Monday, July 25, 2005

The Enron of OPEC

Recently, I watched a screening of "Enron: The Smartest Guys in the Room," a documentary about the Enron scandal and collapse. But, having just completed Matthew Simmons' "Twilight in the Desert," I couldn't help thinking about the world's largest oil company, Saudi Aramco, the national oil company of Saudi Arabia. In the case of Enron Wall Street analysts were almost unanimously too polite to ask the company to show them one crucial thing: how the company made its money. The analysts admitted that Enron was a "black box" and that they just had to take company revenues and earnings on faith. As long as the stock was rising, few people questioned what was going on at Enron.

Like their Wall Street counterparts, energy analysts seem to regard Saudi Aramco as a "black box" whose claims must be taken on faith. The company frequently says it can reach 15 million barrels per day in oil production and maintain that level for 50 years. The proof they offer: "Trust us!" In fact, there has been virtually no independent information about oil in Saudi Arabia since the early 1980s with one important exception: technical papers on file with the Society of Petroleum Engineers. These papers form the basis of Simmons' book, and they cast considerable doubt on claims by the Saudis that they will be able to sustain continuing high production levels for decades.

In the case of Enron the obfuscation and deception appeared on the surface to be part of a conscious strategy to increase the stock price. That meant 10s of millions of dollars for the top managers who sold out before the company collapsed. What motive could Aramco officials have for deceiving the world about its ability to produce oil? Aramco is not a publicly traded company, and so, greedy managers looking to cash in their stock options is not an explanation. However, Saudi Arabia would surely forfeit its premiere position among the world's oil producers if oil experts suspected that Saudi supplies were about to go into decline.

But, all this assumes a conscious strategy of deception. There may be something more troubling at work. As the Enron documentary illustrated, there were many employees--even in top management--who for a long time believed that the company would succeed. That is, they believed their own hype. Could it be that Saudi Aramco officials believe their own hype? After all, the company has been the world's leading producer of oil and has a reputation for cutting edge technology and talented management. And, it has a chorus of cheerleaders from the outside. Among them is perhaps the world's most well-informed oil supply expert, Thomas Ahlbrandt, the head of the U. S. Geological Survey's World Petroleum Assessment, the most thorough study of worldwide oil supplies ever undertaken. I had a conversation with Ahlbrandt last year. He said he worked in Saudi Arabia extensively as a petroleum geologist before joining the USGS and knew the Saudis well. He believes they have the oil they say they do.

With an endorsement like that why should any of the world's energy analysts doubt Saudi Aramco? And, yet the same phenomenon occurred with Wall Street analysts who almost unanimously agreed that Enron was the next big thing. If so many influential analysts knew that Enron was a sound investment, then there appeared to be no need for the kind of scrutiny that other lesser known companies might require.

Perhaps the most disquieting possibility this analogy points to is the rapid decline of Saudi oil supplies. Saudi Aramco has been using the most advanced recovery techniques in the industry for years. While these techniques have been able to maintain high rates of production, those rates may have come with a cost. In "Twilight in the Desert" Simmons says that the history of other giant oilfields subjected to the latest oil recovery technology--he cites the case of the North Sea oilfields--shows that once decline sets in it can be rapid. North Sea production in the British sector is down more than 30 percent since the peak in 1999.

And, so it was with Enron. When the decline came, it was sudden, catching most of the investment community by surprise. Enron had a huge public following and the confidence of virtually everyone on Wall Street practically right up to the end. It was conventional wisdom that Enron could only get bigger and better.

With Saudi Aramco, is it a case of self-deception or conscious bluff? In fact, it may be a little of both. The company has pulled off heroic feats of production in the past. Perhaps these past successes make Aramco officials and the company's outside cheerleaders believe Aramco can recreate the Saudi oil miracle all over again. But, there must be some conscious bluffing in the company's approach as well. Once Aramco learned that Simmons was writing a book critical of its cornucopian claims, it began a public relations campaign to reassure the world that Aramco can supply a large part of our future petroleum needs. (A recent sample of that campaign can be found here. It has the quality of a political campaign based more on endless repetition than actual information.) But, Aramco has released very little new information in the process of this campaign. The company is essentially reiterating its "trust us" message, albeit dressed up a little more formally. (Large downward reserve revisions by Shell last year have now made "trust us" a less credible message.)

