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Energy Insights:81: Oil crisis on horizon

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81: Oil crisis on horizon


by Andrew E. Title


At “Oil Prices, Oil Peaks, and the Gulf Crisis”, a roundtable sponsored by The Nixon Center yesterday, three experts discussed the future of global oil markets, their implications for the United States and the current geopolitical situation in the Gulf. The panelists—all of PFC Energy, a leading industry consulting firm—included its Chairman and Founder J. Robinson West, the Manager of Market Intelligence Services David Kirsch and the Senior Director of Markets and Country Strategies Group Raad Alkadiri. Geoffrey Kemp, director of regional strategic programs at The Nixon Center, served as moderator.

Kemp started off the event by recalling a time when many worried about “the strategic consequences of falling oil prices” in the wake of the Asian Financial Crisis, when prices were around $10 a barrel. Today, he noted, the situation is “exactly the opposite.” To get a “handle on the fundamentals”, Kemp asked the panelists to distinguish short- and long-term “trends both in the oil industry and in the geopolitics of the various regions of the world, particularly the Gulf.”

First to speak was West, who focused on the long-term picture and asserted that the current state of world oil markets is significantly “different than it was in the 70s and early 80s.” After a large number of resource nationalizations in the 1960s and the formation of the Organization of the Petroleum Exporting Countries (OPEC) in 1961, West said, major oil companies were pushed out of “low cost areas” like Venezuela and the Middle East to places where extraction costs were higher; they were buoyed by high demand. But when global thirst for oil leveled off, prices crashed, leading to massive cuts. The end result of this “tectonic” shift was that “national oil companies now controlled over 80 percent of the resources.”

While it is en vogue to say that global oil supplies will soon run dry, West maintained that “the world is not running out of oil. . . .The problem is the world is running out of oil production capacity.” He argued that low or stagnant production in places like Mexico, Venezuela and Iran is due to domination by national oil monopolies, which are often “unwilling or unable to develop the resources themselves.”

Yet another factor straining global markets is “enormous” growth in demand. In the United States, West said, “cheap land, cheap credit, cheap roads and cheap energy” have over the past 25 years spurred suburban sprawl. As a result, cars (and thus oil) are now a necessity for many in the country—and demand for gasoline has indeed been highly inelastic, even as prices rise to around three dollars a gallon.

West predicted that as the Chinese economy grows, so too will its demand for cars and gasoline, serving only to exacerbate the problem. Putting current world oil production at about 82 million barrels a day and placing world capacity at about 18 million barrels more, he wondered when demand would exceed this point. West mentioned two dates—five years from now, and 2020—but treated this scenario as inevitable, despairing over “the geopolitical ramifications.” Indeed, while describing global warming as a serious problem, West argued that the impending supply-demand crisis is more urgent: “The fact of the matter is, there’s a high probability that there’s going to be a production crunch . . . before Bangladesh gets flooded.” Questioning the will of leaders to make the tough choices required to solve these two issues, he spoke of a “massive wreck on the freeway” ahead.

The conversation then turned to shorter-term issues, as David Kirsch talked about the state of the market and pricing. Pronouncing “OPEC . . . once again relevant”, he stated that the cartel of oil producers “just cannot produce” enough oil for a voracious market. This comes after the prospect of a glut led OPEC to lower production by 1.2 million barrels a day in October 2006, when the price fell to about $60 per barrel. This indicates “active market management” by OPEC—very tight control of production.

Like West, Kirsch said the structure of today’s petroleum market was very different from past ones. Oil is now seen as an investment, he said, not just a physical commodity. Pension funds, hedge funds, and other players from the “paper markets” are now major factors. This has brought “a lot of stability” to the market and is making OPEC members less concerned with the supply and demand for physical oil and more interested in financial markets—West related a story of Abu Dhabi leaders more concerned with interest rates than oil prices.

Last to speak was Raad Alkadiri, who focused on the political and economic situation in the Gulf countries. He identified a “set of new dynamics” resulting from high oil prices at play in the Gulf Cooperation Council (GCC) states: Saudi Arabia, Qatar, the United Arab Emirates, Kuwait, Bahrain and Oman. For example, Riyadh now has the third-largest cash reserves in the world. North African countries have benefited as well: Algeria and Libya, formerly debtor nations, have surpluses of $17 to 20 billion and $15 billion, resulting in greater political and economic leverage for their governments.

Alkadiri also talked about the “happy story” of what GCC countries are doing with the cash. Many are pursuing “economic diversification” so they are less dependent on the energy sector, investing oil profits and tackling the “one key issue” in the region: job creation.

