International Perspective, by Marshall Auerback
September 13, 2005
PrudentBear.com
Source"What we all do next will determine how well we meet the energy needs of the entire world in this century and beyond. Demand is soaring like never before. As populations grow and economies take off, millions in the developing world are enjoying the benefits of a lifestyle that requires increasing amounts of energy. In fact, some say that in 20 years the world will consume 40% more oil than it does today. At the same time, many of the world's oil and gas fields are maturing. And new energy discoveries are mainly occurring in places where resources are difficult to extract, physically, economically and even politically. When growing demand meets tighter supplies, the result is more competition for the same resources.
"We can wait until a crisis forces us to do something. Or we can commit to working together, and start by asking the tough questions: How do we meet the energy needs of the developing world and those of industrialized nations? What role will renewables and alternative energies play? What is the best way to protect our environment? How do we accelerate our conservation efforts?"– Advertisement for the Chevron Corporation
As the extraordinary Chevron ad at the top of these pages implicitly concedes, oil is literally the lifeblood of the global economy. All one has to do is gaze outside one’s window on any given day to understand the central role of oil and natural gas in the modern world. The roads are choked with traffic, including enormous trucks transporting goods. Electricity, widely generated from oil and gas, provides light and power, heating and cooling throughout the World, as well as playing a central part in most manufacturing processes. Petrochemicals and plastics are everywhere. The production of food itself is highly energy intensive, oil and gas being required to fuel the tractor, power the irrigation pumps, and transport the produce to market. The populous cities in particular became dependent on distant agricultural trade.
Hence, questions of how much oil we have left have more than passing academic interest. Despite the sharp rise of crude to $70 a barrel last week, and the fact that this is the one commodity which has become an issue of national security, there is still surprisingly little uniformity of views in regard to its long term price prospects or, indeed, the energy complex in general. Broadly speaking, the camps divide into two: on the one side are those who subscribe to the so-called “Peak Oil” hypothesis, which holds that the supply of oil is finite, and that we are in the midst of draining the more than trillion barrels of proven reserves said to be left in the ground. The most prominent spokesmen for this viewpoint are Matthew Simmons and Kenneth Deffeye, both of whom have forecast that global crude oil production is on the verge of a precipitous decline.
By contrast, groups such as Daniel Yergin’s Cambridge Energy Associates (CERA) adhere to a more optimistic view regarding future oil supplies. CERA recently released studies projecting an 18m barrel per day increase in capacity from 2004-2010. The Cambridge view was also echoed in a recent US Department of Energy forecast, which held out the prospect of a 50 per cent increase in world oil production by 2030, largely supported by the major oil companies and others. CERA has made the point that each time forecasts of oil running out have hit the headlines of the major newspapers, these have invariably proved premature. Daniel Yergin himself has made the case that new technologies have consistently facilitated the exploration and exploitation of new sources of oil as prices have gone higher.
In simple terms, “It’s the geologists on one side and the economists on the other,” noted Seth Kleinman of PFC Energy, quoted in a recent article in the New York Times (“On Topic of Oil Supply, Opinions Aren’t Scarce”, Joseph Nocera, NY Times, 10/09/05). There is much to be said for characterizing the debate in these terms. Economists invariably think in terms of supply and demand, arguing that whenever tight supplies have pushed up prices sufficiently, rising prices have both tempered demand and spurred innovation in areas. And they note that “peak oil” exponents have cried wolf many times before.
To be sure, the secular case for higher energy prices is not new: it was mooted some 30 years ago when the first oil price shock occurred. This thesis was associated with a group of futurologists called the Club of Rome and it was laid out in a book entitled “The Limits to Growth”, which noted that commodity supplies had increased ever since the onset of the industrial revolution for two reasons: 1.) the discovery of new lands, and 2) improvements in production technology. These two factors had led to a rate of supply expansion that, ex ante, exceeded the growth in commodity demand at any constant real commodity price. As supply must in the end equal demand, commodity prices had to fall in real terms to clear the market.
Echoing today’s peak oil exponents, the Club of Rome argued that, by the early 1970s, mankind in its search for resources had effectively scoured the globe. The easy-to-produce resources had been found and exploited. The supply of commodities would continue to increase due to technical progress in the production process, but the discovery of new lands would no longer help increase supplies of resources as it had in the past.
