An Expensive Path to Energy Security

This week, the Energy Information Administration updated its estimates of United States crude oil and natural gas reserves, and found that U.S. crude oil reserves have reached their highest point in 36 years. By the numbers:
  • U.S. oil reserves (including both crude oil and lease condensate) increased by 4.5 billion barrels, or 15.4 percent, since 2011. This is the largest annual increase since 1970.
  • Proved oil reserves in the Texas Eagle Ford tight oil play surpassed those in North Dakota’s Bakken.
  • Reserves in Texas increased by a large margin of 3 billion barrels, North Dakota saw the second largest increase at 1.1 billion barrels, and the Gulf of Mexico increased by 137 million barrels.
  • Total proved oil reserves in the U.S. moved from 29 to 33.4 billion barrels, exceeding 33.4 billion barrels for the first time since 1976.
  • 5.2 billion barrels of extensions offset 0.7 billion barrels of decline to net 4.5 billion barrels of increase. (Most of the decline came from Alaska, where depleted supplies are not being replenished by new discoveries).
  • Proved reserves of wet natural gas fell 7.5 percent to 323 trillion cubic feet.
  • Despite the drop in natural gas reserves, production increased about 6 percent from 2011 to 2012.
  • Total discovered oil and natural gas reserves exceeded production in 2012.

When most people think of crude oil reserves, they think of a quantity of oil determined by geology or technology. While geology and technology matter, a significant role is also played by price. By definition, proved reserves are estimated volumes of hydrocarbon resources that analysis of geologic and engineering data demonstrates are recoverable with reasonable certainty. EIA’s report is developed by aggregating survey data from oil and gas field well operators, whose assumptions about which resources are valuable and which are not are primarily driven by what is economically viable.  In a given year, reserves data is constantly changing as existing reserves are produced, new reservoirs in existing fields are discovered, new technologies enable greater recovery, new fields emerge, and higher prices make new resources viable. Thus, EIA’s report is more a measurement of operator perceptions given the economic conditions at the time. EIA also notes that actual prices received by operators vary based on contractual agreements, location, hydrocarbon quality, and other factors. Therefore, spot prices are not a one-size-fits-all indicator of what is viable, although they serve as a helpful guide. Meanwhile, as sustained, high oil prices have enabled drillers to continue upping their estimates of crude oil reserves, the decline in natural gas prices in 2012 (when prices were closer to $2/mBTU) caused the dropoff following the period of sustained increases through the 2000s. Now that prices are higher, moving between $4 and $6/mBTU, we can assume that natural gas reserves will grow again in 2013 and 2014. However, while this is great news, there are a few important caveats to take into account. First, there’s the fact that even with these great increases, U.S. reserves are fairly pitiful compared to the conventional reserves in Middle Eastern and OPEC countries. Data from BP’s statistical review makes this fairly clear. Of particular note are the reserves/production ratios, or the number of years that reserves will last at current production rates. The United States has fairly low reserves compared to other major oil producing countries, and is depleting them at a rapid pace. Fatih Birol, Chief Economist at the IEA, pointed out yesterday at a CSIS event that while the United States has accomplished truly impressive growth in oil production, supplies from the Middle East will be essential to meet the needs of Asia, the largest source of demand growth over the next 10-20 years. Second, there’s the issue of estimate uncertainty. Almost all of the increase in U.S. reserves is due to shale resources, which are far more difficult to calculate than conventional reserves. For decades, petroleum engineers have relied on certain methods for estimating resources based on vertical wells tapping conventional reserves. Applying these methods to horizontal wells and shale reserves is still a relatively imprecise science. Third, on that note, not all shale wells are producing as much oil for as long as drillers had anticipated, which could undermine estimates in the longer term. Outside of the “sweet spots” in shale plays, as drillers expand further into the Bakken and Eagle Ford, they are finding that some of the newer wells are seeing massive decline rates and fizzling out as early as their first year—far earlier than anticipated. IHS analyst Peter Stark told Bloomberg that extremely rapid well decline rates have shown that output from many shale oil wells is falling by up to 78 percent in the first year—a troubling prospect when shale wells are already not as productive as typical conventional wells. One Chesapeake Energy well, Serenity I-3H, gushed 1,200 barrels per day in 2009, and in August of last year was producing less than 100. Compare that to an oil well in Saudi Arabia, where average well productivity is 6,000 barrels per day. American drillers are thus forced to assume great costs by furiously drilling new wells to offset these declines. Field operators have referred to this phenomenon as the “Red Queen” from Alice in Wonderland, who tells Alice, “It takes all the running you can do, to keep in the same place.” And that’s an expensive path to energy security.