Supply: Are Saudi reserves drying up? Outsiders believe Saudi oil production will soon peak then sharply decline, leaving a huge gap in world supply

The penny dropped as Matthew Simmons, a Texas-based energy investment banker, sat listening to oil geologists from one of the world’s most secretive of companies.

“Our oil challenges: aging fields, rising levels of water, and complex formations,” said the Saudi Aramco geologists in a presentation in the Saudi oil city of Dhahran.

Aramco, which controls 98 per cent of Saudi Arabia’s oil reserves, has had its doors shut to the outside world for more than 50 years, keeping energy experts guessing about how much oil the kingdom actually has, and how long its gigantic fields can feed oil-thirsty economies such as the United States.

But this revelation from Saudi Aramco’s oil geologists in 2003 was enough for Mr. Simmons to spend the next two years trying to solve the mystery surrounding Saudi oil fields.

“This was like a basketball coach saying: I got the world-class athletes, but they are just really old; they are losing their eyesight, and they’re starting to use walkers,” says Mr. Simmons, the chairman of Simmons & Co., and former member of U.S. Vice-President Dick Cheney’s energy task force.

Mr. Simmons is one of those “petro pessimists” whose research shows that the entire Saudi oil system is old and fraying; that its oil production will soon reach an apex, and that the ensuing decline will result in the world confronting an immense oil shortage.

He disputes Aramco’s assessment of Saudi oil reserves and future production, pointing to the increasing reliance on pumped water to maintain production from its five big fields, which account for 90 per cent of the kingdom’s oil output.

Saudi Arabia produces 9.5 million barrels a day, or more than one-ninth of this year’s expected global daily demand of 84 million barrels. The Paris-based International Energy Agency, or IEA, which advises 26 industrialized countries on energy issues, estimates Saudi Arabia has 261.9 billion barrels of “geologically proven” reserves, which are enough for another 25 years to maintain its leading position in the oil market.

Over all, Saudi officials claim, the kingdom may contain up to one trillion barrels of ultimately recoverable oil. It’s the only producer in the Organization of Petroleum Exporting Countries (OPEC) cartel that keeps a buffer of spare capacity to swing oil markets when warranted.

But the recent oil price surge, and Saudi Arabia’s apparent failure to use its spare capacity, suggest the kingdom’s position in the oil supply-and-demand equation is changing.

“The biggest question is how quickly and how much Saudi Arabia can bring from its reserves to the consumer markets,” says Dr. Fatih Birol, chief economist at IEA. He says the Saudis will have to open their energy sector to foreign investors in order to make this happen.

Experts say the Saudis, on whom the world is relying to fill the supply gap created by a massive demand from China and India, are unlikely to do it alone. The country’s public finances have been tight for the past decade for a number of reasons, ranging from the huge costs associated with the Persian Gulf War; to public support for the increasing number of unemployed youth, to more spending to counter the threat posed by Islamic militancy. Its budget swung to a surplus only last year when oil exports rose to more than $100-billion (U.S.), sharply up from an expected $77-billion.

Concerns related to Saudi Arabia’s dwindling clout in the global oil markets have also caught the attention of the U.S. government’s Energy Information Administration (EIA), which tracks data across the world’s major producers.

The most critical question facing the world energy market, says Erik Kreil, an analyst at EIA, is whether Saudi Arabia can still influence the world markets by manipulating its excess pumping capacity.

“Saudis have been producing at their maximum capacity. And whatever they have in the spare capacity is heavy oil, which refiners don’t want. If Saudis want to sell this oil then they have to give a heavy discount, which will bring the whole market [down] with it,” Mr. Kreil says.

Limited foreign participation in investment has also prevented Saudi Arabia and other major OPEC members from fully benefiting from the major technological advances that have taken place in the past two decades in the oil sector. These are mostly patented by U.S.-based international oil service companies.

“We think the most strategic issue in the oil industry is that two-thirds of the world’s oil and gas reserves are closed to the free flow of capital; and we think this is an important barrier to increasing the production capacity,” says Mr. Birol of IEA.

Despite these doubts, Saudis dismiss the talk of their oil output peaking.

“The world in general and Saudi Arabia in particular has ample oil available to supply the world’s needs for a long time to come,” Saudi Arabia Oil Minister Ali al-Naimi told an international oil summit in Paris last month. He claimed the kingdom can increase its output to 15 million barrels a day in the near future from the current 9.5 million barrels, and can continue to produce that much for another 50 years.

Still, Mr. al-Naimi says OPEC, led by Saudis, has lost control over prices. “Despite our best efforts, Saudi Arabia and OPEC have had little ability to curb the rapid rise in prices,” he says, blaming speculative buying in the futures market for the recent price surge.

For some, this is no less than an admission from the biggest oil producer that its grip on the market is loosening.

“Even under the most optimistic scenario, Saudi Arabia may be able to maintain current rates of production for several years, but will not be able to increase production enough to meet the expected increase in world demand,” Mr. Simmons says.

“This admission is a wake-up call.”