Peak Oil News: Energy policy or disaster

Wednesday, November 02, 2005

Energy policy or disaster

By Eric Sprott and Sasha Solunac

In the past month, Peter Foster has written two editorials criticizing "peak oil theorists." Rather than questioning the geology (although he clearly believes that even geologically peak oil is nothing to worry about), Mr. Foster apparently relies on blind faith in "free markets" and "human ingenuity" to avert an energy crisis. Furthermore, according to Mr. Foster, any attempt by governments, through energy policy or otherwise, to do anything about the looming crisis is wrong. He likens such actions to those of "old Soviet planners" and attempts to turn the peak-oil problem into a left-versus-right ideological debate. Unfortunately, we believe that laissez faire in this instance is tantamount to a head-in-the-sand approach that accelerates the problem rather than alleviating it.

Don't get us wrong. We are proponents of free markets a la Adam Smith. However, and unfortunately, oil is not a widget that can be produced freely depending on supply/demand signals. Crude oil has three important and distinct differences from your everyday widget. First of all, it is a limited non-renewable resource, the production of which will someday peak in spite of our desire to not have it do so. This is indisputable; the only question is when. Second, unlike the common widget, there are currently no viable substitutes for crude oil. Oil is the pre-eminent transportation fuel. We rely on oil for over 90% of our transportation energy and are expected to do so for at least the next two decades. Try as we might over the past century to find viable alternatives, there are simply none that are as plentiful or as cheap. To believe that we could all continue to drive around in our SUVs and produce ethanol or hydrogen or nuclear batteries to replace the scale at which we currently consume oil is a pipe dream. Third and finally, crude oil has an importance to civilization that few, if any, widgets have. Wars have been won and lost because of it. We've gone to the moon thanks to it. We live our lives enslaved to it. It is something we take for granted and can't imagine going without. We can survive without MP3 players but to do without oil is a terrifying proposition to most. Indeed, it is difficult to imagine a commercial product that we are more dependent on. Perhaps food -- but even then, the food industry is heavily reliant on oil far more than most people are aware.

Therefore, to ignore the fact of peak oil and "let the markets decide" is naive at best and disastrous at worst. Human history is replete with examples of mismanagement of resources when left in the hands of the free markets. One example that immediately comes to mind is the Newfoundland cod fishery. Sorry Adam Smith, but individuals acting for their own benefit do not always produce an outcome that is best for the whole. In this case, laissez faire failed and we are now without the cod that was once considered boundlessly abundant. What's worse, fish is a renewable resource and yet we still managed collectively to bungle it up. Oil is not renewable. We also have close substitutes for fish (chicken, beef, etc.). For oil we do not. Let's not kid ourselves. Peak Oil, when it happens (not if), will be a world-changing event.

We will one day find a substitute for oil (we won't have a choice), but alternatives are still decades away from fruition. If peak oil happens today, or next year, or the year after that, no amount of human ingenuity nor technology will save us. To believe otherwise is naive. This is why we believe the debate on peak oil needs to happen here and now, even if the outcome is unpleasant and alarming. Marion King Hubbert, the geophysicist who predicted in 1956 that U.S. oil production would peak in 1970, was also considered an alarmist in his day. But, in hindsight, he was proven to be correct even though right up until the peak few believed that U.S. oil production was on the verge of going down.

Oil prices soared in the early 1970s. Yet, the free markets failed to avert the decline in U.S. oil production even though there was every economic incentive to do so. We see a similar phenomenon occurring today with non-OPEC oil production. In spite of an escalating oil price, estimates for non-OPEC oil production have been coming down throughout the year. According to the International Energy Agency, back in December, 2004, non-OPEC production was expected to be 1.2 million barrels a day higher this year over last. By July of this year, the estimate was revised down to 900,000 barrels per day. Today the estimate stands at merely 175,000 bpd. In that time the price of oil is up 50%. Why aren't the markets working? Clearly, a blind faith in free markets isn't the solution to the peak-oil problem. It is for this reason that we believe we should be worried about Middle East oil production going forward, especially that of Saudi Arabia. Without a substantial increase in Saudi production in the next few years (every year) we are literally up the creek without a paddle ... let alone a motor.

Therefore, to not have an energy policy, to not have a debate, to keep our heads buried in the sand and to just keep doing as we've been doing, can only lead to disaster. We need a strategy before the crisis hits, not after. It's not a question of left versus right. It's not a question of free markets versus managed economy. It's not a question of Adam Smith versus Lou Dobbs.

It's a question of survival.

Eric Sprott is CEO, and Sasha Solunac an analyst, at Toronto-based Sprott Asset Management Inc.


At 7:42 AM, November 03, 2005, Anonymous Anonymous said...

It probably does not matter in the end what is said about this issue from the sidelines. Petroleum will continue to be produced in sufficient quantities to meet human needs. It is ture, that no left-right, Republican-Democrat, Liberal-Conservative or other polarity has anything to do with anything in this regard.

The fact is however, this concept of "peak oil" is little understood by almost any of those who are expressing worry about it.

There are many influences on oil supply globally. About three years ago, Venezuela went from being a major "friendly" supplier to the USA and Europe, to being (once again) being antagonistic to those so-called "western powers". Nigeria has run hot and cold both politically/socially and as being able to supply from a domestic security perspective. However neither of these countries has tapped any considerable portion of their known, producable reserves. The former soviet union (FSE)has a terrible mess in its oil and gas production sector. If it were to get itself together from a rule of law perspective, the surge in petroleum productivity would blow away these high crude prices in a matter of days. The Arctic region contains enormous known reserves - known because they havwe been produced variously over the past few decades. Geting the stuff out without causing pollution and other losses, is a risk that was not worth pursuing so long as petroleum prices were actually or expected to be under US$30.00. Virtually all on-shore oil fields in the world continue to hold (on average) well in escess of half and possibly in excess of 75% of their known reserves (reserves in place). Until market incentives induce secondary and tertiary recovery, those reserves wait for future generations.

