Wednesday, July 06, 2005

Irrelevance of reserves

Primer on my investment outlook

Bernstein Energy: Oil "manufacturing" calls into question the world's ability to grow production fast enough - My thanks to Spalding Hall for this very informative report by Neil McMahon, Ben Dell and John Dowd of Bernstein Research. It's posted in the Subscriber's Area but here is a brief section:

Not only are reserves becoming more difficult to find, but the global reserves mix is also changing. As upstream focus across the industry shifts from conventional to unconventional development projects, so too unconventional reserves will becoming an increasingly important part of the global resource base. Critically however, the rate at which conventional and unconventional reserves can be developed and produced are very different, which may lead to over-optimistic estimates of the production growth that can be delivered from the reserve base.

Their differing development rates are a simple reflection of the fact that conventional and unconventional production are very different processes. Production from traditional, large oil field "gushers" is reliant on natural reservoir pressures. Initially these pressures are high and provide a natural force by which production can be ramped-up quickly, and to a high annual depletion rate, constrained only by economic factors (number of wells drilled). As oil is extracted, reservoir pressure decreases, leading to production decline. Conversely, unconventional production (e.g. heavy oil, oil sands, LNG, GTL) is essentially a manufacturing process, with production a function of the number of processing units built (refineries, power generation facilities etc). While this means that production is unbound by natural limiting factors such as reservoir pressures, the economic limiting factors are far greater. Manufacturing oil, costs more and is harder to scale versus traditional field production, not to mention the lower quality per barrel realized. Consequently, the development of unconventional resources takes far longer.

There is a danger then, that global annual reserve additions will become a less meaningful measure of production potential in the future, given the additional time and resources required to develop unconventional reserves. Indeed, reserve figures of the future may lead to a false sense of supply security unless the issues associated with unconventional resource development are fully appreciated.


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