In January, Saudi Aramco announced they had completed a new analysis of the size of their oil reserves. This new report is significant because true size of the Saudi reserves has been a very hot topic since Aramco delayed its plan to IPO last year. We recently authored two blogs on this subject (What is the Real Size of the Saudi Oil Reserves? Part 1 and Part 2) which provided an overview of our own estimates of the reserves.

Dating as far back as the fall of 2017, we have argued that the Aramco IPO would be hindered by the required regulatory disclosure regarding the size of their oil reserves. Aramco’s reserve reports are a closely-held state secret and the last published report dates to 1979. Throughout the 1980s, we believe Aramco reclassified its probable reserves into proved reserves and since then they have held this reported level flat at 260 bn bbl despite having produced over 110 bn bbl during that period. We have long argued that the size of the Saudi reserves is much closer to 160 bn bbl than their stated amount of 260 bn bbl and that this discrepancy would ultimately make a public listing on a major exchange impossible. When Aramco indefinitely postponed their listing in 2018, we took this as a major indication our analysis was correct. Then, in a surprise move in January, Aramco announced that DeGolyer MacNoughton had completed the first new audited reserve report in 40 years, confirming their proved oil reserves were in excess of 263 bn bbl. DeGolyer MacNoughton is a very reputable reserve engineering firm based in Houston whose founding member was actually involved with the original Saudi Arabian oil surveys in the 1940s.

While the reserve report is a major announcement from Aramco, it invites as many questions as it answers. Until the full report is released (and it remains unclear that it ever will be), we cannot answer the crucial question surrounding reserve reconciliation: How was Aramco able to increase its reserves over the last thirty years despite having produced over 100 bn bbl during that time? Without access to the full audited reserve report, it is impossible to say for certain. In the meantime, we can speculate.

Intuitively, the two sources of reserve additions are new field discoveries and improved recovery factors from existing fields. The last major fields to be put into production in the Kingdom were the Khurais and Manifa fields, both of which were discovered in the 1950s – the last era of major new discoveries. Since then, both the size and number of new field discoveries have slowed sharply. While it is possible that a major new discovery was made over the last thirty years, the likelihood (and strategic motivation by Aramco) that this occurred without anyone finding out is extremely low. Instead, any new field discoveries have likely come from small oil pools. Some statistical techniques can be used to estimate additional “undiscovered” oil resources. Although we will not go into them in detail here, several industry papers from thirty years ago have alluded to 30 bn bbl of total undiscovered oil resources, mainly coming from a multitude of smaller pools. The other source of reserve additions is improved recovery factors. Back in 1979, total Saudi Arabian oil-in-place figures were approximately 530 bn barrels (a number which appears in various reports many times). At the time, proved reserves were pegged at 110 bn bbl suggesting a recovery factor of 20%. At the time, this figure was in line with both the US average recovery factor of 23% and consistent with the assumed limit of a field producing from solution-gas drive. Since then, secondary recovery (in which water is injected into the reservoir) and tertiary recovery (in which gas is injected into the reservoir) have steadily increased recovery factors. Based on the latest technology, 70-80% recovery factors are possible under ideal situations using both secondary and tertiary recovery techniques.

Using the 530 bn bbl original oil-in-place figure as a starting point and adding 30 bn bbl of additional resource from recent small-field discoveries results in 560 bn bbl of original oil in place. Given that Saudi Arabia has produced 160 bn bbl from its fields and still has 270 bn bbl remaining, suggests that a total of 430 bn bbl of the 560 bn bbl original oil in place will be produced, implying a recovery factor of 77%. In other words, absent a major new field discovery, it seems unlikely that the Saudi reserve figures will be able to overcome field depletion going forward.

In our last quarterly letter, we profiled Dr. King Hubbert, a Shell geologist whose prediction in 1956 that US conventional oil production would peak in 1970 (which it then did) made him famous. His analysis, although very controversial, suggests that a hydrocarbon system will experience peak production when 50% of its recoverable reserves have been produced. Our analysis, as of today, suggests Saudi Arabia has produced 160 bn bbl of its 430 bn bbl of ultimate recoverable reserves, or nearly 40%. If Saudi Arabia produces at 10.5 mm b/d, it would hit the 50% mark in approximately 14 years. After this point, according to the Hubbert curve, production would enter its period of structural decline. We should point out that Aramco’s full reserve report has not yet been released and, on the surface, seems to be very optimistic. Peak production could likely occur sooner. However, even taking the headline at face value suggests that recovery factors are likely approaching industry-record levels. With these most optimistic assumptions, we appear to be quickly approaching the 50% level in produced recoverable reserves after which it will be increasingly difficult (and expensive) for Aramco to maintain production. We provide this analysis as a “best case” bookend scenario and would like to stress that, until we see the full reserve report, we feel that the risk to the proved reserve number is to the downside, with bullish consequences for world oil markets.

This blog contains excerpts of our in-depth commentary “OIL BULL MARKETS PAST & PRESENT, AND YELLOW JACKETS”.  If you are interested in this subject, we encourage you to download the full commentary here.