) - Yet-to-produce c)-a) or d)+e).

2.2 Resources - Traditionally taken to be "total oil in the ground" regardless of recoverability. Ivanhoe¹² refers to it as "oil available with someone else's money". Resources reflect the geologist's estimate based on interpretation of exploration (usually seismic) data, prior to any drilling. The geologist was motivated to "find" a lot of oil, in order to secure financing. In early days (circa 70 years ago) resources could be as much as 10xEUR. Since the mid `70's with development of robust computer models, extensive data bases, and digital 3D mapping, resource estimates are much more accurate, about equal to EUR. Ivanhoe notes that government agencies, academics and economists tend to estimate resources (oil companies report reserves). They then assume that "oil-in-the-ground" will someday be recoverable with improving technology, when in fact much of it was never there in the first place. Be very wary of any analysis or conclusions based on "resource" estimates.

2.3 Reserves - initial reserves are the estimate of oil available after drilling. They usually reflect the engineer's conservative opinion of recoverable in a known time, with a known technique and cost. Ivanhoe refers to reserves as "oil available with our money". With improved analytic techniques reserves are usually revised upwards. Nearly all discoveries prior to the mid 70's have been back adjusted, so reserves appear to grow, when in fact it is a result of refining originally conservative estimates. Reserves can also "grow" because of reporting regulations (SEC requires reporting of proven reserves), or for political reasons - e.g. OPEC allocation of quotas based on reserves. To add to the confusion there are 3 commonly used estimates: Proven - i.e. 90% probability that EUR will be equal or higher Proven + probable - i.e. 50% probability - the most likely case Proven + probable + possible - i.e. 10% probability - very unlikely to be realized. Further, sometimes natural gas liquids (NGL) or non- conventional (also termed unconventional) oil are reported as reserves.

The result is that summing reserves from all of the world's countries or oil provinces, without critical analysis, will almost certainly lead to a too high total. The detailed data needed to do the critical analysis resides in closely held data bases (e.g. Petroconsult in Geneva) and is not available to most economists, or even to the USGS Delphi participants. Economists and the USGS therefore systematically overstate reserves. It has been assumed that improved recovery techniques also cause reserve growth. Evidence indicates that such new technology increases recovery rate but has little or no impact on EUR. It does accelerate depletion. Current reserves of course are c) - a) - e), EUR minus cumulative production, minus yet-to-find.

2.4 Discoveries - New fields found through surveys and exploration. Discoveries add to reserves. In a given "province" (e.g. - North Sea), the large fields are the easiest to recognize from survey data, and are therefore the first to be discovered. Subsequent discoveries tend to be sequentially smaller.

2.5 Conventional Oil - Normally refineable crude oil, recoverable with current or confidently planned technology and tools.

2.6 Non-conventional (Unconventional) Oil - Venezuela (Orinoco) bitumen, Athabasca tar sands, shale oil and very very deep water offshore oil. Not recoverable &/or refineable by conventional means

2.7 Economically recoverable - recoverable with a positive payback on exploration + development + recovery costs, at a given price. Economically recoverable may increase as price increases.

2.8 Energetically recoverable - recoverable with a net energy yield, when burned as fuel, in excess of the energy used to build the equipment, supply the material, drill the well and pump and transport the oil. A couple of small North Sea fields have been exhausted only 2 years after being drilled. It is possible (probable?) that they were economically but not energetically recoverable, unless they were drilled with a used (energetically paid for) oil platform.

2.9 Gb - One billion barrels or 109 barrels equals 1000Mb or one thousand million barrels. Resources and reserves are normally expressed in Gb or Mb

2.10 NGL - Natural Gas Liquids or gas condensate. Sometimes included in reserves or EUR.

2.11 R/P - Reserves to Production Ratio - the number of years to total exhaustion of reserves at the most recent year's production rate.

3.1) EUR c) Variously estimated from as low as 500 Gb in the 1940's based on poor data, to 3500 Gb in the 1960's based on anticipated impact of technology that hasn't panned out. Estimates over the past 20 years have converged on 2000 Gb20. Woodward - review of 40 estimates - mean 2000 Gb, median near 2200Gb Rand Corporation - between 1600 and 2000 Gb OPEC 2138 Gb Petroconsult - 1800 Gb (plus 200 Gb NGL) The author will use 2000Gb.

