This chapter provides an overview of oil exploration and production and the data that measures these "upstream" activities of the industry. Upstream activities are closer to the source, and "downstream" activities, such as refining and marketing, are closer to the consumer.
Finding oil isn't a single activity. It is a series of steps: identifying a prospect, testing the rock, drilling a well, determining whether the find is commercially viable and estimating the dimensions of the reservoir with further drilling. Production wells are then installed and gathering pipelines are assembled to transport the oil to central points for further shipment.
The upstream sector involves the most investment risk because of the high capital expenditures and great uncertainty that oil will be found. On the other hand, it historically has provided greater rewards in terms of profit and return on investment than other segments of the industry. Recent technological advances have reduced the uncertainties and contributed to the more efficient use of capital, enhancing the industry's success, even in a low-price environment.
What Oil Is and Where It Comes From
According to the most widely accepted theory, oil is composed of compressed hydrocarbons, and was formed millions of years ago in a process that began when aquatic plant and animal remains were covered by layers of sediment -- particles of rock and mineral. Over millions of years of extreme pressure and high temperatures, these particles became the mix of liquid hydrocarbons that we know as oil. Different mixes of plant and animal remains, as well as pressure, heat, and time, have caused hydrocarbons to appear today in a variety of forms: crude oil, a liquid; natural gas, a gas; and coal, a solid. Even diamonds are a form of hydrocarbons.
The word "petroleum" comes from the Latin words petra, or rock, and oleum, oil. Oil is found in reservoirs in sedimentary rock. Tiny pores in the rock allowed the petroleum to seep in. These "reservoir rocks" hold the oil like a sponge, confined by other, non-porous layers that form a "trap." (See illustration.)
The world consists of many regions with different geological features formed as the Earth's crust shifted. Some of these regions have more and larger petroleum traps. In some reservoir rock, the oil is more concentrated in pools, making it easier to extract, while in other reservoirs it is diffused throughout the rock.
The Middle East is a region that exhibits both favorable characteristics -- the petroleum traps are large and numerous, and the reservoir rock holds the oil in substantial pools. This region’s dominance in world oil supply is the clear result (see graph). Other regions, however, also have large oil deposits, even if the oil is more difficult to identify and more expensive to produce. The United States, with its rich oil history, is such a region. Regional roles in oil supply are discussed more fully below.
To identify a prospective site for oil production, companies use a variety of techniques, including core sampling -- physically removing and testing a cross section of the rock -- and seismic testing, where the return vibrations from a man-made shockwave are measured and calibrated. Advances in technology have made huge improvements in seismic testing.
After these exploratory tests, companies must then drill to confirm the presence of oil or gas. A "dry hole" is an unsuccessful well, one where the drilling did not find oil or gas, or not enough to be economically worth producing. A successful well may contain either oil or gas, and often both, because the gas is dissolved in the oil. When gas is present in oil, it is extracted from the liquid at the surface in a process separate from oil production.
Historically, drilling a "wildcat" well -- searching for oil in a field where it had not yet been discovered -- had a low chance of success. Only one out of five wildcat wells found oil or gas. The rest were dry holes. Better information, especially from seismic technology, has improved the success rate to one out of three and, according to some, one in two. Reducing the money wasted on dry holes is one of the aspects of upstream activity that has allowed the industry to find and produce oil at the prices prevailing over much of the 1990's.
After a successful well identifies the presence of oil and/or gas, additional wells are drilled to test the production conditions and determine the boundaries of the reservoir. Finally, production, or "development," wells are put in place, along with tanks, pipelines and gas processing plants, so the oil can be produced, moved to markets and sold. Once extracted, the crude oil must be refined into usable products, as discussed in the chapter on oil refining.
How Oil Is Produced
The naturally occurring pressure in the underground reservoir is an important determinant of whether the reservoir is economically viable or not. The pressure varies with the characteristics of the trap, the reservoir rock and the production history. Most oil, initially, is produced by "natural lift" production methods: the pressure underground is high enough to force the oil to the surface. Reservoirs in the Middle East tend to be long-lived on "natural lift," that is, the reservoir pressure continues over time to be great enough to force the oil out. The underground pressure in older reservoirs, however, eventually dissipates, and oil no longer flows to the surface naturally. It must be pumped out by means of an "artificial lift" -- a pump powered by gas or electricity. The majority of the oil reservoirs in the United States are produced using some kind of artificial lift.