All the Saudis would have to do to refute Simmons and other critics is to release detailed oilfield data and allow independent audits. So far, they have refused, and no one expects them to change their minds.

Draw your own conclusions.

Monday, July 18, 2005

Looking Back to the Peak: A Letter from the Future

The following is a letter written in 2024 to a writer seeking information on the unfolding energy crisis from a newly appointed U. S. member of the hastily formed International Committee on the Energy Emergency.

Dear Robert,

Your question about how the world reached such a crisis in energy is both easy and difficult to answer. The easy answer is that we have been in an energy emergency for more than a decade without even realizing it. We simply mislabeled it as solely an economic problem. The more difficult answer must trace the events of the last 20 years in order to provide the background you will need to understand our current predicament. To that end I decided to put my thoughts into writing since the explanation is a fairly lengthy one.

You will recall that at the beginning of this century a small, but well-informed group of petroleum geologists began to garner increasing public attention with their warnings about world peak oil production. They were aided by oil prices that rose from only $10 a barrel in 1999 to almost $75 at the beginning of 2006. Everyone wanted to know, "What's causing these high prices?"

The usual suspects were trotted out--OPEC, demand from China and India, the oil companies, the government, oil speculators, and a temporary shortage caused by low investment in oil exploration. In this environment the idea that the world was approaching its all-time peak in oil production began to gain some currency. Yet, even after hearing of peak oil, the public remained confused about its significance and unsure which of the many explanations concerning high oil prices they should accept. And, they were further confused by contradictory reports that the world, in fact, had huge and growing reserves of oil, and that therefore, prices would soon decline. While even government and international agencies acknowledged that oil would peak someday, they believed such a peak would not come until the mid 2030s. How mistaken they were!

As prices continued their upward trend, the notion that a genuine energy crisis existed began to take hold. By 2008 world economic growth began to slow as oil prices reached $95 a barrel. This price was a little above oil's all-time inflation-adjusted high. Many commentators were quick to point out that this mattered less than before because the world economy was on average using far less oil per unit of output than in used to. Their explanation, of course, obscured the fact that in absolute terms the world was using oil at its greatest rate ever.

Although the optimists were wrong about the price of oil, they were right about new supplies rising to meet demand--or rather almost meeting it. For even as production rose, demand kept rising faster which, of course, expressed itself in higher prices. But, economists insisted that it was only a matter of time before high prices would be their own undoing as the inevitable new supplies flooded the market.

You'll recall that at the beginning of 2009 a long-simmering concern about Iran's nuclear capability came to a boil. The new American president, who seemed intent on establishing his military bona fides, ordered a surprise air attack on suspected Iranian nuclear installations within days of assuming office. I use the word "surprise," but it many ways it could hardly have been a surprise except for the exact timing. The United States had been making veiled threats about an attack for four years. Perhaps after so many threats without any subsequent action people stopped believing the Americans would actually attack. The Iranians, of course, vehemently denounced the American attacks, but strangely said nothing about how they planned to respond.

Then, oil tankers in the Persian Gulf started to disappear. It was soon clear that the Iranians were sinking them, but the Iranian government said nothing. The Americans responded with more air attacks. By this time, however, all tanker traffic in the gulf had ceased. Oil futures catapulted upward and now traded at about $165 a barrel. The Iranians remained silent even as the Americans vilified them nightly in the press. Across the Arab world, street demonstrations denounced America and its new president while providing the usual scenes of flag burning.

You can imagine what a shock this was to the world economy. At first, there were gas lines everywhere, but then they quickly faded away. People found that they didn't really need to sit in line for gasoline which they could not afford anyway. Prices of everything jumped overnight. All those protestations by learned economists that we were now much less dependent on oil made little difference to actual consumers. They were suddenly hit with a huge reduction in their standard of living. They had to spend a lot more money for energy and that meant they had less money for everything else.

The Americans declared that all shipping in the Persian Gulf would now be protected by the U. S. Navy. The navy arranged to have all oil tankers and other merchant vessels reflagged with the American flag as the United States had done once before during the Iran-Iraq war. Tankers began to move back into the Gulf and prices fell sharply reaching $80 a barrel at one point as traders sold and sold. No sooner had the oil started to move out of the Gulf than a few tankers were again sunk, this time by small boats manned by suicide bombers who had eluded the large navy warships. That shut down tanker traffic for good. Insurance companies refused to cover Persian Gulf-bound tankers, American flag or no.