The picture is not entirely rosy, however: Alkadiri reported that clients are extremely worried about regional trouble spots. One is Iran, where a possible conflict could have a disastrous effect on the oil market. This led him to counsel against strengthening sanctions against Tehran, which he said would damage both the U.S. and Iranian economies. Kirsch agreed, saying that a war in the Gulf would likely lead to an average oil price of $150 per barrel and “trigger a global recession.”

Another concern is Iraq. Alkadiri served with the British delegation to that country from 2003 to 2004, and his was a decidedly pessimistic view of the situation in Baghdad. Focusing on the debate over the division of hydrocarbon revenues, Alkadiri argued that the lack of political reconciliation and a “collapsing” central government in post-surge Iraq are the central issues. He called the parties “too parochial” to compromise; at one point he said factional leaders were “too well-protected” in Green Zone, allowing them to follow destructive policies at “no cost to themselves.” As long as a settlement of differences is elusive, he said, investment in the energy sector will remain risky.

Asked about possible solutions for averting crisis in the question and answer session, West responded he only sees politicians who “haven’t a clue” searching for “pain-free solutions”—and thus looking for ways to increase supply. He criticized current alternative energy research programs as wasteful. Ethanol’s inefficiency, he said, made it more of a “vast agricultural subsidy program” than a genuine energy policy.

The other option is to reduce demand, West said, “but that involves pain”—and the United States has failed in this respect as well. The size of cars, for example, has only grown in recent years. This led West to make a sobering prediction: Only the “massive economic dislocation” caused by an oil shortage will induce American leaders to find alternatives to petroleum and make the tough choices necessary to curb demand.


Andrew E. Title is an apprentice editor at The National Interest.

Offshore Energy

Waking up to the truths of oil’s past, present and future

Parts of Baku are now toxic wasteland

THE makers of A Crude Awakening mince their words only slightly, describing their investigation of the peak oil phenomenon as “a naïve quest to examine the world’s dependency on fossil fuels” and the results as “a bit of a downer”.

But Basil Gelpke and Ray McCormack have the look of film makers who have heard all the questions before — and answered most of them — in the three years since they completed the film. But installed in a modish glass room in a London advertising agency they give every impression of being as enthusiastic about their project now as they were then.

Completed on and off as time and money allowed, the film has graduated from festival competition and critical acclaim to mainstream media interest. In the last few days they have had “everyone from The Sun and the Financial Times, to Power Engineer and the Mail on Sunday” in front of them.

Still clearly enthused about their subject, they talk over the themes of the film and the topics they only touch on: what happens next for the world and hydrocarbon man?

They also make it clear that their film contains no hard answers, merely that they have made a film that is the result of research rather than their own preconceptions, which is about as evasive as you can get while remaining engaged with the subject.

“The aim was to get people talking about the issue,” says Gelpke. “Of course if we had known when we started this three years ago that oil prices would triple, we would have put the money we spent making the film into buying oil futures.” It’s a reflection, he says, that documentary makers don’t do it for money, but for glory.

Most professionals in energy shipping will be aware of the concept of peak oil and the flurry of books forecasting the twilight of civilisation that will follow the end of the era of hydrocarbons.

Gelpke and McCormack’s film adds a little more to the pot of knowledge about the past and present and hints at the doom-laden scenario to come. But this is an admirably intelligent film — moreAn Inconvenient TruththanFahrenheit 9/11, lighter on the polemic, longer on information, albeit with an ear for soundbite.

“The business community is now interested, so that suggests that something will happen,” says McCormack. They first came across the story in a hedge fund analysis note, but even before they had finished the film investment funds and investment banks were requesting screenings for staff.

Despite its downbeat predictions, Gelpke denies that they were attracted by the chance to preach the apocalypse. “I don’t think its a political film at all. It has political implications, but to me the important thing is that it’s a film about geology.”

The film includes little input from the oil majors themselves but McCormack while admitting they didn’t always push too hard, says there are individuals they would have liked to be involved. “A couple of people we asked never said yes and never said no, but we weren’t doing a Michael Moore. We weren’t going to doorstep them with a camera on our shoulders. The film was never meant to point the finger at oil companies which are providing a valuable resource — at what has been until recently very reasonable prices.”

Rather, he says, they wanted to draw attention to consumption and how wasteful we are. “We felt we probably wouldn’t hear anything we didn’t already know. These guys’ positions have been repeated in the last couple of years. More interesting were the people who had moved on to think-tanks academia or retired and had less obligation to shareholders to toe the line.”

That included giving a former secretary general of Organisation of the Petroleum Exporting Countries the opportunity to say what he really thought, “and some other people took that opportunity”.

The film appears unashamedly aimed at curing ignorance among the majority of US consumers that they are paying far below the real price for oil and that declining prosperity will go hand-in-hand with its disappearance.

That is an easy tale to tell since the US’ own oil rush provides an encapsulated lesson in what happens when commodities are treated as if they are inexhaustible.

