Peak Oil News: The real trouble with oil

Monday, May 02, 2005

The real trouble with oil

The Economic Times

A young Winston Churchill, on the eve of the first world war, took a gamble that changed the course of history. As First Lord of the Admiralty, he decided to convert the British navy from Welsh coal to imported oil. The resulting gains in speed gave Britain’s navy a decisive advantage over Germany’s. It also set off a geopolitical scramble as Britain sought to secure oil supplies before its rivals did. Churchill believed that “safety and certainty in oil lie in variety, and variety alone.”

By mid-century, America was the superpower scrambling to secure oil supplies around the world. Fearing depletion of its vast domestic store of petroleum, America forged an alliance with the then-new oil province of Saudi Arabia (whose crown prince was visiting George Bush again this week, see article). Driven by the same desire for energy security, today’s aspiring superpowers are in a similar race. China and India have recently tried to bribe, bully or buy their way into “equity oil” in Latin America, Canada, Russia and Africa.

No place to hide
And yet the billions they are spending on this quest for energy security could well be wasted. Thanks to the spectacular rise of futures trading, oil has become a fungible global commodity. The conventional notion that stakes in oil fields add up to energy security no longer holds up: if there is an oil shock, then the market price of every barrel of oil in the world will shoot up past $100 a barrel.

A similar folly is unfolding in America, where Congress is trying to boost “energy independence”. It is now considering an energy bill that would allow oil drilling in pristine parts of Alaska and would dole out billions in subsidies for the oil and gas business. This is mad. America has so little oil, and guzzles so much, that it will never again be energy-independent while relying on oil. America’s best hopes for energy security lie in the resilience of global oil markets, in conservation and in alternative energy sources.

As ministers from the world’s largest energy-consuming economies gather in Paris on May 2nd for a summit, they will naturally worry about the effects of high prices on their economies. But consuming countries are not the only ones that should be worried. As our survey of oil in this issue explains, the arrival of $50-a-barrel oil actually heralds big trouble for oil firms and producing countries as well as for consumers.

High oil prices have not yet produced an economic shock among consuming countries, but further rises, especially sharp ones, would undoubtedly hurt the world economy, and that would inevitably harm producers too. Beyond this obvious point, however, higher prices could even do harm to both oil firms and producers.

Big oil firms may be rolling in money today, but that disguises the fact that their longer-term prospects are bleak. Behind the reserves-accounting scandal at Royal Dutch/Shell lies a problem bedevilling all of the majors: replacing their dwindling reserves. Just as existing fields in Alaska and the North Sea are rapidly declining, OPEC countries and Russia are shutting them out. If they are to survive in the long term, the big oil firms must embrace other sources of energy aside from oil.

As hard as it is to believe, higher oil prices could be bad news for producing countries as well. Political leaders in Russia, Venezuela and other oil-rich countries are bending laws to crack down on foreign firms and to strengthen their grip on oil revenues through state-run firms. This may be convenient for the political leaders themselves. Alas, it is unlikely to do much for their countrymen. Corruption and inefficiency have been the typical results of government control of oil resources.

Producing countries should instead embrace open markets. Shutting out foreign investment will only hurt their own oil output by excluding the sharpest managers and latest technologies. For another, economic liberalisation (including reform of bloated welfare states) would help OPEC countries diversify their economies-as the NAFTA trade deal has done for oil-rich Mexico-and so prepare them for the day when the black gold starts running out.

Safety still requires variety

If George Bush scrapped America’s pork-laden energy bill in favour of such a market-based approach, he would be applauded by many on the left and right alike. Greens would cheer, of course, but so too would many conservatives. In recent weeks, leading conservatives concerned about the security risks of Middle East oil have called for a shift towards domestic energy sources (there is even a faint hope for cold fusion-see article).

Mr Bush has already shown support for technologies such as hydrogen and fuel cells, which in time may well replace petrol and the internal-combustion engine. He should craft policies that would at last begin to wean America, by far the world’s largest energy consumer, from its fierce addiction to oil. As in Churchill’s day, energy security still depends on variety. But now that variety needs to be sought in sources of energy, rather than sources of oil alone.


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