Oil shot back up to $202 a barrel at one point and then settled at about $180. And, there it stayed week after week. European navies came to help, and the U. S. Navy sent reinforcements to try to stabilize the situation. All of this took several weeks of frantic negotiation and positioning. Perhaps the most important players were the insurance companies which had to be absolutely convinced that no suicide bombers would make it through. Real progress came when the EU and the U. S. agreed to bear the total cost of any bomb-related sinkings. Sailors could only be lured into manning Persian Gulf-bound tankers with quadruple the normal wages and large life insurance packages to protect their families. These wages and insurance packages were heavily subsidized by both governments.

By this time the world economy was careening into a recession. World stock and bond markets were sinking. Efforts by the major central banks to reverse the downtrend only seemed to make it worse as traders worried that all the easy money and credit would only stoke inflation further. If the problem had only been oil prices, perhaps the economic damage could have been limited. But, the U. S. dollar had been in a precarious position for years. Huge dollar holdings by Asian central banks had been the only thing keeping the dollar's value from declining too precipitously. Now, the banks were powerless against traders who simply didn't want to own anything denominated in dollars. Eventually, some smaller Asian central banks in Korea, Singapore and Taiwan began to see that the situation was hopeless. They unloaded their dollar holdings and this spawned a second round of dollar selling. The dollar fell by 35 percent within three weeks. There it stabilized for a few weeks before falling another 20 percent in a second frenzy of selling related to the ongoing debacle in the world markets.

The combination of a slowing world economy, a dollar meltdown and a sudden megaspike in oil prices was simply too much. What had looked to be a bad recession quickly turned into a depression, a highly inflationary one as it turned out. Prices rose 20 and 30 percent on just about everything across the board except for oil products themselves which in many cases doubled. The general price hikes were exacerbated in the United States by the falling dollar. U. S. consumers were seeing prices rise 50 to 60 percent almost overnight.

The worldwide financial crash and the high inflation that accompanied it destroyed the savings of much of the world's middle class. Many rich people also lost considerable wealth. Those rich people, however, did not face the problem that so many others were facing now, namely, how to pay for life's necessities: food, shelter, transportation, heat, and clothing. Only a very narrow group of investors saved their skins with prudent investments in gold bullion and oil-related stocks and trusts. Hedge funds practically disappeared overnight. Even many of those which had bet on the right things were wiped out because they used derivatives--paper promises, really--to do so. After the crash most of the banks and brokerages on the other side of those derivative trades were unable to make good on their losses.

To everyone's surprise within a few months the world economy began to revive somewhat. Oil prices came down all the way to $100 a barrel. (With the dollar halved in value, the real price would have been comparable to about $50.) But, the mild recovery stalled and the oversupply of everything--copper, pulp, steel, autos, new homes, coal, computer chips, manufactured goods of practically every kind--began to weigh on markets. The central banks kept trying to pump up the money supply and make loans easily available, but it was to no effect. Businesses and individuals simply did not have enough confidence to borrow and spend. And, their remaining purchasing power had been badly eroded.

Within a year unemployment in Europe moved to 18 percent. In the United States, official unemployment reached 11 percent, though most believed it was actually double that. China and India were reeling without a plan for the millions of urban industrial workers who had no jobs. The slump resulted in riots in some Chinese and Indian cities, riots that ended with the deaths of many at the hands of both rioters and police.

The 9/11 terror attacks had prompted increasing military action by the United States and Great Britain including the invasion of Iraq in 2003. In the face of a ruined world economy it looked at first as if these military operations might intensify. But, as a confrontation between the United States and North Korea loomed, China occupied North Korea on the pretense of protecting it from an American invasion. In reality, North Korea had become too dangerous even for China. Soon, the North Korean government was replaced by one more to China's liking. The North Korean army was reduced in size and its nuclear weapons dismantled under the watchful eyes of international inspectors. This move seems to have been the one that halted major foreign military operations by the United States and Britain from that time until the present.

On the economic front, protectionist measures were imposed everywhere and helped to cripple the occasional mild recoveries. This was the world in which government economists declared that there was now an oversupply of almost everything including oil. In a very narrow technical sense, they were correct. The marketplace was simply not demanding as much oil as it used to. In addition, the high oil prices of the latter part of the previous decade had led to many energy-saving advances and a move to more efficient hybrid cars and trucks. Some uses, such as heating oil for homes disappeared in many parts of the world. Few people wanted to be held hostage to oil for heat. Much like the early 1980s, oil consumption actually declined even as new supply appeared to be ready to come onto the market.