But they say the need for a wake-up call has declined in North America since the film was made. “People in America like conspiracy theories,” remarks Gelpke. “But a lot of people there realise instinctively how much they depend on oil. In many ways they are more vulnerable.”

McCormack picks up the theme. “In the US they struggle to a greater degree that we do here. Life is more competitive and when gas goes up by a dollar a gallon that’s tough when you’re driving 150 miles a day to a McJob.”

In the film, Republican congressman Roscoe Bartlett says that “not one in 100 people are aware of the scale of the problem”, and McCormack believes that was true three years ago. “Now we have 700 people in Toronto turning up at midnight on a Wednesday to see it,” he says. “Rental demand on Netflix has been incredible.”

Key contributor David Goodstein, from the California Institute of Technology, suggests that the growing realisation of oil dependence in the US will result in repeats of the Iraq invasion. But Gelpke and McCormack think consumers are primarily interested in the effect on their pocket. “I was there when gas went over $3 a gallon and it made the headlines,” says Gelpke. McCormack agrees there is “virtually no taxation on fuel, it is indirectly subsidised and the public don’t realise that”.

It’s not as if Americans shouldn’t be aware — mass oil consumption is a product of the American century and the green revolution that allowed increasing food production to feed an increased population. But the US is not the only territory with the ghost of an oil industry. Baku fed the modernisation of Soviet Russia and is now a rusting, toxic wasteland. Lake Maracaibo in Venezuela looks little better.

The US even had its own storm crow in M King Hubbert, who in 1956 predicted that US crude production would peak in the late 1960s to the early 1970s. Derided at the time, he was lauded when the prediction came true in 1970 and was accepted officially in 1975. In 1974, he predicted that global oil production would peak in 1995.

So have the warning signs been ignored? Experts including consultant Colin Campbell, former Opec secretary general Fadhil Chalabi and Matt Simmons, suggest that the inflation of reserves by the main producer countries is to blame, since high reserves mean a bigger Opec quota. But it also means that those countries have become prisoners of their budgets.

Thus, the world has sleepwalked into a new energy crisis by refusing to accept that replaceable reserves must be dwindling as consumption increases. McCormack thinks that concern at this, rather than adopting a purely political position, is the right response. “It’s such important substance and you get the feeling that no-one is keeping an eye on our consumption levels. Everyone has their ‘peak oil’ moment when they hear someone discussing the subject intelligently, but the question is what happens when demand overtakes supply. What happens next? That is the real question.”

Agreeing that global oil consumption figures are “more or less out there” the fact that the IEA predicts the future based on the past suggests things will change dramatically when the price goes up in earnest.

The fact that crude is being extracted from oil sands should be enough to demonstrate that the era of cheap oil is over. Next year the UK becomes a net importer and North Sea oil will be exhausted by 2030. Consumption growth demand from the countries that more of less sat out the 20th century as oil consumers, goes far beyond the protection potential of known reserves.

This leads in two directions — the hunt for alternatives and securing access to the remainder.

The outlook for the former is not good and the latter is little better. The hydrogen economy promises much, but currently consumes more energy than it produces. Ethanol, thanks to its inefficiency, is no better. Replacing hydrocarbon power generation with nuclear might require the equivalent of 10,000 power stations, exhausting global uranium deposits in 20 years. Solar and tidal power appear the only alternatives, but depend on huge advances in technology to generate power consistently.

McCormack suggests that “the foremost thing we can do is increase energy efficiency in certain parts of the world — the US in particular. We can do an awful lot more”, he says.

Gelpke agrees. “What is worrying is how dependent food production is on cheap oil and that one calorie of food output equals 10 calories of hydrocarbon input. That’s pretty worrying”. Part of what happens next is coal — the environmentalists’ nightmare since it is abundant and relatively cheap. For all the talk of China’s growing oil demand, its industrial revolution is a coal-fired one.

“The question that gets us into trouble is coal, because it is not the energy of choice,” says Gelpke.

The film suggests that with the average US car consuming 10 miles per gallon, the price of petrol should be something like $75 a gallon if drastic energy-saving measures are going to work. Serious queues at the pumps — for which America had a dry run in 1973 — will be the norm in 10 years or less.

The looming fear is of “decade-long resource wars” and a reckoning with the Middle East. Having traded protection for energy with its proxies and allies since the end of the Second World War, the US might in future not limit its intervention to rogue states, but rather step in as necessary to guarantee the flow of remaining oil by taking direct control in its client states.

If the viewer hasn’t experienced a downer yet, then the closing predictions might: the end of oil will cause a seizing of the global economy so severe as to create a depression at least as serious as that in the US in the 1930s, but on a global scale, potentially cutting the global population to 1.5bn-2bn.

