by Tom Bower
Lee Raymond and Rex Tillerson told analysts on March 11, 2004, that all the circumstances justified ExxonMobil’s booking in Kashagan because, in their judgment, “all necessary approvals” would eventually be given. Faced with the company’s insistence, Winfrey and Murphy had retreated. ExxonMobil was too big and too powerful in Texas to risk confrontation. “Our policy is the most conservative and rigorous and disciplined,” said Raymond. “You may call that risk-averse. I call it prudent management.” ExxonMobil simply resisted the SEC’s pressure to adopt the new rules for booking reserves. Total had also been permitted to keep its reserves booked. Yet in ostensibly similar circumstances, Shell — and by implication Watts — was accused of securities fraud. Its rivals had stood silently on the sidelines watching Shell’s self-inflicted evisceration for their similar conduct.
Watts was incandescent, but was alone in his battle to show that Winfrey and Murphy had picked on Shell in order to berate the whole industry, and had exploited van de Vijver’s ambitions. The two officials had failed to comply with the statutory requirement to consult the industry before unilaterally changing the rules, and Watts was their trophy. For regulators, he knew, the process was not about the truth, but about winning. Neither SEC investigator understood the contradictions contained in their correspondence with all the oil companies. With hindsight, Watts realized that his timid obedience in debooking the Kashagan reserves as ordered by the SEC had been foolish. ExxonMobil had refused, and the SEC meekly acquiesced. If ExxonMobil had informed Shell of its stance, as exposed in the correspondence, Watts lamented, he would have been partly protected. Accustomed to danger in Nigeria, where guns could be hired for $20, he challenged the SEC to a fight in court. The public cross-examination of Winfrey and Murphy would prove, he promised, that the SEC officials were technically incorrect, even if they had acted in good faith. In support of his argument, CERA published two reports in 2005 and 2006 confirming that the 27-year-old system was “under stress,” unreliable for shareholders and unsuited to world pricing, where up to $6 trillion would be invested by 2030 to increase production of oil and gas.
Watts’s battle against the SEC began in London. The FSA, relying unquestioningly on the Polk report, had in May 2005 rejected Watts’s defense. “The FSA thinks they’ve got my head on a plate,” he told his lawyers. His submission, exposing flaws in the background research commissioned by Polk, persuaded the FSA to abandon its case. Fearing embarrassment after the collapse in London, the SEC terminated its own investigation in August 2006, and declared Watts to be innocent. Only the stigma remained, and the absence of support from his former colleagues at Shell.
By then, Jeroen van der Veer had capitalized on the disarray. “Don’t waste a crisis,” he was advised. The moment was right to merge Shell with Royal Dutch, but on different terms from those Moody-Stuart had proposed six years earlier. Some preparation had been undertaken in secret by Watts, despite a promise extracted by van Wachem not to consider any change. “I know the difference between 60 and 40,” Watts had told van Wachem. Van Wachem had since retired, and in the aftermath of the reserves crisis, with a defeatist mood prevailing among the British directors, van der Veer could rely on their support against the Dutch conservatives. The only issue was whether the headquarters should be in The Hague or London, where the company would be quoted to avoid punitive Dutch taxes. “The queen will never agree to the company leaving Holland,” said van der Veer, explaining the delicate problem he had faced in persuading Queen Beatrix to allow the company to retain the word “Royal” in its title only on condition that its headquarters remained in Holland. On that trifle, the British directors surrendered their power.
Once the news emerged toward the end of 2004, van Wachem sought to persuade the Dutch not to sacrifice their legacy, but it was too late. Shell’s headquarters were moved from London to Holland, where the corporation would be encumbered by Dutch labor laws and conservatism, and estranged from British government support. In the short term, it was easier to fire British employees.
The oil-producing nations were delighted by Shell’s humiliation and confusion. Weakening the Big Four reinforced the power of the national oil companies. The traders were also satisfied. When Andy Hall saw that Shell had exaggerated its oil reserves, he realized that he now had convincing evidence for an inevitable shortage of oil and rising prices. “The trend is your friend,” he smiled, certain of huge profits.