Over time, these "primary" production methods become ineffective, and continued production requires the use of additional "secondary" production methods. One common method uses water to displace oil, using a method called “waterflood,” which forces the oil to the drilled shaft or "wellbore."
Finally, producers may need to turn to "tertiary" or "enhanced" oil recovery methods. These techniques are often centered on increasing the oil's flow characteristics through the use of steam, carbon dioxide and other gases or chemicals. In the United States, primary production methods account for less than 40 percent of the oil produced on a daily basis, secondary methods account for about half, and tertiary recovery the remaining 10 percent.
Both the varying reservoir characteristics and the physical characteristics of the crude oil are important components of the cost of producing oil. These costs can range from as little as $2 per barrel in the Middle East to more than $15 per barrel in some fields in the United States, including capital recovery. It is interesting to note that technological advances in finding and producing oil have made it possible to bring once-expensive deepwater Gulf of Mexico oil into production for less than $10 per barrel.
The Impact of Upstream Technology
Technology's contribution to finding oil is huge. Technology cannot change geology but, by revolutionizing the information available about the features of a geologic structure, it has enhanced the likelihood of finding oil. A primary benefit is the ability to eliminate poor prospects, thus considerably reducing wasted expenditures on dry holes. In addition, drilling and production technologies have made it possible to exploit reservoirs that would formerly have been too costly to put into production and to increase the recovery from existing reservoirs.
Technology also has contributed to making oil exploration and production safer for the industry and for the environment. Offshore production can be operated from onshore, with automatic shutoff systems to minimize the pollution risk. Infrared photography can pinpoint a trajectory of spilled oil, allowing equipment and personnel to be deployed quickly and effectively, thus minimizing damage.
In addition, technology has been responsible for the rejuvenation of offshore exploration that has taken place beyond the Outer Continental Shelf.
The Mideast remains the largest oil-producing region, as shown in the accompanying graphs. Mideast dominance in oil reserves -- the estimated amount of oil that can be produced from known reservoirs -- is even more pronounced: the region holds about two-thirds of the one trillion barrels of global proved oil reserves (graph), so the region's critical role in world oil supply will continue and will grow. (The United States, by contrast, holds only 4 percent of global proved reserves.) Several core developments have shaped the pattern of regional oil production:
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The higher oil prices of the 1970s and early 1980s (graph) afforded a strong economic incentive to explore for and produce oil, and production rose in many areas. At the same time, oil demand declined -- the expected response to the high prices. Saudi Arabia became the "swing supplier," reducing its production as necessary to balance supply and demand. Its rejection of that role in mid-1985 -- its output had fallen to about 25 percent of its 1980 peak -- brought the full force of the supply/demand imbalance onto markets and resulted in the price collapse of 1986. Prices did not return to the pre-1986 level until the Persian Gulf conflict of 1990-91, and then only briefly. When, in 1998, Asian demand faltered with the region’s economies, and northern hemisphere demand faltered with the warm winter, the high production levels resulted in another price collapse. The market reaction in 1998, however, was not the same as in 1986 –- demand did not recover as quickly and supply did not fall as quickly. Hence, the low price period lasted longer and showed lower prices in 1998 than in 1986. In early 2000, oil prices exceeded the levels of the Persian Gulf conflict in nominal terms. Sharp as the price increases were in early 2000, however, crude oil prices remained less than half of the early 1980s peak in terms of real buying power. |
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Saudi Arabia (graph), the market-balancer in the early 1980s, has been the world's largest producer during the 1990s. Not only did Saudi Arabia increase its production to fill the gap left by the loss of Iraqi and Kuwaiti supplies after Iraq invaded Kuwait in 1990, but production declined in the other two large producers, the United States and the Former Soviet Union. |
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Mideast production would have been higher throughout the 1990s if Iraq's production (graph) had not been constrained by the United Nations sanctions imposed after Iraq invaded Kuwait in 1990. The so-called "Humanitarian Oil Sales" have provided Iraq only limited and closely controlled reentry into world oil markets. |
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Mideast production also would have been higher at various times if it had not been for the market-balancing role played with varying degrees of success by the Organization of Petroleum Exporting Countries (OPEC) (use your browser's "Back" button to return to this page). OPEC currently includes Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela. Ecuador and Gabon withdrew their membership at the end of 1992 and 1994, respectively. |
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North America (graph)is the second largest producing area after the Middle East. The United States, the second largest producing country in the world, accounts for almost 60 percent of the North American region’s total. Canada, the United States and Mexico all have long production histories, and production from mature fields has been declining. However, a new surge in technology has benefited both new field development and more complete production from existing fields. |
