House Of Cards: The World’s Future Hinges On Oil


(Part one of a two part series on oil and the crisis in the Middle East)

At the intersection between peaceful prosperity and a global Jihad stands the House of Saud.  They are the ruling Royal Family of Saudi Arabia, only a few generations removed from their tribal Bedouin forefathers. 

Some 10,000 princes control the world’s single largest oil reserve, nearly 300 billion barrels in all.  Yet the Saudi Kingdom has been America’s energy vanguard. However, in the past four weeks more mayhem has occurred in the Middle East than happened during the previous four generations.

In the last month Tunisia and then Egypt fell under the weight of political dissent and the wireless revolution.  Just as revolt spread across Eastern Europe 20 years ago, political unrest is a contagion in greater Arabia and has now infected Bahrain and Libya.  Neither is as politically significant as Egypt, yet both carry far more weight when it comes to the world’s most important resource — oil. 

Last week crude oil surged more than $10 per barrel.  On Thursday it reached the $103 per barrel threshold that has not been seen since 2008.

It was no coincidence that as oil prices rose last week, stock prices fell.  By mid-week the Dow had lost nearly 500 points from where it opened the week and, unless the Middle East is stabilized, Dow 12,000 may be just a happy remembrance.

Global markets certainly seem fragile in the wake of rantings by Libyan strongman Muammar Gaddafi.  His defiance was reminiscent of Hitler’s final days in the bunker.  Fortunately, Libyans don’t fear Gaddafi the way Germans feared Hitler so the Marines won’t have to land on the beaches of the Mediterranean. 

That doesn’t mean that Gaddafi can’t force a bloody civil war onto Libya, which is Africa’s No. 1 oil producer.

Late last week, Italian oil giant Eni, the largest foreign oil company in Libya, said production in the country is being shut down due to ongoing violence. 

Eni produces about 250,000 barrels a day from Libya, which has total oil output of 1.6 million barrels per day. The largest oil firm in the country is the government-run National Oil Corporation. It reports that production is grinding to a halt.  This erases roughly 2 percent of the world’s current oil supply.

Some have tried to calm the markets saying that Saudi Arabia will resume its role as the world’s historical swing producer and will match any falloff resulting from the revolution in Libya.  Not so says Barclays.

"Firstly, the grades and quality of crude available from Saudi Arabia is likely to be different from Libya," says Suki Cooper at Barclays Capital.

Cooper points out that Libya has extremely lightly graded oil which is cheap and easily refined into gasoline. Even Saudi Arabia has heavier oil than Libya. As a result, Libyan oil cannot be easily replaced by oil production from anywhere in the world.

According to Cooper:

“Libyan crude is sweeter, with CPC Blend and Azeri Lights likely to feel the shortages. Effectively, West African crude should receive a higher bid from the Med, with the ultimate effect likely to be seen via a widening in the Brent-Dubai spread, as prompt supplies of Brent-related crudes [SIC] remains the issue.

"Also, the time taken to bring those Saudi barrels to the market is likely to be significantly longer compared to the ongoing Libyan production. Thus, the concept of a barrel for barrel replacement is not a correct one.

"Ultimately, the overall significance of the situation in Libya is more than just about lost barrels. It continues to inject a huge amount of uncertainty in the oil market especially for the medium term, as destabilisation (sic) in the Arab world, home to the world’s largest oil and gas reserves and production, is of extreme significance."

There is a much bigger problem thatBarclays doesn’t address. It is a question the energy world is afraid to even touch on. 

It is the fact the Saudi Arabia’s oil fields have been bled down over the past five decades.  Pressure inside the giant oil domes of Saudi Arabia have fallen drastically since the early 1980s and the House of Saud cannot simply open up the oil taps the way it used to every time Arab unrest raised its ugly head. 

The Saudis have hundreds of oil reservoirs. Yet 90 percent of the country’s oil production comes from only five fields, and all of them were discovered before 1966. The largest is Ghawar, an oil field so large that its production accounts for about 60 percent of all Saudi Arabian oil output. The giant Ghawar Field stands out as the region’s crown jewel.

Ghawar was discovered in 1948 and production started two years later.  In 1981 it reached a peak of 5.7 mb/d. That is almost 1 mb/d more oil than is produced in all of the United States.

Since its discovery, Ghawar has produced more than 55 billion barrels of crude. No one is sure exactly how much crude the Ghawar Oil Field still contains. The evidence suggests that official oil reserve claims have been vastly inflated. It is almost certain there’s not as much oil at Ghawar as the Saudis say. And for an oil-hungry world, that is bad news. But it gets worse.

Mixing Water With Oil

In Saudi Arabia, seawater is injected into oil fields to increase pressure and stimulate production.

Currently, only 30 percent of the oil in a reservoir can be extracted. But injected water increases that percentage — known as the recovery factor — and maintains the production rate of a reservoir over a longer period of time. As the volume of water that is lifted along with the oil increases the volume of oil decreases proportionately until eventually what flows out of the reservoir is almost pure water and the field is no longer worth operating.

The national oil company of Saudi Arabia and Ghawar’s operator is currently injecting nearly 8 million barrels of sea water each day.

It will be decades before Ghawar is abandoned.  But the field can no longer do what it once did — increase output during periods of political instability and soaring prices.  The Saudi safety-net that was Ghawar no longer exists.  The greatest oil elephant the world has ever known is dying. 

Thirty years ago Saudi Arabia could and did ramp-up oil production as high as 14 mb/d.  To meet the current loss in Libya and the uncertainty in the rest of the Persian Gulf 14 mb/d is what it would take to sooth the oil markets.  But regardless of prices or pressure from Washington, the House of Saud will have a tough time keeping oil production above 10 mb/d this year.  Over the short-term that means $100-plus per barrel of oil.  Over the longer term, Saudi Arabia has a much bigger problem than the fact that its wells are running dry. 

As Libya burns and protests erupt in Bahrain, Saudi princes are not fretting about how much oil their country will pump.  They are worried if their blood is about to flow.

Action To Take

Unless you own stocks whose business it is to discover or deliver real assets, sell them immediately.

Yours in good times and bad,

John Myers
Editor, Myers’ Energy and Gold Report 

Personal Liberty

John Myers

is editor of Myers’ Energy and Gold Report. The son of C.V. Myers, the original publisher of Oilweek Magazine, John has worked with two of the world’s largest investment publishers, Phillips and Agora. He was the original editor for Outstanding Investments and has more than 20 years experience as an investment writer. John is a graduate of the University of Calgary. He has worked for Prudential Securities in Spokane, Wash., as a registered investment advisor. His office location in Calgary, Alberta, is just minutes away from the headquarters of some of the biggest players in today’s energy markets. This gives him personal access to everyone from oil CEOs to roughnecks, where he learns secrets from oil insiders he passes on to his subscribers. Plus, during his years in Spokane he cultivated a network of relationships with mining insiders in Idaho, Oregon and Washington.

Join the Discussion

Comment Policy: We encourage an open discussion with a wide range of viewpoints, even extreme ones, but we will not tolerate racism, profanity or slanderous comments toward the author(s) or comment participants. Make your case passionately, but civilly. Please don't stoop to name calling. We use filters for spam protection. If your comment does not appear, it is likely because it violates the above policy or contains links or language typical of spam. We reserve the right to remove comments at our discretion.