Economics, Finance and Strategy

Wednesday, October 19, 2005

Peak Oil : The Next Depression

What is the “Peak Oil” situation?

All oil production follows a bell curve. Oil is increasingly plentiful on the upslope of the bell curve, increasingly scarce and expensive on the down slope. The peak of the curve coincides with the point at which the endowment of oil has been 50 percent depleted. Once the peak is passed, oil production begins to go down while cost begins to go up.

In practical and considerably oversimplified terms, this means that if 2000 was the year of global Peak Oil, worldwide oil production in the year 2020 will be the same as it was in 1980. However, the world’s population in 2020 will be both much larger (approximately twice) and much more industrialized (oil-dependent) than it was in 1980. Consequently, worldwide demand for oil will outpace worldwide production of oil by a significant margin. As a result, the price will skyrocket, oil-dependant economies will crumble, and resource wars will explode.

When are we expected to reach the Peak Oil stage?

Colin Campbell, who helped to found the London-based Oil Depletion Analysis Centre, reckons global peak production of conventional oil - the kind associated with gushing oil wells - is approaching fast, perhaps even next year.

"About 944bn barrels of oil has so far been extracted, some 764bn remains extractable in known fields, or reserves, and a further 142bn of reserves are classed as 'yet-to-find', meaning what oil is expected to be discovered. If this is so, then the overall oil peak arrives next year," he says.

The US Geological Survey (USGS) states that reserves in 2000 (its latest figures) of recoverable oil were about three trillion barrels and that peak production will not come for about 30 years. The International Energy Agency (IEA) believes that oil will peak between "2013 and 2037" and Saudi Arabia, Kuwait, Iraq and Iran, four countries with much of the world's known reserves, report little if any depletion of reserves.

What will be the effects?

Higher oil prices result in increased costs for the production of goods and services, as well as inflation, unemployment, reduced demand for products other than oil, and lower capital investment. Tax revenues decline and budget deficits increase, driving up interest rates. These effects will be greater the more abrupt and severe the oil price increase and will be exacerbated by the impact on consumer and business confidence.

Financial Consequences: Banks have created capital by lending more than they had on deposit, being confident that Tomorrow’s Expansion, fuelled by cheap oil-based energy, was adequate collateral for Today’s Debt. The decline of oil, the principal driver of economic growth, undermines the validity of that collateral which in turn erodes the valuation of most entities quoted on Stock Exchanges


Important Facts

Oil is not as elastic as other commodities and hence, increasing prices are not reducing demand. Infact, world oil demand, for a host of reasons, tends to be bolstered by "high" oil and gas prices until and unless "extreme" prices are attained. To illustrate, as of April 2005, a barrel of oil costs about $55. The amount of energy contained in that barrel of oil would cost between $100-$250 dollars to derive from alternative sources of energy. Thus, the market won't signal energy companies to begin aggressively pursuing alternative sources of energy until oil reaches the $100-$250 mark.

No new refineries have been built in the US for almost 30 years. In addition to lowering their investments in oil exploration and refinery expansion, oil companies have been merging as though the industry is living on borrowed time

Survival Strategies.

Governments may be persuaded to sign the Depletion Protocol whereby imports are cut to match world depletion rate, such that world prices fall into reasonable relationship with cost, and profiteering from shortage avoided; the current monumental waste of energy may be reduced; renewable energies from wave, tide, wind, solar, hydro and geothermal sources may be brought in; and the nuclear option re-evaluated.

Conservation: Practical mitigation of the problems associated with world oil peaking must include fuel efficiency technologies that could impact on a large scale. Technologies that may offer significant fuel efficiency improvements fall into two categories: retrofits, which could improve the efficiency of existing equipment, and displacement technologies, which could replace existing, less efficient oilconsuming equipment.

Improved Oil Recovery: IOR encompasses a variety of methods to increase oil production and to expand the volume of recoverable oil from reservoirs. Options include in-fill drilling, hydraulic fracturing, horizontal drilling, advanced reservoir characterization, enhanced oil recovery (EOR), and a myriad of other methods that can increase the flow and recovery of liquid hydrocarbons.

Heavy Oil and Oil Sands: This category of unconventional oil includes a variety of viscous oils that are called heavy oil, bitumen, oil sands, and tar sands. These oils have potential to play a much larger role in satisfying the world’s needs for liquid fuels in the future.

Hydrogen: Hydrogen has potential as a long-term alternative to petroleum-based liquid fuels in some transportation applications.