Water and oil don’t mix
October 17, 2006
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Fears that the massive Ghawar oil field in Saudi Arabia may have passed its prime have been the stuff of speculation for many years. Ghawar has underpinned Saudi Arabia’s dominance of the oil market ever since it came on stream in 1951. With its ability to pump out some five million barrels per day on average, more than half of Saudi Aramco’s total of 9.1 million barrels per day, the slow death of Ghawar may help to ensure that the low oil prices of the 1980s are but a dream for the average consumer.
Don Coxe, an analyst from the Bank of Montreal, once described Ghawar as having passed “Hubbert’s Peak”, a phrase used in honour of geologist M King Hubbert, who predicted oil field decline in the 1950s. The best indication of this is the steadily increased usage of water injection in the wells. Water injection is normally used on older oilfields to maintain pressure within the well and force out more oil. The problem is, once the water reaches the well head, the field has to be abandoned. Many are now pondering the connection between Saudi production and increasing water usage. As Coxe puts it, “Isn’t water flooding [the] Viagra of ageing wells?”
However, the problem for the Ghawar field may go deeper. Matthew Simmons, an advisor on energy policy for the Bush administration, has speculated that the over-exploitation of the field in the past has caused damage to its geological structure. Large amounts of oil may now have become unreachable with present oil extraction technology. The Saudis contest this, saying that only 48 per cent of the Ghawar’s fields had been used by 2004, with the use of water injection falling thanks to the use of more advanced drilling techniques. More technical information on the field is generally not released, and much speculation still surrounds the actual state of the field.
So, what does this mean for the market? Saudi Arabia acted as the “central bank” of oil. Whenever the oil market needed to be stabilised, or when extra production was called for, Saudi Arabia was always there to assist. Most members of OPEC were famous for their wild disregard of production agreements, and it was only thanks to Saudi over-capacity that the organisation could demand any sort of respect. Without the central bank to keep them in line, the ability of OPEC to stabilise oil prices – indeed its entire viability as an organisation – is put in doubt. With the price of oil now falling, it appears that many of the OPEC members are once again not being as good as their word when it comes to production cuts.
However, the Saudi ability in the past to act as a central banker in the short term appears to have damaged the long-term future of Ghawar. When looking back, the Saudis have been asked to up production on many occasions, especially to make up for the loss of Iraqi oil. And Ghawar oil is the light grade that refiners love. Most of the new fields coming on stream in Saudi Arabia are producing heavy, sulphurous oil that is harder to refine, and which trades at a discount.
Low oil prices in the past were underpinned by large amounts of easy to extract and refine oil, and this is what Ghawar was famous for. As the stock of this oil declines, lower grades of oil that are more expensive to produce and refine are being brought on stream. It is not as if the world will run out of hydrocarbons any time soon – it won’t. But the price we will pay for oil does have a certain number of price floors within it that over the medium term will reflect the rising real costs for energy.
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