3.2 Cumulative Production a) Generally accepted as about 820 Gb at end 1999.

3.3 Yet-to-find e) Ranges from a low of about 150Gb for Campbell (Petroconsult) to 600Gb for the USGS (United States Geological Survey). Both the recently low and declining discovery rate, and Laherrere's parabolic9 fractal analysis would support the lower number. The USGS number derives from a Delphi exercise rather than analysis of hard data. The knowledge, motivation of and influence on the Delphi participants are not known. The author, being an optimist, has used 200Gb.

3.4 Reserves c) - e) - a) While the reserves by country or province are subject to considerable disagreement, the total tends to be accepted as near 1000Gb. Late 1995 published data will illustrator the range of disagreement - all in Gb17.

OGJ = Oil & Gas Journal

Petro = Petroconsult

WO = World Oil Journal

USGS = US Geologic Survey

NOTES: In 1987/88/89 ME reserves jumped by near 280 Gb without new discoveries and with little new drilling. Some of the increase may have been new analysis, but timing would suggest political motivation to influence OPEC quota allocations. ME-stated reserves have remained constant for several years, despite annual production and lack of discovery. FSU - has been strongly overstated in the past (10% probability numbers?). Given the geography it could be expected to be substantially greater than North America. Petroconsult discounts ME and FSU strongly (too much?) for the above reasons. The author goes with c) - e) -a) = 980 Gb.

During 23 years reserves grew by nearly 40% of the sum of starting reserves plus discoveries. However, it is likely that at least 130 Gb was political (See 3.4) Real growth due to drilling and improved mapping and analysis may have been 30% or about 13 Gb/yr average. (It may have been much lower, also.) Notes: As new technology has now been applied to most old discoveries (Odell17 notes a major effort on enhancing known fields during this period), and as new discoveries were more accurate to start with, little further reserve growth should be expected. Perhaps 3 to 4 Gb/yr will be realized during the next decade.

3.6 Discovery

1990 23.8

1991 23.7

1992 23.9

1993 23.7

1994 24.3

1995 24.9

1996 25.4

1997 26.1

1998 26.2

1999 26.7

2000 28.1 (projected)

NOTES. Discovery is now running less than 25% of consumption. Stock draw down from Oct. `99 through Feb. 2000 was about 250 Mb6, or 4 months of the 3 recent OPEC increases. (16 months of the first increase).

3.8 What is a large discovery?

The largest field ever discovered was 90Gb - in Saudi Arabia. That is 3 years world supply in 2002 terms, assuming it is all recoverable. It is only 1.5 years to the Hubbert Peak and declining recovery, if it was the sole source.

Today a big field would be 0.5 Gb.

The Caspian Sea referred to as a major find has an EUR of 30 Gb, enough to postpone the Hubbert Peak about 6 months.

60 - 70% of known oil is in 300+ "Giant" fields

94% of known oil is in 1311 "Major" & "Giant" fields

3.9 When can we expect the Hubbert peak?

1999 Reserves 980 Gb. Possible reserve growth to 2020 70 Gb. Yet to find 200 Gb. Cumulative production 820 Gb. Initial resources 2070 Gb. 50% depletion 1040 Gb. Already depleted 820 Gb. Remaining to Hubbert Peak 220 Gb. Average annual consumption 2000- 2010 - 31 Gb/yr. Hubbert Peak in 220/31 = 7 years - i.e. 2007.

3.11) How about unconventional oil?

Unconventional "resource " estimates, vary from about 1300 - 4000 Gb. (100 years supply.? - No, only about 1/6 of it is considered to be energetically recoverable.) However, the resources are meaningless for purposes of this paper. What counts is the rate of recovery projected over the next 20 years. In spite of nearly 30 years and several billion dollars no successful technology has been developed to recover shale oil, and efforts have largely been abandoned. Orinoco bitumen is already producing (Orimulsion), and tar sands may be attractive at about $50.00 per barrel. It is estimated that, with sufficient investment (billions of dollars) bitumen and tar sand production could be brought to 2Mb/day in 2010 (about 2% of needs) and 7 Mb/day in 2020. This addition would reduce the rate of decline after the Hubbert Peak slightly.

Notes: One can imagine an energy efficient world in which North America would need less than 10 Mb/day by 2050 and it could all come from tar sands, at a high enough price.

NOTES: Excess supply in Q2 and Q3 does not make up for prior destocking. The swing supplier is Iraq. They have no reason to help and have already announced production problems.

Total supply is above 98% of capacity in Q4, - no room for problems.

3.13 What's wrong with R/P? BP/Amoco statistics show that we have about 38.5 years of reserves at the 1998 production rate. This ratio is essentially a meaningless number as it assumes implicitly that oil can be produced at a constant rate, until the last drop is recovered, and then recovery will drop instantly to zero. The real world doesn't work that way.