Canadian oil sands were looked upon as moose pasture reserves until about 1995. At that time Suncor switched its mining technology and diversified its upgrader. They also successfully applied scrubbing technology to the utility plant flue gas - not only cleaned it of sulphur but generated a stable by-product that overcame a serious tailings management problem that had plagued the industry for decades.

Because these changes overcame some of the fundamental viability problems for Canadian oil sands, other technology that had been in development but was not considered worthwhile in a dying industry, suddenly came to the forefront. Bitumen ore was crushed and mixed with water in the mine so that the extraction process started before it even reached the fixed plant. Transportation was by slurry pipeline rather than rummer belts that had stretched for tens of kilometers giving nothing but hazard and break-downs for the previous 25 years.

This kind of change occurred in enhanced oil recovery during the same period. Reservoirs with more than 90% water became producable because of oil-water separation technology. New ways to make up reservoir pressure by injecting waste water and other gasses or liquids, by injecting heat and so on - moved the producability of reserves ahead faster than production so that regardless of how much was produced, each year the proven producable reserve number grew.

This technology found its way around the world. Interestingly most reserves in the world were still producing so cheaply that this enhancement technology was not of interest. But it will be one day and these prolific reservoirs will get new life through technology.

These are but small samples of a very large point. Anyone who intends to influence other people's opinions about petroleum shortages has a moral obligation to be informed or to admit to being a snake-oil salesman. If one does not have a clue about the thousands of facts that clearly indicate that there is not a looming shortage, that person does not have the informed authr=ority to comment.

Of course there will be a day when we slip past the half-way point in our ability to produce. It will not be a point that is noted because reserves cannot be specified at any time, well enough to know when we reach the mid-point.

Statistics about production and producability are not gathered from data meant to reflect how much the world can produce. The amount that is produced is more a matter of geopolitics than physics or chemistry today.

The war in Iraq is a good example. Bush Sr. declared that the USA had to launch desert strom, to "protect our interests in the middle east." Bush Jr. could not say that given the political situation during his first term. Under the cloud of general confusion about terrorism he was able to manufacture a WMD story that lasted long enough to get the US troops into Iraq. But why?

To that point the USA had an embargo surrounding Iraq. To make an embargo work, you have to ensure that it does not have any leaks. They passed a lot of spooky legislation to use their market power to punish countries that circumvented the embargo. Canada was subjected to this from time to time though it is not widely known.

In the year before the Iraq invasion, German, French and Russian interests made deals with the Hussein family interests and their corrupt officials, to explore and develop Iraqui oil. China took petroleum out the back door of Iraq throughout the embargo. The Chinese action was foregiven because China was too big to punish and because it took some heat off of the world market so as to keep prices in a safe zone for the US economy.

But when these Euro-Asian countries began to get friendly with Iraq, a power balance issue arose. US and British companies could not compete with these other country counterparts. I am sure they were screaming their big lungs out in Washington. Then USA and UK marched/flew in and overturned these land deals by wiping out the Iraqi part of the deal. You will note the alignment of countries that ensued. The opponents were the countries who were losing their deals. When US invited other countries to participate in the post-invasion governance and restoration of Iraq, these three powers said, "not unless you give our deals back."

All this played out in front of us all. There is no secret here. And to be sure, any country that spends a trillion dollars to "protect its interests in the middle east," when those interests have to do with petroleum energy, in the end has to cost that expenditure against its per-barrel economics of petroleum. 2000 dead Americans is not a cost-able item at this stage.

Why do that when there is so much oil in the world?
1. more than 3/4 of the world's known reserves are in hands not friendly to the US
2. the remaining oil reserves are the most expensive to produce.

While all of that was true and some of it remains true, technology is changing the cost profile. Also the market itself has become complex. Aggregate supply/demand does not behave in accordance with neat rules assumed in economic models.

It is humorous in a way to hear inexpert, uninformed people making declarations about how the market is and how it will be when those who are in the middle of it don't know.

For example there are some very large and successful petroleum companies that would like to be sold to the likes of China but thay cannot determine a value for reserves in place. Since reserves constitute the biggest piece of an oil company's balance sheet and future earnings, company valuation is impossible. None of this would be true if current oil prices were known to be based on true global shortages. A shortage is a solid chunk of information. Market emotion is not solid.

Finally, the reason we ought to object to the fringe noise buzzing around the oil market is that it obscures the truth on the basis of which people who constiture the market, would make sound decisions. People have unnecessarily eaten higher prices for coffee, orange juice, veggies, anything made of steel and so on - from time to time all because it was rumoured that these comodities might be in short supply - but never proved to be in fact.

So those who stir up hobgoblins around petroleum supply are in fact providing a cover for those whose product sells for more when emotions run high.

In the end the doomsday merchants are so good for prices that a cynic would be tempted to think they might be paid by smaller-scale oil interests to bolster the market.

Look instead to Shell, Exxon and BP. They do not think, act nor declare that we face a real shortage or that prices need to be this high or will continue to be. Spurts and emotions like this are not good for those who are in it for the long haul.

Rudy Krueger
Alberta, Canada


Post a Comment

<< Home