$38 Oil, In Perspective Jude Wanniski May 4, 2004

When the price of West Texas Intermediate (WTI) oil hit $38.31 on Monday, it was the first time since October 1990 that it went that high. The parallel with political upheaval and distress in the Middle East could not be clearer. Financial reports Monday linked the 85-cent jump in oil to the weekend killings of five foreign petrochemical workers in Saudi Arabia. The U.S. Ambassador issued a statement encouraging Americans to go home, as they could not be protected from Islamic militants. The Saudi oil industry, with 265 billion barrels of oil in proven reserves, has a production capacity of 10.5 million barrels per day (mb/d) against world consumption of roughly 75 mb/d. It is highly unlikely that domestic terrorists would be able to seriously impair the industry’s ability to export, or even whether they will aim at doing so. However, the killings do ratchet up the risk that has already been priced into a barrel of oil because of the continuing disruptions in Iraqi production and the constant threat of a wider conflict. The OPEC ministers seem to agree that a world price of $28/bbl would be reasonable. With gold at $392/oz., that works out to 14 bbl. to the ounce (not far from the 15 bbl./oz. average that has prevailed since 1948), as opposed to 10.3 bbl./oz. at $38. We would be hard pressed to find a sustained oil/gold ratio at that level in recent history, which tells us that the price is almost entirely geopolitical.

We also continue to reject the idea that the long-term oil/gold ratio of 15 bbl./oz is history, or that it must be finally true that the world is running out of oil. Michael Halbouty, the legendary Texas wildcatter, had it right 25 years ago when he said at the height of such fears: “There is no shortage of energy anywhere on earth that is not caused by government.” At the time, the Club of Rome was warning of oil depletion by the end of the 20th century. Proven reserves were then at 643 billion bbl., and today they are at 1.2 trillion bbl. When I wrote the energy editorials for The Wall Street Journal back then, I learned that experts have been predicting exhaustion of oil reserves as early as 1920, when George Otis Smith, the director of the U.S. Geological Survey argued that “We have apparently used up 40% of our oil supply… There is need for a countrywide thrift campaign looking to the saving of this essential resource. Where will my children, and children’s children, get the oil they need in ever-increasing amounts. What is to happen when, following the United States, Mexico must reduce her output with the progression exhaustion of her oil resources.” At the time, proven oil reserves were less than 20 billion bbl., and the gold/oil ratio was 14 bbl./oz.

Currently, the International Energy Agency forecasts global oil demand will increase to 120 mb/d by 2030 from the current 75 mb/d. North America is projected to rise by nearly a third; China will double its oil imports; and the European Union will import 92 percent of its oil. The U.S. Department of Energy reckons 53 percent of U.S. petroleum supplies will come from OPEC, including 26 percent from the Persian Gulf. It notes that new oil fields discovered outside the Middle East tend to be small, expensive to develop, and require high transportation costs. One of the chief reasons there are constant editorial demands from The New York Times for higher gasoline taxes, adherence to the Kyoto Treaty on global warming, or support for alternative energy sources is its goal of reducing U.S. dependence on Arab oil. The war in Iraq was specifically undertaken to remove its enormous oil wealth – at 110 billion bbl., second only to Saudi Arabia’s – from the Arab/Israeli equation, with the added benefit of having its oil production pay for reconstruction. Vice President Cheney last year said production would be up to 3 mb/d by the end of 2003, but that number may not be achieved in 2005 unless there is pacification.

My personal belief is that world oil consumption will rise faster than estimated by the IEA and that patterns of production will be altered dramatically over the next decade. For example, China should be more than self-sufficient in oil by 2015. It needs only to develop its infrastructure in a way that makes prospective oil fields in the interior not yet discovered open to exploration so that equipment can get in and oil can get out. The former communist countries, including Russia and China, have scarcely been explored. In 1980, when I wrote “Energy in Abundance” as a new chapter 13 in the second edition of The Way the World Works, I noted that in the entire history of oil only 3.3 million wells had been drilled on earth and the United States had accounted for 2.5 million. This is because the U.S. is the only country that gives the citizens the mineral rights to surface property ownership. Wildcatters can make their own deals with farmers or ranchers without government involvement. In the rest of the world, governments decide through a bureaucratic process who drills, where and when, and who gets the lion’s share of production. In the 20 years since, another 1.3 million wells have been drilled, with the U.S. drilling 727,000 wells.
 
Recall the 1920 forecast of the U.S. Geological Survey that when we used up our oil, we would then use up Mexico’s oil. Mexico is the size of the entire oil patch of the U.S. that contributed 3.3 million wells drilled over the last 145 years, but because the Mexican government controls oil production, it has barely scratched the surface. In the eight years between 1996 and 2003, there were 209,400 wells drilled in the United States. During the same span, 2,392 wells were drilled in Mexico. The total for all of Latin America, excluding Mexico, was 20,553. Poor people sitting on giant, undiscovered oil fields grow poppies instead to make ends meet.

It gets even more ridiculous for Africa. Including Alaska, the U.S. has 3.675 million square miles. Without Alaska, it has 3.08 million square miles. Africa has 11.5 millions square miles. During the past eight years, the U.S. has drilled 209,400 wells, but all of Africa – including Libya, Nigeria and Algeria – has drilled only 6,280 wells. In 1980, I pointed out that Madagascar, off the southeast coast of Africa, is almost as big as Texas and has the same geophysical properties as Texas, but in its entire history only 83 wells had been drilled. With the same complications of bureaucratic governance and high taxes still existing, exploration remains stagnant. Per capita GDP still is under $300. The Middle East has 56.5% of the world’s reserves. Because the countries with the oil do not need to look for more in the immediate future, there is practically no exploration there. Saudi Arabia drilled fewer than 1,000 in the eight-year period to 2003, mostly production wells. Iraq drilled fewer than 100. You can begin to see how two Soviet scientists in 1976 could estimate the total crude-oil resource base of the world at 12 trillion barrels.

Even that staggering number looks very low when we think of the technological advances since 1976. In my arguments about the silliness of the global-warming hoax, I hit upon the idea of taking all the oil produced since 1859 and replacing the water in Lake Tahoe, Nevada with it. As of last year, the oil would not fill more than one-third of the Tahoe cavity. If you look at a wall map of the world, you will find the cartographers cannot make a blue dot small enough to identify the lake.
 
What will it take to change the patterns of oil development so the U.S., with only 22 billion bbl. of reserves can feel secure with global supplies from myriad sources outside the Middle East? My thinking has been all these years that the U.S. President, whoever he or she happens to be, need only encourage the people of the world to encourage their governments to give them mineral rights to their surface deeds. It would only take one or two countries leading the way, and soon there would be wildcatters all over the globe finding oil and gas where they least expect it. I suggested the idea to Karl Rove in 2001, when President Bush was on his way to meet with Mexico’s President Vicente Fox, and he seemed impressed. Nothing happened, but then Big Oil does not necessarily want a world awash with cheap oil. It will probably take a crisis in the Middle East to break the ice. Maybe the one now brewing in Saudi Arabia will do the job. There is no doubt it will happen sooner or later, perhaps in my lifetime.

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