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North Sea production, off the United Kingdom and Norway, began in the late 1970s. In contrast to predictions from the early 1980s of the imminent decline in the region’s production, the North Sea (graph) has yet to see its peak. The region's success with new exploration and production technology, and hence its continuing volume growth, has been a central factor in world oil markets for a decade. |
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Production in the Soviet Union peaked at about 12 million barrels a day in the early 1980s (graph), when it was the top world oil producer. The region’s demand collapse, in combination with its aggressive production targets set to maintain foreign exchange, masked its rapid production decline in the late 1980s as the Soviet Union broke up. The former Soviet Union has recently been the third-ranked producer, after Saudi Arabia and the United States. One of the most visible new production prospects has been the Caspian Sea in Central Asia, in spite of the enormous logistical and political hurdles involved in getting the oil produced to world markets. (EIA has produced several analyses of these issues. See the links in Guide to Supply.) |
Because the United States is the world's largest importer, as discussed in the chapter on Trade, it is easy to forget that it:
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is the oldest major global oil producer; |
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is formerly the Number 1 global oil producer; |
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is currently the Number 2 global oil producer; |
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has produced more oil, cumulatively, than any other country (180 billion barrels from 1918 to 1999); |
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has produced more oil, cumulatively, than the current reserves of any country but Saudi Arabia. |
Production in the United States has several unusual aspects. One is the private ownership of resource rights. In most major producing countries, the government owns the rights to develop resources. For privately owned property in the United States, the decision to explore for and produce oil is between the landowner and the producing company. The producing company compensates the landowner by the payment of a royalty on each barrel of oil produced. Early in the industry's development, there were few government restrictions. Now, there are overriding rules about well spacing and environmental standards. The only government agency to restrict production volume was the Texas Railroad Commission, which limited production in Texas depending on projected demand and production volumes in other areas of the United States. However, since the early 1970s, there have been no restrictions to production by any government agency.
The private
ownership of resource rights contributes to two other aspects unique to production in the
United States -- the active participation of thousands of independent producers and the
prevalence of the “stripper” well, one producing less than 10 barrels a day. As the industry was developing, many entrepreneurs
with limited capital resources, but a high tolerance for risk, joined its ranks and, in
fact, discovered some of the largest fields in the United States. Most of the time, their finds were less dramatic,
but large enough for a small company to be a success.
The company's success was, of course, the landowner's success as well. Many of the wells never flowed with very high
volume and, as they aged, volume dropped. Nonetheless,
stripper wells are likely to remain in production as long as the price of oil covers the
production cost. They currently account for
about 75 percent of all wells in production in the United States and produce somewhat less
than 900,000 barrels per day, 15 percent of the total U.S. crude oil production.
Just as oil
resources are not evenly distributed around the globe, neither are they evenly distributed
throughout the United States. Given the way
production data are reported, the biggest production region by far is the U.S. Gulf Coast,
and the largest producing state is Texas (graph). The Gulf Coast region is home to two of the most
important producing provinces, the Permian Basin, located inland in West Central Texas and
Eastern New Mexico, and the Federal Offshore portion of the Gulf of Mexico.
Texas has been the largest producing state since the
late 1920s, when it surpassed California. For
a time in the late 1980s, Alaska rivaled Texas, as the more mature Texas fields declined
and production from the giant Alaskan North Slope fields, begun in 1977, was still
approaching its peak level of about 2 million barrels per day. Since that time, however, production from the
Alaskan North Slope has fallen rapidly.
Production
from the Federal offshore, now about equal to
output from the Alaskan North Slope, is limited by policy to California and the western
and central Gulf of Mexico. New production
areas, or “plays,” led to a resurgence in activity in the Gulf of Mexico, the
only area with active new leasing. Leasing, drilling, production and the numbers of fields
under development all set records in 1997, as the deepwater Gulf of Mexico became the
place to be for almost any larger oil company, domestic or foreign. (Links
to additional details and graphics on offshore activity.) These new prospective oil producing areas are
further offshore, in the much more challenging deepwater.
The pace and timing of these deepwater plays, like all other upstream exploration,
were impacted by 1998's low prices.
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To Schematic of a Petroleum Trap |
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To Upstream Technology |
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To Federal Offshore |
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To Reserves and Resources |
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To Guide and Links to Supply Data and Sources |
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To Supply Graphs and Charts |
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To Table of Contents |
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To Next Chapter (Demand) |
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To Map of Petroleum Administration for Defense Districts |