Prices will rise to and stick at unheard of levels so that consumers will begin to see the conveniences of their modern lives replaced by the realties of the post-hydrocarbon economy.

For many, that seems a long way away. But Gelpke and McCormack leave me with two final thoughts — that the latest estimates predict a steeper fall-off from peak production than was previously thought and that the decline of the world’s most important resource coincides with the industrialisation of the world’s two most populous countries. Just the former would be bad enough, but the interdependence of the two creates a far greater long-term problem, and despite his upbeat approach Gelpke can’t help admitting “that’s what worries me most”.



Written by Tom Whipple   
Thursday, 20 September 2007

It has been a busy week on the peak oil front. On Monday, former U.S. Secretary of Energy and Defense, James Schlesinger told the world peak oil meeting in Ireland that, indeed, imminent peak oil is for real and we should get on with doing something about it. On Tuesday, the Federal Reserve cut interest rates by half a percent, thereby driving oil prices to an all-time high above $82 a barrel. On Wednesday, the stocks report disclosed an unexpectedly large drop in U.S. crude inventories and, finally, a tropical storm may thrash around in the Gulf oil fields this weekend.

Unless the storm turns out to be a really bad one, the most important development of the week is the further decline in U.S. crude oil stockpiles by 3.8 million barrels. Although U.S. stockpiles are still above average for this time of year, they have been falling rapidly since last May. Most ominously, U.S. crude imports for the last four weeks have averaged 750,000 barrels per day less than last year. Thanks to a good week for gasoline imports, U.S. gasoline stockpiles actually rose by 400,000 barrels last week, but are still perilously close to minimum operating levels. Remember that that U.S. burns about 65 million barrels of gasoline a week so a 400,000 addition to the stockpile really is not significant.

So far, gasoline prices, which are the major concern to most, have not risen very much. This is attributed to the drop in demand which takes place after Labor Day and the transition to cheaper-to-produce winter gasoline which goes on the market in September. This situation is unlikely to last much longer. Many knowledgeable observers are beginning to talk of $90 or even $95 oil this winter which will bring gasoline prices to new highs.

We built up our stockpiles well above average earlier in the year, so that we are still 40 or 50 million barrels away from being in trouble and we always have the strategic reserve to fall back on. However, if imports continue to run 3-5 million barrels per week lower than last year, we clearly will be in trouble a few months from now.

While awaiting further developments I would like to make some observations on “The Virginia Energy Plan” published last week. The 180-page plan, which was mandated by the General Assembly last year, reflects the goals of all those with an interest in the future of Virginia’s energy: producers, consumers, environmentalists and many others. There is something for everybody which is why the most of those concerned could find something to praise. Even the Sierra Club called it a “very well balanced report,” but then went on to release their own report which calls for cutting carbon dioxide emission by 80 percent before 2050.

It would be nice to say the legislation and energy plan were written to prepare the state for dealing with the consequences of declining oil supplies, but this is only partially true. The original legislation was drafted to encourage drilling for oil in Virginia’s coastal waters, but then in true legislative fashion, was decorated with so many amendments and compromises that nearly everyone found something to like.

Since the notion that peaking world oil production will soon cause major problems has not yet firmly taken hold in the minds of most Virginians, the plan is not cast around mitigating the consequences of peak oil. From the peak oil perspective, the major flaw is the timing which speaks of goals in decades when the real problems may be months away.

There is nothing wrong with reducing the rate of growth of energy use by 40 percent over the next 10 years, unless one has an appreciation of just how bad the peaking of world oil production and more importantly exports is likely to be. If things turn really sour, it is likely that Virginia will be dealing with absolute reductions in available energy, particularly liquid fuels,ten years from now and not just slowing the rate of growth.

Marked reductions in the availability of imported oil and products, which seems to have started already, will undoubtedly impact other fuels as the nation scrambles to substitute natural gas and electricity for vital functions such as the production and distribution of food.

When shortages start to develop, be it in the next 30 weeks or the next 30 months, a new paradigm for energy will rapidly form.

Once you get by the lack of urgency in Virginia’s plan, there is much to praise. The emphasis on conservation and consumer education is exactly what will be needed to cope with the consequences of peak oil. Indeed, this week the state’s largest power company announced a plan to aid the distribution of compact fluorescent light bulbs around the commonwealth.

There is nothing wrong with reducing emissions, renewable energy, increased investment in energy R&D, improved electricity and natural gas infrastructure and a host of other recommendations.  These are exactly what the state and the whole world, for that matter, will need to mitigate the consequences of reduced availability of oil.

So where does this leave us? Virginia, unlike many other states, has a formal, written, coordinated plan. While it does not contain a sense of urgency and the goals clearly are not in proportion with the crisis we are likely to face, it is a good start. Plans can be changed. Goals can be moved up -- especially if there is no other choice.





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