In the aftermath, one would have thought that investment in alternative energy sources would have been increased. But, those of us who said that this economic downturn was only a temporary reprieve from an oil peak were ignored. Instead, many cash-strapped governments ceased all subsidies for wind, solar, and energy conservation. Several, however, retained their by then sacred subsidies for biofuels, essentially another farm subsidy. Some incentives for nuclear power were rescinded around the world, but existing giveaways to the coal and oil industries in the United States continued.

The oil glut was on.

For almost 10 years the on-again, off-again economic recovery bedeviled countries and their governments. The usual tools of fiscal and monetary management no longer worked as expected. But, even so, economic activity was actually ratcheting up very slowly. In 2019 life seemed to be returning to what people used to call normal. Unemployment had been dropping for two years now in most countries, and there was a whiff of prosperity in some major cities around the world. The following year the world economy began to take off growing by four percent. That growth rate has been exceeded in each of the years leading up to today.

Three years ago oil was only $54 a barrel (barely $18 if adjusted for 2009 dollars). But yesterday it stood at $378 a barrel and, of course, everyone is afraid that we may slide into another long, deep depression as a result.

Now here is the key point. Oil consumption in 2009 reached a little over 95 million barrels per day. It declined to 85 million barrels per day by 2014 where it stalled until 2019. Since then oil consumption has been growing slowly at about 2 percent per year until now when we've reached 94 million barrels per day.

I believe that we will never see 95 million barrels per day. That means the peak in world oil production was in 2009. The events of that year masked this fact and prevented the world from facing up to it squarely. Few preparations have been made for this moment. Yes, we are even more efficient with oil than before, and we've made some strides in deploying alternative energy, especially in Europe. But, in the overall, the world is faced with the same problems we would have faced in 2010 had we not had an economic downturn.

The American and worldwide transportation systems remain woefully dependent on oil-based fuels. Agriculture continues to be drenched in oil derivatives for fuel, pesticides and herbicides. Manufacturing industries need oil to make fibers, petrochemicals, plastics and a myriad of products that we are still all heavily reliant on.

I'm afraid the prosperity that everyone was hoping for is about to be derailed.

With my appointment to the commission I think the president is acknowledging that voices like mine were wrongly ignored. Even in the face of the previous decade and a half of economic hardship, the United States and the world should have been working diligently on alternative fuels and on building new transportation and agricultural systems. Those efforts could have provided employment for many, stimulated the world economy, and helped us to avert today's crisis all at the same time. But the political will was not there. And, it wasn't there because the understanding wasn't there.

Now, we face a gargantuan task. I believe the world is up to it. It will challenge every assumption we have about the way we live--about energy, about work, about government, about war versus cooperation and sharing, about consumption as the primary value.

Robert, your work as a writer will be more important than ever in bringing understanding to all those who must help make the needed changes.

Thanks for your interest in the Committee and especially, for trying to understand how we as a human community came to this point. I hope you also will spend some time exploring how we can make the needed energy transition.

Best wishes and good luck with your article!


William T. Harwood, Ph.D.
Member, International Committee on the Energy Emergency

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Sunday, July 10, 2005

It's the rate of extraction, stupid!

Even if the world suddenly had 10 trillion more barrels of oil in the ground, it might not matter much in the short term. If the maximum possible rate of extraction ended up being something under what we currently consume or what we'd like to consume, we would still be in deep trouble. So, when reports appear that new technologies are going to double the amount of oil we can extract from old wells, the crucial question to ask is not, "How much?" but rather, "How fast?"

True, oil supplies will last longer if these technologies succeed at doing what they promise to do. (Don't let anybody kid you into thinking that we know they will. These technologies have yet to be widely deployed or tested.) But, even if we increase the amount of oil that is ultimately recoverable, we may not solve the real problem. We have a world economy entirely dependent for its growth on ever-increasing rates of oil production. This is the crux of the peak oil problem. It's not that there won't be any more oil; it's that at some point we will not be able to get it out of the ground at the rate we would like. And, of course, worse yet that rate will start to decline even though huge amounts of oil remain. To date we've been extracting the easy, fast-flowing oil. Increasingly, we are going after the hard, slower-flowing oil.

