Monday, October 25, 2004

Do high oil prices foreshadow a deeper crisis?

Beneath the current chatter about rising oil prices a little known debate among geologists, economists and energy analysts is highlighting a startling question: Could world oil production be close to peaking, not just temporarily, but for all time?

If so, further dramatic price rises lie ahead--possibly within a year or two, but almost surely within the next decade according to some experts.

Not even these pessimists believe the world will run out of oil any time soon. The key issue is whether due to geological constraints the world is near or at its maximum production level. If this assumption proves correct, rising oil demand will collide with falling oil production and initiate an era of permanent shortages.

The consensus view among economists, geologists and energy analysts, however, is just the opposite. The consensus thinkers believe that large oil discoveries lay ahead and that new technology for finding and extracting oil will keep the world awash in petroleum for decades to come.

While predictions about peak world oil production have been around since the mid-1970s, the recent run-up in prices has sparked new interest in dissenting views about oil's future. A small, but growing group of oil geologists and academics has been expanding on the work of M. King Hubbert, a Shell Oil Company geophysicist. In 1956 Hubbert predicted that oil production in the continental United States would peak around 1970 and thereafter decline. He was widely ridiculed at the time, but he proved correct. Oil production from the lower 48 states continues to decline to this day.

Hubbert's basic idea was that because oil is a finite resource, its production rises in a bell-shaped curve, reaches a maximum, and thereafter begins a gradual decline. The pessimists have applied Hubbert's model to world oil production and come up with peaks that range from 2005 to 2020. With energy needs continuing to expand worldwide, especially in rapidly growing countries such as China and India, demand for petroleum is now rising swiftly. If world supplies were to shrink, something would have to give and that something would be price.

At current prices oil is still relatively cheap, according to Douglas Reynolds, associate professor of oil and energy economics at the University of Alaska-Fairbanks. It would have to reach $70 to $80 a barrel just to match its inflation-adjusted price during the last oil shock in 1979. When the peak does occur--something Reynolds expects between now and 2015--prices will likely reach between $150 to $300 a barrel.

The exact date for a peak is impossible to pin down because it depends on economic growth rates, recessions (which lower demand temporarily), imprecise oil resource estimates and possible additional large discoveries which might push back the peak.

"It'll be years before we can look back and say whether it happened," says David Goodstein, vice provost and professor of physics at the California Institute of Technology. But, "unlike the first shock in 1973, it won't be temporary," explains Goodstein who recently published "Out of Gas: The End of the Age of Oil."

For this reason, he counsels, "we ought to give ourselves the best head start we can." With bold political leadership and public resolve he believes the world could kick its fossil fuel habit within a decade or two. "If we're very fortunate, the worst (we'll experience) will be continuously rising prices, not panic," he says.

Matthew Simmons, chairman of Simmons & Company International, a Houston investment bank specializing in energy, says warning signs are already flashing. Some 70 percent of all current oil production comes from fields discovered over 30 years ago. Oil is now depleting at rates faster than new discoveries can replace it. Costs for finding new oil are rising as well. "The days of the easy stuff disappeared long ago," Simmons says.

Simmons is technically correct according to a report compiled by IHG Energy, a division of the global energy consulting firm IHG Group. But, he leaves out growth from additions to reserves, which expand as additional work is done on existing fields and technology makes more of the oil extractable. When both new discoveries and reserve additions are counted, the oil industry continues to replace all its depleted reserves, the IHG report says.

Peak oil theorists counter that peak oil production always follows peak discovery and that world oil discoveries peaked in the 1960s. Simmons disputes the notion that new technologies will expand the pool of recoverable oil by very much in the future. He says these technologies are already widely used and any effect they've had on reserves is in the past. Now, all those technologies act like extra straws in the same glass, drawing down oil resources more quickly without increasing their recoverable size.

Because oil deposits are never 100 percent recoverable for both economic and geological reasons, the effect of technology on recovery rates is critical to the debate. "Recovery factors could double using 'smart well' technology," according to Thomas Ahlbrandt, World Energy Project Chief at the U. S. Geological Survey (USGS). ("Smart well" is a generic term applied to a wide array of technologies used to enhance oil recovery.) Ahlbrandt led a team which evaluated world oil and gas resources in the late 1990s, an assessment that is continuing and expanding.

How much oil the world has left depends on how much it had to start with. Ahlbrandt's team believes the earth had an endowment of 3 trillion barrels of oil. (The team also came up with a low estimate of 2.2 trillion and a high estimate of 3.9 trillion.) The pessimists often put the earth's total oil resource near 2 trillion barrels.

The total amount of crude oil consumed through 2003 is about 900 billion barrels. The world consumed almost 29 billion barrels of oil last year and is set to consume more this year. The U. S. Energy Information Administration (EIA) expects demand to grow to more than 43 billion barrels a year by 2025.

