How much smaller? Well, that’s the $64 trillion question that has issues hanging off it such as the price of oil, global warming, peak oil and the exploration paradox.

What’s that you say? You’ve heard of the first three (price, warming and peak) but not the fourth – the paradox.

Allow Slugcatcher to explain. The paradox is all about oil discoveries getting smaller, and oil companies not spending on exploration.

The message then was all about a warning from Art Smith, chairman and chief executive of the US oil industry consultancy, John S Herold, that the “oil model” as we have come to love it, was broken.

According to an interview Art gave to Barron’s magazine, big oil companies have become bankers.

They are far more interested in husbanding their cash hordes, paying dividends and buying back their own stock to enrich their shareholders that they have almost forgotten how to explore.

The world according to Art is heading for a return to oil at $US80 a barrel – and sooner than most of us expect.

The Art of the paradox

Fascinated with Art’s view of the world, The Slug decided to follow up his original comment on the oil paradox by having a chat to the man himself, hunting him down to his office near Memorial Park in the oil world’s headquarters, Houston.

It was during this encounter between a man who really knows it all (Smith), and a casual commentator who thinks he does (The Slug), that the crisis facing world oil became much clearer.

Peak oil, the theory which revolves a belief that we will struggle to pump much more than the current 80 million barrels of oil a day (give or take a million) is creating a perfect storm for big ticket corporate takeovers – because it is combining with the exploration paradox.

Consider these words of wisdom from Art in Houston: “The data [about the paradox] is hard to refute,” he said. “The reserve adds per well drilled, which is based on our analysis of $US200 billion in capital and 60,000 wells, is indicating that reserve size, and reserve additions, are continuing to trend lower.”

Art, helpfully, translates this into simple English: “We’ve creamed the good stuff already.”

Listening to Art is a bit like listening to an expert discussing global warming. Deep down, you know he’s right. On the surface, you’re in denial because everyone in the oil patch lives for the moment when he might make an earthmoving discovery.

These are being made, as The Slug has noted in the past. Chevron’s recent ultra-deep water Jack discovery in the Gulf of Mexico is an example of big finds still being made.

But even an old oil bull must acknowledge that the rate of discovery has declined, as has the average size of discoveries.

It’s this trend – fewer and smaller – which has turned big oil companies from wildcats into pussycats. Quite simply, big oil has become risk-averse.

That, in a nutshell, is the exploration paradox which has become the No. 1 theme in talks given by Smith, and which he explained in detail to The Slug.

“Oil companies are not making the discoveries they expect,” Art said. “Big oil companies have effectively become bankers. Rather than spend money on exploration which is not yielding results, they’re spending money buying their own stock and paying dividends.”

Understanding why this is so probably requires a psychology degree rather than a degree in petroleum engineering because what’s happening in world oil is really quite remarkable – defying even the most basic of human sentiments, the so-called wealth effect.

For oil types who’ve lost touch with their emotional side, the wealth effect is created by a sensation of feeling wealthier, such as how you feel when the value of your house rises. It doesn’t necessarily mean you’ve got a fistful of dollars, but you “feel wealthier” – and people who feel wealthier in the oil game because of high oil prices are supposed to spend more on exploration so they can get wealthier.

But that’s when we return to the problem of the shrinking pool, and Art’s analysis of 60,000 oil wells and goodness knows how many billions of dollars.

“Companies are not finding what their geologists are telling them is down there [and] the last downturn [in the oil price] made them very hesitant to invest capital based on today’s oil pricing,” Art said.

What Art is saying is that we’ve entered a new era in the history oil, and how it works out will be a truly fascinating experience.

On the one hand, we have peak oil (which implies steadily higher oil prices), on the other, we have global warming (which implies a fear of burning oil), and on some other appendage is the oil paradox (higher prices are not generating increased exploration).

Why is this all so?

Obvious, really, and summed up in the opening words of this rant: the oil world is shrinking.

Oil discoveries are getting smaller, as Art’s 60,000 well analysis has demonstrated. Exploration spending is not rising, as would normally be expected. And oil companies are looking for growth by acquisition.

A simplistic explanation of all this is that we are entering a period of ferocious takeover activity as oil companies seek to grow, or just maintain, their oil reserves by buying someone else.

But the long-term result of this corporate cannibalism is that the oil industry itself is in grave danger of shrinking, along with its oil pools.

The price might be high, and the profits fabulous, but the business itself is in serious danger of unstoppable decline.

First published in the March issue of Petroleum magazine