In retrospect, the Club’s timing was problematic (to say the least), given the subsequent collapse of oil prices in the 1980s. This would seem to provide strong prima facie support to the Yergin thesis. On the other hand, it is hard to argue against the basic facts of geology. The oil industry has been finding and producing oil for 150 years, and has now learnt a great deal about its occurrence in Nature. In the words of Colin J. Campbell,
“It discovered that oil is derived from algae that proliferated at times of global warming to be preserved in stagnant rifts as the continents moved apart. In fact, the great bulk of the World’s oil comes from just two such epochs about 90 and 150 million years ago. Gas comes from both vegetal remains, as found for example in the deltas of tropical rivers, and ordinary oil where that has been heated excessively on deep burial. Once formed, the oil and gas, being under high pressure, moved upwards through the rocks. Some was dissipated; some escaped at the surface; but some was trapped in geological folds and against faults, where it occurs in the minute pores between the sand grains. Oil in a reservoir is like rising damp in an old wall, save that it moves faster being under high pressure.”The industry, with the help of modern seismic surveys and geochemistry, has now mapped the World’s more prospective areas, and has found almost all of the giant fields within them. New discoveries are helping to offset, but not replace the production of mega-fields, such as Saudi Arabia’s Ghawar and Safaniyah, or Mexico’s Cantarell (PEMEX itself conceded that 2005 is the year that Cantarell will begin an irreversible decline in production. This is set to drop from 2.11 million barrel per day to 2.02 million for this year). What the industry has determined is that when commencing exploration of an area (basin, state, country, etc.), the largest reservoirs are the easiest to find. Total production rises as they are brought into production and exploration for smaller reservoirs continues. Eventually enough small reservoirs cannot be found to offset the declines in production from the large reservoirs as they are depleted. Prices and technology affect the area under the curve – the total amount of oil and gas recovered over time – but not the shape of the curve. It is a process similar to aging and death in living organisms.
So whilst the “Club of Rome” appears egregiously wrong in terms of timing, it is hard to argue with the basic thesis: just as the process of aging and death ultimately supercedes economic determinism, so too it is difficult to see how the “laws” of supply and demand can ultimately overcome the limitations brought about by Mother Nature. Price may indeed ration demand and spur additional exploration, substitutes, or technological alternatives, but the more germane question to pose is where we stand in regard to the oil patch’s “ageing process”.
If one is to believe the thesis expressed by Matthew Simmons in his latest book, “Twilight in the Desert”, Saudi Arabian production will start to decline precipitously as new reserves fail to come on stream to replace rapidly depleting older giant fields. Much of the book is based on Simmons’s review of numerous technical papers published by the Society of Petroleum Engineers, although it is worthwhile noting that these studies largely covered 23 major “problem fields” in Saudi Arabia, but failed to assess the future viability of some additional 62 fields. According to Groppe, Long & Littell, while most of the currently producing fields will invariably yield less crude production, there will be some new production from at least 9 new fields in Saudi Arabia and from new developments in the Neutral Zone, which will somewhat offset declining production of crude (although not completely), whilst condensate and gas liquids will also contribute to supply. To be sure, these fields are far removed from the standards of previously exploited mega-fields, but their future production profiles do suggest a gradual, as opposed to an imminent, sharp decline in Saudi oil production. In terms of total liquids, peak production may well be deferred a few years because of continued growth in the world’s natural gas industry, which will bring with it more production of condensate, natural gas liquids and new liquids from gas-to-liquids projects.
And it is worth noting that any new field – be it in Saudi Arabia, the Caspian Sea, or Canada – all share the characteristic of being expensive to develop: Shell Canada, for example, recently announced that it was going to raise its investment in the Alberta tar sands to $7.3bn from $4bn to produce a mere additional 100,000 barrels a day.
As far as today’s markets go, the Hurricane Katrina-induced spike to $70 oil would have been impossible in the absence of an exceptionally tight supply/demand backdrop. It is also undeniable that the storm has highlighted refining constraints. No new refineries have been built in the United States for some 30 years. But the absence of these refineries implicitly concedes the broader case made by those in the “Peak Oil” camp: after all, why invest billions if the underlying resource to be refined is rapidly depleting in any event? Had the companies retained substantial supply beyond the cheap and easy sources available in the larger mega-fields, they would have had good reason to produce ample refining capacity, before turning to the difficult and costly sources offshore and in hostile environments.
