Crisis in the Pipeline – AP –

By Daniel Yergin
Wall Street Journal
“The sooner Prudhoe Bay is safely back in operation, the better: A market this tight is very vulnerable to shocks of any kind. The shocks don’t have to be physical. From late March, the price of oil has been primarily driven up not by actual disruption (until Prudhoe Bay); rather, it has been fear of disruption,” writes CERA Chairman Daniel Yergin in the August 9, 2006 edition of the Wall Street Journal.

The abrupt shutdown of the Prudhoe Bay oil field on Alaska’s North Slope adds to the slow-motion supply shock that’s been pushing oil prices up the “wall of worry.” It comes on top of the interruption of production by insurgents in Iraq and Nigeria, continuing production declines in Venezuela since President Hugo Ch├ívez consolidated his rule, and some supply that has yet to come back after last year’s Gulf of Mexico hurricanes.

Add it all up, and about 2.3 million barrels per day of capacity is currently out of commission. Though only about 2.6% of total world capacity, this loss is very significant in a market where the balance between supply and demand is so tight. It exceeds the extra “spare capacity” that is the shock absorber for the oil market.

Unlike what is happening in Nigeria, Iraq and Venezuela, Prudhoe Bay’s troubles are of an engineering nature that can be fixed, perhaps in a matter of months. And despite the recurrent images, the problem is not along the 800-mile Trans-Alaska Pipeline System (TAPS), but in the far smaller network of pipes that gathers crude oil from wells. While challenging, replacing 10 to 22 miles of gathering pipes is not on the same order of difficulty as quelling an insurgency spilling out of the creeks of Nigeria’s Delta region.

Moreover, the reason for the shutdown was precautionary — not an accident, but rather the detection of greater-than-expected corrosion inside the pipes, along with a leakage totaling about five barrels.

* * *

Prudhoe Bay, along with the other subsequently discovered fields on the North Slope, has been a bulwark of U.S. energy supply for several decades. Yet it almost did not get discovered. In the mid-1960s, after a string of dry holes, the explorers were about to give up. But since the drilling rig was still on the slope, and already paid for, they decided to have one last try — and the discovery well came in with a roar on the day after Christmas, 1967.

The next thing was to build the system. But that, too, almost did not happen. Trucks and tractors and pipe were brought up to a staging point on the banks of the Yukon River. And there they stayed, unmoving, for half a decade, as development was held up by environmental objections. The project only got the go-ahead after the tumultuous shock of the 1973 oil embargo. By 1977, oil was moving down the TAPS pipeline.

Prudhoe Bay turned out to be the largest oilfield ever discovered in North America. It proved critical to improving America’s energy position — adding two million barrels per day at the same time that automobile fuel-efficiency standards were saving two million barrels per day. Although Prudhoe Bay’s output — 400,000 barrels per day, out of 860,000 on the entire North Slope — is far lower than it was in the 1980s, the field has been a workhorse. While its proven recoverable reserves were originally estimated at 9.6 billion barrels, output to date has been 11.7 billion barrels, with at least another two billion still to go.

The sooner Prudhoe Bay is safely back in operation, the better: A market this tight is very vulnerable to shocks of any kind. The shocks don’t have to be physical. From late March, the price of oil has been primarily driven up not by actual disruption (until Prudhoe Bay); rather, it has been fear of disruption — arising from anxiety about Iran’s looming showdown with the United Nations over its nuclear program, and about the possible spread of the conflict between Israel and Hezbollah — compounded by the suspicion that the two may not be unconnected. The math in the mind of the market is pretty simple: Iran’s exports of 2.5 million barrels per day are considerably bigger than the current spare capacity in Saudi Arabia and a few other countries. (Still, it should be remembered that the U.S. Strategic Petroleum Reserve, and the strategic stocks held by other governments, are equivalent to almost 600 days of Iranian exports.)

Yet there is another side to the picture, though not one that spells relief any time very soon. Despite fears of “running out” of oil, Cambridge Energy Research Associates’ new analysis of oil-industry activity points to a considerable growth in the capacity to produce oil in the years ahead. Based upon our field-by-field examination of current activity and of 360 new projects that are either underway or very likely, we see capacity growing from its current 89 mbd to 110 mbd by 2015, a 25% increase. A substantial part of this growth reflects the advance of technology, i.e., the rapid growth in “non-traditional” hydrocarbons, such as from very deep offshore waters, Canadian oil sands, and liquids made from natural gas. (We are not counting in this increase the additional supplement that will come from ethanol and other fuels made from plants.)

There are important qualifications, however. First, this is physical capacity to produce, not actual flows, which, as we have seen over the last year, can be disrupted by everything from natural disasters to government decision, to conflict and geopolitical discord. Second, while prices are going up rapidly, so are costs; and shortages of equipment and people can slow things down. Third, greater scale and technical complexity can generate delays. Still, a 25% increase in physical capacity by 2015 is a reasonable expectation, based upon today’s evidence, and that would go a long way to meeting the growing demand from China, India and other motorizing countries.

Admittedly, it may be hard to conceive of this kind of increase when oil prices are climbing the wall of worry, when each new disruption reverberates around the world, when Iranian politicians threaten $100 or $250 oil in the event of sanctions, and when so many geopolitical trends seem so adverse. All this underlines the fact that while the challenges below ground are extensive, the looming uncertainties — and risks — remain above ground.

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