An important part of the equation is absent from the discussion of where oil prices are heading. This missing component is the decline in the now aging super giant oil fields of the world. These fields account for a significant part of world supply.

This story actually begins in 1986 when the price of oil crashed and an industry was largely put into a severe tail spin. As a result, the largest companies began to restructure their companies to survive a long period of surplus capacity. At the same time, they began to sell their U.S. production assets to smaller independent companies that could operate cheaper than the majors. The restructuring of the the major oil companies shifted profit centers to countries that had more favorable tax and regulation policies. During this same time, half the work force employed by the largest companies was replaced by outsourcing. This has continued and has spread to even the smallest companies. Today, many prominent companies have a surprisingly small number of full time employees. This evolution of company structure has led to great flexibility for these companies to shift resources to projects that are seen as having superior profit potential in a changing oil price scenario.

As the price of oil changes, as it always does, the flexibility to shift resources and focus to alternate projects is molding the real value of future oil. This is because both National and private oil companies have the ability to halt projects in a very short time. This is what happened at this last drop in the price of oil below last years highs. It is unprecedented how drilling rigs, and projects were silenced world wide, and virtually overnight. Projects around the world were put in the “suspended indefinitely” category. This leads me to my point. World wide oil production declines at about 5% per year. Normally, rigs are running around the world to replace oil deliverability lost to natural decline.

I believe two things not currently being discussed will significantly influence oil prices during the next 12 months. First, natural decline is not being replaced as it was in the past. Second, the rate of decline will be sharper than it was in the past. This accelerated decline is a story in itself. I expect the largest decline to come from OPEC producers. Since the 1980s, OPEC members were assigned daily production quotas based on reserve studies that determined each member’s total in the ground reserves. The larger the reserves, the more a member country could produce every day. This led to creative accounting in the reserve reports that the Western world mostly took at face value.

Then came 2008. As demand increased, it became apparent that most OPEC nations could not produce 100% of their assigned quotas. This woke us up to the fact that when the global economy begins to grow, supply pressure will greatly influence the price of oil. This is over the longer term. In the short term, the natural decline of aging major oil fields will play a bigger role in the price of oil than is commonly believed or reported. Stark realization of the effects of unrealistic reserve reporting will come when Saudi oil production begins its decline a full 35 years before it is commonly expected. I predict we will see this in the next 5 to 8 years depending on several other factors, such as the degree of transitioning to alternative fuels and global economic activity.

One thing has been consistent over my 30 years of observation, and that is the experts are always wrong. It is a little like a 7 day weather forecast, it does not allow for a change in the wind direction on the 2nd day.