The energy industry and, in essence, the entire geopolitical landscape completely changed on May 26, 1908. It was on this day that George Reynolds tapped an oil reserve in modern-day Iran, the very first oil discovery in the Middle East. That well, which was the beginning of the company we know today as BP (NYSE:BP), also set the foundation for the Middle East to be the predominant oil-producing force around the world. Today, though, that position is starting to slowly slip away. Let's take a look at why oil production in the Middle East is not what it once was and what we can expect in the future.
Where the oil is
Historically, the Middle East has benefited not only from the fact that there are massive quantities of oil beneath the surface, but it is also extremely cheap to develop them. As recently as 2009, average upstream costs for the Middle East were one-third lower than the rest of the world. These abundant, cheap resources have given the region a major leg up in oil production ever since the major fields were discovered there in the 1950s.
The fact that these fields have been producing for more than 60 years is what is starting to make production and development tricky. In order to maintain or increase production at these mature fields, more expensive extraction methods will be needed.
Today, there are three stages of well production: primary, secondary, and tertiary. Primary is when the formation needs little to no assistance in moving oil to the surface. Secondary extraction uses fluid injection to push oil to the surface, while tertiary methods -- also known as Enhanced Oil Recovery or EOR-- use CO2 and steam injection to release the remaining oil. These new methods have been found to be very effective in maintaining production at mature fields. It is estimated that less than 30% of all oil in a formation can be extracted through primary measures, but implementing secondary and tertiary methods can increase recovery up to 80%.
But as each process is implemented, so too does the cost to extract oil increase. Today, every country in the Middle East is implementing some form of EOR to their oil fields. For some of the smaller countires, it has been in practice for years. Total (NYSE:TOT) has been using gas flooding in Abu Dhabi for more than 20 years. This is a telltale sign that the cost of extracting oil is getting more expensive for all players in the region.
EOR isn't the only sign that production isn't as simple as it once was, though. Royal Dutch Shell (NYSE: RDS-A), BP, and Eni (NYSE:E) have all requested recently that the Iraqi government reduce its production targets at various fields across the country, which under current production goals would deplete more than half of the country's reserves in 20 years. Furthermore, during Core Laboratories' (NYSE:CLB) recent conference call, CEO David Demshur noted that the company has seen a "surprising" amount of increased interest in its reservoir management and production enhancement divisions.
What to do?
There are plenty of doom-and-gloom pieces out there saying either peak oil is upon us or that peak oil is dead so pick your poison. Rather than pontificating about the fate of the industry, let's take a look at what this means for investors instead. The current situation is probably best described by Demshur:
... the national oil companies there now realize that their reservoirs are not exempt from the laws of physics and thermodynamics, and they need to start concentrating on enhanced oil recovery projects to indeed keep their production levels where they are at today.
Many of the national oil companies in the Middle East do not have the experience to do EOR or production optimization on their own. This is where oil services specialists come into play. Both Core Laboratories and Schlumberger (NYSE:SLB) saw sizable upticks in revenue from the Middle East region. If Middle Eastern oil production trends were to continue, it would not be a stretch to see these two companies as well as other oil services grow their Middle Eastern business substantially over the next several years.
For the integrated majors, it is harder to tell if this region will be as lucrative for them. Since most of the countries in the region produce oil through their respective national oil companies, companies like Exxon and BP receive technical service agreements just like oil services companies rather than a share of production. The question is, will a heavier reliance on processes like EOR lead to more lucrative service contracts for these big players?
What a Fool believes
According to the U.S. Geological Survey, there are an estimated 500 billion barrels of oil yet to be discovered, which is on top of the 1.6 trillion that we have today. So while there is still an abundant supply of oil remaining, it is nonetheless a finite supply and the price of extraction will continue to climb as we need to drill deeper and deploy new innovative techniques.
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