Chapter Seventeen
The Alarm
TOWARD THE END OF 2003, there was an abrupt change in the oil market when prices unexpectedly passed $35 a barrel. “Prices are too high,” admitted OPEC’s spokesman, adding that its target price was between $22 and $28. The unexplained bubble, OPEC feared, would explode, and prices would collapse. Blaming “speculators” and “geopolitics,” OPEC’s statisticians initially cast doubt upon their own data; later they were surprised when the steady decline of oil delivered during the year was unexpectedly reversed, and were bewildered about the destination of the extra supplies. In early January 2004, the mystery was resolved. IEA researchers in Paris belatedly identified China as the “culprit.” Consumption there had risen during 2003 by a remarkable 11.5 percent. The extra demand reflected not only the widespread purchase of new generators and industrial expansion, but China’s inefficiency. The country required three times more oil and coal to manufacture the same item than the US and Europe. The equivalent of 16 million barrels of oil was being squandered every day. China’s demand for oil had doubled in 10 years, and was accelerating. Every year, the country’s energy growth was the same as Britain’s total consumption. Between 2000 and 2004, the unexpected surge had consumed an additional 5.8 million barrels a day (out of the world’s total consumption of 82.4 million barrels). Previously, there had been no fear of shortages: the oil producers had been confident of their ability to produce an extra 12 million barrels a day if required. But within months, the combination of China’s demand and disruption in several oilfields meant that the excess capacity had fallen to one million barrels. The IEA presented an alarming scenario: “What if everyone in China swapped his or her bicycle for an automobile?” In 2003, China was importing 16 percent of America’s total oil production, but if the Chinese owned as many cars as Americans by 2010, imports would rise to 40 percent of America’s total, absorbing all the world’s anticipated extra production.
China’s unprecedented demand enhanced the oil peakists’ argument. Daily production, Colin Campbell was convinced, could not increase beyond 87 million barrels. The dwindling safety net of excess capacity was revealed by the stark statistics. Fifty-two out of 99 oil-producing nations, it was said, had passed their peak, and a further 16 would hit their peak soon. In the short term, the world could rely on Russia and the Middle East to satisfy the extra demand, but soon even they would “go short,” and, since the discovery of new oil was declining, an oil crisis was inevitable. By May 2004, problems in Venezuela, Iraq and Nigeria, where violence forced Shell to cut production by 10 percent, had pushed oil above $40. Reports described the market as being “on a razor edge,” and the prospect of $50 oil as having “lost its shock value.”
Reassurance was offered by Guy Caruso and the EIA. Despite the uncertainty and the decline of production in the North Sea and Alaska, the EIA and the US Geological Survey assumed that there would be an abundance of supply. Production, forecast the EIA, would increase to 107 million barrels a day in 2020, and to over 120 million by 2025. According to the EIA, the OPEC countries would increase their daily production from 29 million to 61 million barrels, while production in the non-OPEC countries would rise from 50 million to 64.6 million barrels. Oil over that period, the EIA estimated, would cost about $35 a barrel on average but would rise to between $49 and $54 in 2010. No serious shortages were anticipated before 2037, and even they would be soluble.
Caruso’s optimism provoked ridicule from the oil peakists. The EIA, Campbell and his supporters believed, was in league with the Bush administration to u
nderestimate future price rises and overestimate the reserves. One foundation of their argument was the seemingly authoritative death sentence pronounced by Matt Simmons, the Houston banker and energy consultant, on Saudi Arabia’s prospects.
Simmons was completing his book Twilight in the Desert, an examination of hundreds of surveys by engineers working over the previous decades in Saudi Arabia. By analyzing their reports about the reserves in the world’s biggest oil producer, Simmons claimed to have pierced the remarkable wall of secrecy imposed to prevent outsiders discovering whether the Saudi assertion of seemingly limitless oil reserves was true, or whether supplies from the Kingdom would begin to decline. Sensationally, Simmons concluded that Saudi Arabia was going to run out of oil soon. The giant Ghawar field, he wrote, was being filled with water to force the oil toward the surface, proving that the gusher would soon be dribbling. That assertion made Laney Littlejohn incandescent. “Matt doesn’t hear very well,” he commented. “Thirty percent of water is necessary in Ghawar to get pressure, and it’s been like that since the 1970s.” Littlejohn’s message was ignored, as was his successor Carl Calabro’s testimony that “Saudi Arabia says it has 75 years of reserves left,” and Guy Caruso’s that “Saudi Arabia is working towards 75 percent recovery.” Sixty-five percent of the world’s proven reserves — 1.05 trillion barrels of oil — were said to be in the Middle East, but since the Arab oil states regarded the quantity of their reserves as a state secret, even that was uncertain.