It is also worth noting that economists’ optimistic scenario regarding future oil production rests on the assumption that there will be relative political and labor stability in the Middle East, North West Africa, South America, and Caspian regions. But as recent events have shown, these areas are prone to conflict that disrupts the flow of oil. As the Washington Post's Justin Blum reported last year
(“Terrorists Have Oil Industry in Cross Hairs”):
"Terrorists and insurgents are stepping up attacks on oil and gas operations overseas in an effort to disrupt jittery energy markets, destabilize governments and scare off foreign workers, analysts said. The attacks have been most intense in Iraq, but also have occurred in recent months in Indonesia, Pakistan, India, Russia and Nigeria."More fundamentally, Yergin’s contention that “there is no ‘peak oil’ problem before 2020” largely rests on production forecasts which historically have proven to be overly optimistic. Cambridge Energy Associates’ 2004 production forecasts assumed an 85.68 mmbd capacity, yet none of the production reporting entities in aggregate have come close to approaching this figure. And starting from the wrong number clearly affects projection forecasts for the future.
In addition, the claim that the “proven” reserve base is expanding (a contention recently made by energy economist Michael C. Lynch) needs to be taken with a grain of salt; “proven” versus “probable” reserves involve issues of classification, not changes in aggregate supply. The Securities and Exchange Commission long ago moved to impose strict rules about what could be reported for financial purposes. It established various classifications: Proved Producing Reserves refer to the estimated future production of current wells, whereas Proved Undeveloped Reserves refer to what can be produced by infill wells that have not yet been drilled. As the price of oil increases, it becomes economically feasible to spend more money on production, so it makes perfect sense that oil which could not be classified as “Proven” at $22.00 per barrel can become reclassified in an environment of $60 plus oil. But this does not change the aggregate amount of crude in the ground. All this suggests is that reserves may indeed be a function of price, but not of supply.
Reserve reporting outside the US has also become highly politicized, particularly after OPEC decided to impose quotas on its members based in part on the member states’ reserves. The reporting of such reserves became a vital issue for the country concerned, determining its production level and indirectly its standard of living, which relied heavily on oil revenue. In 1985, Kuwait added 50 per cent to its reserves although nothing particular changed in the oilfields. It transpires that it began reporting the total found, not the reserves left to produce. Three years later, Venezuela doubled its reserves by the inclusion of large amounts of heavy oil, which had been known for many years but not previously counted as reserves. That led other Middle East countries to retaliate with massive overnight increases to protect their quota. In fact, it may have made sense to base quota on the amount found, not the remaining production, to avoid having to perpetually re-negotiate as production changed the relationships. But it also explains why the numbers have barely changed since and illustrates that there are more complex dynamics at work here than the mere supply/demand preoccupations of the economists.
It seems an obvious point to make within this debate, yet seldom does the geopolitics of oil get discussed. As Michael Klare has noted (Blood and Oil, The Dangers and Consequences of America's Growing Dependency on Imported Petroleum”), Iraq has developed into a two-front war: the battles for control over Iraq's cities and the constant struggle to protect its far-flung petroleum infrastructure against sabotage and attack. The first contest has been widely reported in the American press; the second has received far less attention. Similarly, the American military has begun to conduct war games (known as “Oil Shockwave”) to determine what steps the United States could take to mitigate the impact of a significant disruption in overseas production and delivery, such as might be produced by a civil war in Nigeria and a terrorist upsurge in Saudi Arabia. Likewise, “pipeline politics” have been woefully under-covered in the mainstream media, yet they clearly underline US, Russian, Iranian and Chinese diplomacy in Central Asia. Whether one believes that Peak Oil is real or not, it is hard to dispute the notion that the world is behaving as if it were. After all, if future oil supply is so plentiful, then how do the energy bears explain the growing politicization of oil policy and the recurring use of military force to gain control over valuable supplies? Such actions only make sense if the resource is a rapidly depleting one.
A discussion of oil and depletion dynamics invariably becomes highly charged. All policy makers have an incentive to talk down the price of oil because its ongoing rise has increasingly engendered rising global political tension and resource wars of all sorts, as well as proving inconvenient to western consumers, who consider cheap energy to be a God-given right, rather than a once-in-a-generation anomaly. Additionally, the actions of today’s major global players continue to belie optimistic projections that higher prices per se will sort out the long term problems implied by depletion dynamics. Whatever CERA or other oil economists might argue, it is undeniable that both the US and China have already declared that oil is a strategic commodity. And both countries have shown themselves to be increasingly uninhibited in a military sense when it comes to them safeguarding vital energy supplies. If crude continues to rise inexorably, it will be hard to think of this state of affairs as a temporary situation from which we can hope to recover quickly. A higher price will almost certainly have some impact on the supply/demand equation, but the balance of evidence suggests that current existing depletion rates will negate the overall effect of any new additions as well as contributing to further global political instability.