While the USGS makes no formal projections about peak oil production, Ahlbrandt points to the work of EIA analysts who used the USGS numbers to construct 12 different scenarios for peak oil production ranging from 2021 to 2112. (The 2112 scenario assumes the highest estimate of oil resources and absolutely no world economic growth between now and then.) The most likely scenario calls for a peak in 2037. (Story continues below.)

No Longer a Question of 'If'

The Pessimists' Timeline
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Source: Hubbert Peak of Oil Production Website

Three More Optimistic Scenarios
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The USGS survey did not include non-conventional sources such as tar sands which in Canada alone may hold more oil than Saudi Arabia. But, the difficulty of extracting the oil makes it much more costly to produce than conventional oil. Since so much energy is involved in the extraction process, the costs of extraction rise when energy prices go up.

Ahlbrandt says that extensive deposits of new oil are likely to be found in the Arctic, especially northeast Greenland, and offshore in the South Atlantic. He admits that in the case of Greenland significant technical hurdles would have to be overcome.

He also points out that 80 percent of all the oil wells ever drilled have been drilled in the United States. When Hubbert did his work on U. S. production, Ahlbrandt explains, he was dealing with a very mature set of oil fields about which much was known. He says compared to the United States the rest of the world has barely been explored, and this is part of why he believes many large deposits are yet to be discovered.

Still, the pessimists remain unconvinced and even alarmed by current indicators. "I don't buy that we haven't found the biggest fields yet," Reynolds says. After all, he adds, "if (a field) is that big, it's pretty darn easy to find. It's not like it's hiding behind the moon."

Beyond this Russia has said it is now pumping at full capacity. In addition, The New York Times reported earlier this year that advanced oil recovery techniques may not be delivering as promised, citing a precipitous drop in production from a major field in Oman even after the techniques were applied. Also in question, the Times reported in a separate story, is the ability of Saudi Arabia, the world's largest oil exporter, to produce more than it already does.

"If this is true, then we're at the peak," says Simmons.

Simmons has been seeking additional data from Saudi Aramco, the Saudi national oil company. But recent releases of information from the company haven't satisfied him that it can significantly increase production to supply the growing needs of the world.

Ahlbrandt, who previously worked as an oil company geologist in Saudi Arabia and who knows Saudi oil officials well, says he's comfortable with Saudi Aramco's reassurances and believes that Saudi Arabia has vast oil deposits yet to be developed.

Reynolds says that may not matter much for reasons that have nothing to do with geology or oil reserves. His work has shown that large state oil companies such as Saudi Aramco and Mexico's PEMEX tend to be risk averse. The governments that own them are more interested in having a consistent stream of profits to pay for various government expenditures than making heavy investments in exploration that might fail to produce results.

Reynolds now puts Russian oil companies in this category since the Russian government has made it clear that transferring ownership of Russian oil assets to foreigners won't be tolerated. He expects the Russian government to take tighter control of its domestic oil industry through taxation and backdoor moves at nationalization that might include taking control of a company for failure to pay taxes.

That means governments of the world's top two oil exporters and a third very important one may delay investment in oil exploration in order to fund more government spending, Reynolds says. Perversely, higher prices may make it even more likely that the state-controlled companies will do this. Saudi Arabia, Russia and Mexico may figure that bringing a lot more oil onto the market will only drive prices down, penalizing them for their investments.

Reynolds contends that this behavior among three big exporters will likely push the date of peak oil production forward. But, it will also make production declines on the other side of the peak less dramatic as the oil that has been held back is finally brought into production.

He added that even if the USGS numbers are too low and the world's total oil resource is twice the mean estimate--that is, 6 trillion barrels--this would only push the peak back by perhaps another 10 years, still not a lot of extra time to make a transition to alternate fuels.

Both sides of the debate agree that oil is not a limitless resource and that someday the world will have to wean itself from its oil habit. But, there's a lot riding on whether that day is close at hand or whether it lies comfortably in the future.

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matt said...

3 more optimistic scenarios from the EIA: 2037 etc.

Why are they optimistic? These are real doomsday scenarios. Decline rates after these late peaks (if oil geologically realistic) are so steep no economy can survive these production crahses. These scenarios are therefore not even desirable. Moreover, the continuously growing oil production would result in more oil dependent physical structures which would be unsupportable after the peak.

HoosierDaddy said...

From the political standpoint, they are optimistic in the sense that it will be someone elses's problem when it finally happens.

Most of the folks in charge will be gone in 30-40 years so they don't care. In order to deal with this issue you have to sell 20+ years of hardship as folks are moved and transportation and industry is retooled. Most elected leaders are thinking of the future in 4-8 year increments and even the command economies aren't that farsighted.