Colin Campbell supported Simmons by describing the oil states’ inconsistencies. In 1980, he said, Kuwait had reported reserves of 65 billion barrels. In 1985, having produced over 20 billion barrels, it restated its reserves as 90 billion barrels, and added another two billion in 1987, although no new discoveries of oil had been announced in those seven years. Similarly, Abu Dhabi increased its reserves from 31 billion barrels in 1987 to 92 billion in 1988. In the same two years, Iran increased its reserves from 49 billion barrels to 93 billion; Iraq increased its from 47 billion barrels to 100 billion; and Saudi Arabia would announce that its had increased from 170 billion barrels to 258 billion, again without revealing any new discoveries. The following year, Khalid al-Falih, an Aramco senior vice president, stated that Saudi Arabia possessed 260 billion barrels of provable oil reserves and assumed that a further 100 billion would soon be found, some offshore. The Kingdom, according to al-Falih, had 25 percent of the world’s reserves, and had only used 25 percent of them. Production, he said, would soon rise to 12 million barrels a day. “Peaking won’t happen any time soon,” he concluded.
Campbell suspected that the announcements were phony. The OPEC producers were, he believed, jockeying to increase the amounts they were permitted to sell according to their quotas. But even if the new reserves were accepted, Campbell argued, the Middle East’s maximum oil reserves would have been 696 billion barrels. By subtracting past production of 255 billion barrels, only 441 billion barrels remained. Considering that the world had so far consumed 944 billion barrels and, according to Campbell, 65 different authorities agreed that the world’s total reserves were about 1,930 billion barrels, that meant the world had used 49 percent of its oil, and was about to hit the peak. If the OPEC countries’ suspicious figures were discounted, then the peak had already been passed.
To reconcile the incompatible predictions, a public debate was organized in February 2004 in Washington between Matt Simmons and Mahmoud Abdul-Baqi, the vice president of Aramco’s exploration. Simmons’s challenge was piercing. Abdul-Baqi, he believed, could not prove the Kingdom’s ability to fulfill the EIA’s forecast that it would expand production from 9.95 million barrels a day in 2004 to 13.6 million by 2010, and 19.5 million by 2020.* “The sweep of easy conventional oil is ending,” he said, and future production from Saudi Arabia’s new fields would be “complex.” If Aramco was to disprove his assessment, he challenged Abdul-Baqi, it should be transparent about its reserves and their rate of decline. Without that candor, his forecast of Saudi Arabia’s imminent crisis was undeniable. Abdul-Baqi appeared undaunted. Saudi Arabia, he replied, could currently produce 10 million barrels a day, and could increase that to 15 million until 2054, considerably longer than the EIA’s forecast. “We will continue to deliver for another 70 years at least,” he pledged. Spurred by Chinese demand, the prospect of oil rising to $50, he continued, would encourage Saudi Arabia to immediately increase its production by 3.5 million barrels a day without any problems.
“Simmons is asking all the right questions,” said Nansen Saleri, an Aramco reservoir manager, later that day, “but giving all the wrong answers.” Simmons’s specific technical descriptions, said Saleri, were not a full picture of daily operations in the oilfields but a mere snapshot, ignoring the ability of Aramco’s engineers to solve the problems Simmons had identified. By the end of the day, one irrefutable truth united Simmons and Abdul-Baqi: Saudi Arabia would be unable to permanently produce unlimited quantities of oil. Simmons’s doubts about Aramco’s candor remained. He had persuaded even Saudi Arabia’s sympathizers in the audience to question whether Aramco’s “tired” reserves could cope.
