For some days, I have watched the debate on Saudi resources set off by Matt Simmons with amusement - the kind of amusement one feels when listening to discussions about economics in a small-town barber shop. But now, since some seem to be taking the concerns voiced by Simmons and his followers (e.g. Morse) seriously, I feel compelled to comment.
Are the major currently producing fields in Saudi Arabia aging? Of course. But that, in and of itself is no basis for concluding that Saudi Arabia cannot maintain or even expand production in the near to medium-term - perhaps for even two or three decades - even without additional discoveries.
Morse tries to make much of the fact that the big fields in Saudi Arabia are fifty years old - and claims that big fields typically decline after 50 years. But his assertion fails to take account of the fact that, over those fifty years, the Saudi fields have been produced at much lower intensity than is the practice elsewhere, simply because market limitations and deliberate restrictions of production for reasons of market management have constrained production (relative to reserves) to levels far below that which would be typical (and economically optimal) in a purely competitive situation (which governs production decisions outside OPEC). So, with resources which are very large relative to amounts which could be profitably marketed (taking account of the impact of additional production on price, which Saudi Arabia must do because of its dominant position in the market), the fields have been operated at production levels on the order of 1 to 2% of reserves, not the 7% or so that is typical in a purely competitive environment. In view of this observation, simple conclusions such as "big fields decline after 50 years, therefore Saudi production from big fields is about to decline," are simply not warranted.
As fields age, production costs rise. Of course. That's the reason production from a given field is eventually allowed to decline (cost of maintaining the last barrel exceeds price) and eventually stop (it becomes uneconomic to keep the field on stream at all).
Are production costs rising in Saudi Arabia? Yes, simply because the fields are aging. Maintenance and/or expansion of production from existing fields will require handling larger water cuts, a higher well density, etc., etc., etc. And it may become necessary (economically desirable is a better term) to employ more and more sophisticated (and expensive) producing techniques, to spend more money on data acquisition to support reservoir management, etc.
But these things just say that costs are going to rise. It does not imply that (in the near to medium term) it will become economically attractive to allow production to fall. Nor does it even imply that it will become economically unattractive to augment production. One certainly cannot infer on technical grounds that production MUST fall. The decision to maintain production or allow it to fall is an economic decision - based, it is true on physical, technical and engineering considerations (and the price of oil) - but an economic decision, nevertheless.
So costs are going to rise. What is the significance of that? We would be well advised to start with some idea of the current level of costs. At the present time, despite the inclusion of a lot of social costs borne by Saudi Aramco and the fact that the company must provide its own infrastructure (houses, roads, utilities, etc.) in most producing areas, the long-run marginal cost of oil in Saudi Arabia is on the order of $1-2 per barrel. $1.50 is probably a pretty good number. (This number should be interpreted as economic cost, not accounting cost, i.e. it is inclusive of return on capital).
I am not going to belabor the point because it should be obvious. If the price of oil is $25 (or more, as is currently the case), the fact that marginal cost is likely to rise from a level of $1.50 provides no basis whatsoever to come to the conclusion that Saudi Arabia will not be able to maintain current production levels or expand significantly, should it choose to do so.
It might be informative to consider the case of Shaybah, which was brought onstream in 1999, I believe (I am not going to look it up). This 500 thousand barrel per day increment was developed at a total cost (including a several-hundred-kilometer road into the sand mountains of the Rub' al-Khali, housing for personnel, etc.) of $2.5 billion or $5000 per daily barrel. Assuming a $25 oil price (and ignoring O&M on the order of 5% per annum of facility cost), the simple payout period for this investment is 200 days, just over six months. Against that background, it is obviously farcical to think of costs and investment requirements as significant impediments to the maintenance and/or expansion of production in Saudi Arabia.
In considering Saudi Arabia's capacity to maintain or increase production, we would also be well advised to keep in mind the fact that there are a large number of discoveries which have never been developed (Rimthan, Dibdibah, and others) and fields which have previously developed, but subsequently shut in (Khurais, Abu Jifan, Mazalij). Why were these fields not developed? Because they are uneconomic as stand alone propositions? No. Simply because the costs have been higher than alternatives, i.e. higher than the cost of maintaining production (and excess capacity) in other fields and reservoirs. As the effects of depletion cause costs to rise in currently producing fields, Saudi Aramco can be expected to (continually) reassess the relative economic merit of maintaining or expanding production in currently producing areas as opposed to developing one or more of the smaller fields which are now on the shelf.
Conclusion: the stock of undeveloped discoveries which Saudi Aramco has on the shelf will serve to reduce the impact on costs of depletion effects in reservoirs which are currently producing. If the cost of getting additional oil out of Ghawar rises to $2.50 and Field Z can be brought on for $2.00 - then field Z will be developed as an alternative means of maintaining or expanding production. (But field Z is currently still on the shelf because it costs more than $1.50.)
Finally, we should keep in mind that exploration efforts in Saudi Arabia would rationally have ignored small (seismically identified) structures which may contain oil but which are too small to consider as potentially economic relative to reservoirs which have already been drilled or already placed on production. As time goes by, as costs in other areas rise and as technology progresses, it will become economically attractive to investigate structures which, to date, have appeared to offer too small a payoff to be worth the trouble. If you have $1.50 oil on the shelf now, why chase a prospect that would likely cost $5.00. (That $5.00 prospect in the US, of course, would be regarded as something of a bonanza.)
The bottom line of all this is that what matters as far as Saudi production capability is concerned is cost, its magnitude relative to the price of oil, and how fast it is rising. With current long-run marginal costs around $1.50 per barrel and prices of $30, we have a long way to go before we should get very concerned about Saudi Arabia's ability to maintain or increase oil output.
On the other hand, since the course of Saudi production in the future will be governed by decision (i.e. whether or not to maintain or augment production at increasing costs), we might well be concerned about Saudi willingness to develop additional capacity. Should they expand capacity and keep the price of oil under $30? Or should they sit back and enjoy the revenue benefits of rising international prices as production stagnates or declines? That is not an easy question and one which has considerable political content.
Yes, Virginia, despite rising costs associated with depletion, the Saudis CAN maintain and/or increase its production for a considerable period of time. Should they? Will they? That's another question. And it's their decision. And it is not a decision to be made now for all time. It will be examined again and again as time passes.
W. L. Littlejohn
PS. I was a member of the Economics Dept. and the Corporate Planning Organization of Aramco (later Saudi Aramco) from 1972 until 1996, and was directly involved in discussion and development of crude oil production plans throughout that period. I am not a petroleum engineer, geologist, or geophysicist, but believe I can claim a reasonable familiarity with the economically relevant aspects of crude oil production and planning in Saudi Arabia.