Another gloomy outlook on production

"In our view, the combination of low oil prices and a global credit crunch will prove rather damaging for the oil industry," the February 3 report authored by the company's commodity team said. An IEA finding that decline rates in its database of field have been 4.2% since 2003 was extrapolated out to a global decline rate of 4.5% by Merrill Lynch, and "these rates..could accelerate further over the next few years."

The report also suggests that non-OPEC production has peaked. "The IEA works under the assumption of oil production decline rates of 4.7% to 2015, expecting an increase in non-OPEC output to 51 million b/d
over the next 7 years," according to the report. "In contrast, in our base case scenario we estimate output
decline rates of 5%, and see non-OPEC oil production stuck in the current 49 to 50 million b/d range in the same period. Should the credit crunch push decline rates to 6%, however, non-OPEC production could decline precipitously toward 47 million b/d by 2015 from the current levels."

It's important to note that there are analysts who believe that what has definitely peaked for awhile is demand. Slower growth rates even post-recession, conservation measures taken during the last price runup, government mandates, etc. will combine to keep demand growth rates less than what agencies like the IEA are predicting, according to this worldview. But if Merrill Lynch and others are correct, that's going to be necessary to keep prices from spiking again.

"Broadly, oil production decline rates are a function of investment rates and the size and age of fields. All these factors point to steeper oil output declines going forward," the report said. "In particular, if the low oil
price, high cost of money environment persists for most of this year and next, our base case scenario for non-OPEC production could prove optimistic."

The report doesn't seem to subscribe to the peak oil theory in the sense of resources not being available. But they come with a price. "The world has used up 1 trillion barrels and there are still 4.5 trillion barrels to go in the ground, but non-OPEC oil does not come cheap," the report said. In Canada, the report reiterated earlier Merrill Lynch projections that a WTI price less than $70/b would "continue to put Canadian oil sands projects at risk," and estimated that $200 billion in oil sands capital spending has been put on the shelf because of the oil price decline.

New output doesn't always come cheaply in OPEC either. For example, the report said deepwater Angolan projects need $60/b to yield a 15% rate of return.