Those firmly unconvinced by Simmons included the chief executives of the oil majors. Lee Raymond did not believe in oil shortages. Contrary to the alarmists’ scenario, he knew the world had become less reliant on oil. Since the 1970s, conservation and oil substitution in the industrialized countries had reduced oil consumption per unit of GDP by 40 percent. China’s surge of demand, ExxonMobil’s planners believed, would prove to be temporary. Rising prices would eventually force the country to limit its consumption. The strategists also knew that the oil market was more complicated than the oil peakists portrayed. Energy was no longer a wholly free market determined by economic forces, but was increasingly political, controlled by governments and foreign policy. Talk about the decline of non-OPEC oil supplies was as unreliable as the uncertainty about the published data describing reserves and decline rates. Reliance on that data fed the pessimism. Production data was the only reliable guide, and that remained healthy.
Nevertheless, a conversation with the billionaire financier T. Boone Pickens during a round of golf at Augusta National in Georgia was retold with relish by Matt Simmons. “Why are you advertising against peak oil?” Lee Raymond was asked by Pickens, an oil peakist. “Because we have very bright people and they don’t believe it,” replied Raymond. “So why haven’t you increased production?” asked Pickens, knowing that ExxonMobil’s reserves had risen 26 percent, from 9.6 billion barrels in 1994 to 12.1 billion in 2004, but production had dropped 2 percent, from 909 million barrels to 893 million in 2003. Pickens pounced on Raymond’s failure to convincingly explain ExxonMobil’s’ flatlining production over the past 10 years. To Pickens and Matt Simmons, Exxon’s stagnation confirmed the end of unlimited oil. Raymond’s reply encouraged Pickens’s speculation in energy, reportedly earning him $1.5 billion in 2005 while promoting the value of wind farms. To prove his conviction, in 2005 Simmons would bet John Tierney, a New York Times columnist, $10,000 that the average daily price for crude in 2010 would be over $200.
Lee Raymond’s refusal to be alarmed by the rising prices was shared by John Browne. Browne had disclosed in March 2004 that for investment decisions, BP was pricing oil at $20, although he believed that the price would rise. With a sense of satisfaction, he announced that BP’s reserves had increased from 8.6 billion barrels in 1997 to 18.2 billion boe in 2004. The corporation’s profits had also increased, by 35 percent in the second quarter and 43 percent in the third. Rather than invest all the profits to discover new oil, he pledged to return $33 billion in cash to shareholders over the following three years. Boosting BP’s share values silenced the doubters. “I think,” said Browne, “that it is not helpful for the world to believe that we are running out of oil, which we are not.” His certainty relied on Peter Davies’s assessment that the world’s unexplored reserves probably amounted to five rather than three trillion barrels, and that high prices
would be temporary. To many, Browne continued to appear a genius. BP had sold its shares in PetroChina, earning $1 billion profit, and he had bought Arco’s and Amoco’s reserves for between $10 and $15 a barrel at a time when prices were hovering around $55. “The best is yet to come,” he boasted. Only a handful judged that the “Sun King” was exaggerating.
CERA, the industry’s authoritative consultants, also contradicted the oil peakists and predicted in early 2005 that oil production could increase to 101.5 million barrels a day by 2010. This contribution by Dan Yergin was condemned by Matt Simmons as “part of the complacency machine.” “Dan Yergin,” said Simmons, “is the ‘Peace in our time’ propagandist, the most dangerous man in our time.” In that cacophony, criticism of Simmons was muted. Few could disagree with Colin Campbell’s observation that the debate had unexpectedly changed. “Just months ago,” he said, “the debate was whether $20 could be held. Now $50 is a floor rather than a ceiling.” Even his critics agreed that the predictions of doom were causing prices to rise. “Simple economics says that this [surge in demand] can’t continue,” commented Oil & Gas. President Bush’s vow to end America’s “addiction to oil” and encourage the switch to renewables added to the atmosphere of peril. Even a CERA researcher spoke of a peak in 2020. The oil economists employed by Saudi Aramco at Box 8000 in Dhahran could only smile. Since 1999 the Saudis had been controlling production, hoping to influence prices. They had never anticipated that a combination of oil peakists and speculators could achieve their goal.