New recovery methods may deliver more oil from wells which had been left for dead. But the rate of flow in the vast majority of cases will be much slower than these wells produced in their prime. Still, if enough old wells are tapped, the overall rate of oil production worldwide may be able to move up for a time based on this alone. But, undergirding this approach there seems to be a hidden assumption that in the long run much of the world's yet-to-be discovered oil will be the fast-flowing kind. This then would allow worldwide production to keep pace with continuously rising demand. But, can we be so sanguine about the fast-flowing characteristics of this as yet unseen petroleum?

There is, of course, a second problem rarely discussed in conjunction with these new recovery methods. They use lots of energy. That means, in essence, that the oil they produce won't come cheap. Higher prices are going to be necessary to justify deploying these methods. And, those higher prices will come only with tight supplies.

If the new recovery methods are wildly successful, they might actually bring down the price of oil for a time. Ironically, this could make those very recovery methods uneconomical and lead to their abandonment. If, on the other hand, they are only moderately successful, they may result in a lengthy plateau in oil production. But, even if the rate of oil production merely plateaus in the medium term, that will mean an end to world economic growth until we find a suitable substitute for oil and deploy it on a broad scale. Such a plateau would certainly be disruptive, but it could also buy us some time to make an energy transition.

As we search for the best way to make that transition, we should be careful not to confuse a palliative (such as new oil recovery methods) with a cure. The only cure for a nonrenewable energy system is a renewable one. The sooner we take our medicine, the better.

(Via Energy Bulletin .)

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Wednesday, July 06, 2005

Be Careful What You Wish For

With the announcement of Sandra Day O'Connor's retirement from the U. S. Supreme Court, right-wing evangelicals have begun to salivate at the prospect of a new, solidly antiabortion justice to replace her. But, they should be careful what they wish for. If the Bush administration ultimately manages to get enough new justices confirmed so that the court will overturn Roe v. Wade, what would be the result?

Evangelicals think that the result would be tough new antiabortion laws in the states and possibly at the federal level. But, in truth, those evangelicals would be playing with fire. Once the principle that the state can control a woman's reproduction is re-established, that control could just as easily be used to limit family size or even prohibit women from having children at all. "Impossible!" you say. "It'll never happen!"

Trouble is, it's already happened--and not just in China where the one-child policy has been China's major tool for stemming population growth. In the United States in the early part of the 20th century many state laws allowed the forced sterilization of the mentally ill, the mentally retarded, the deaf, the blind and others deemed unfit to have children. This was part of the unfortunate eugenics movement which sought to "improve" human populations by preventing so-called "defective" persons from procreating. "Certainly, no one is thinking about this today," you may respond. Probably not.

But, future policy on controlling reproduction may look more like China's than that of the eugenics or the antiabortion movements. Why? We are headed into what some consider a resource challenged future. Energy, water and good soil for growing crops may be in shorter and shorter supply as the world population continues to grow over the next several decades. In fact, the scramble for energy resources, especially oil, is unfolding right now before our eyes. The fight over water and good arable land won't be far behind.

It's not inconceivable that many governments will come to the conclusion that there are too many mouths to feed and that the job of governance would be made easier by slowing down and even reversing population growth. With Roe v. Wade gone, it will be much easier for the U. S. government to limit family size and to enforce such a limit either directly (i.e., through forced abortion and sterilization) or through sizeable financial penalties.

Those who support reproductive rights have always emphasized voluntary measures to control family size for a reason. They know only too well what happens when the state starts making decisions about reproduction. Here's where the law of unintended consequences will most assuredly be felt. Besides abortion, some right-wing evangelicals also oppose the wide dissemination of birth control methods. They regard birth control as an invitation to promiscuity and, in the opinion of a few, a sin against a God who wants us to "be fruitful and multiply." How ironic it would be if the same antiabortion justices favored by many evangelicals ended up paving the way for mandatory population control--possibly including obligatory use of birth control and forced abortion and sterilization. After all, if the government has a right to compel a woman to have a child, it must also have the right to prevent her from having one as well.

Perhaps today such an outcome seems improbable. But, it's impossible to say what future generations will find acceptable when faced with extreme resource and population pressures. Do we really want to find out?

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