SANE Views

Vol.6 No.29, 07 August 2006

On the other side of the oil 'peak'

Jeremy Wakeford is a Board Member of the South African New Economics (SANE) Network and is a Lecturer at the School of Economics, University of Cape Town.

The article below was published in Business Day, on Wednesday, 2 August 2006. Please follow the link below.

http://www.businessday.co.za/articles/topstories.aspx?ID=BD4A243450

On the other side of the oil 'peak'

ASTEEP rise in the price of oil over the past few years has led to increasing concerns about its possible effect on the world economy. While the oil price trend is usually blamed on short-term, politically related (actual or feared) supply disruptions, or rising demand from the emerging Asian giants, the depletion profile of this finite resource poses a far more fundamental threat. In the 1950s, a petroleum geologist named M King Hubbert theorised that oil production in a given region would roughly follow a bell curve, rising to a peak when approximately half of the total oil had been extracted and thereafter gradually falling towards zero. To the shock of the oil industry, Hubbert correctly predicted the 1970 peak in oil production in the lower 48 states in the US. He subsequently hypothesised that world oil supply would follow a similar curve, mirroring the pattern of oil discoveries, which peaked in the 1960s.
Global oil consumption has exceeded new discoveries every year since 1981, and more than half of the 44 significant oil-producing nations have passed their individual production peaks. It is just a matter of time before the world peak is reached.

In recent years, a handful of petroleum geologists using Hubbert's methodology have been predicting a global oil peak somewhere between last year and 2016. The Association for the Study of Peak Oil and Gas, an international network of leading scientists studying fossil-fuel depletion, estimates that "regular" oil peaked last year and forecasts that all liquids plus gas will peak in 2010.
Until recently, the so-called "peak oil" phenomenon was not widely publicised, understood or accepted. However, over the past year or so it has become more broadly acknowledged. Even some large oil companies - ChevronTexaco and Shell - have admitted that "easy" oil production has peaked. Other prominent figures voicing concern include former US president Bill Clinton and Roscoe Bartlett, a US congressman.

So far Sweden is the only government to have publicly acknowledged peak oil. From numerous reports it is clear that the US government is well aware of the problem, but the Bush administration is keeping quiet while it strategically positions its military close to key world oil supplies and distribution routes, notably in the Middle East.
The peaking of global oil production marks the end of cheaply available oil, not the end of oil per se. Will the market not take care of the problem by stimulating new oil discoveries and investment in alternative energies?
Many experts agree that most undiscovered oil probably lies in less accessible deep-water and polar regions, while the much-vaunted tar sands and shale oil have very low net energy returns.

In any case, further discoveries or enhanced recovery from existing oil wells will merely delay the peak.
While there is considerable scope for increasing energy efficiency and reducing consumption, both have limits, especially given current energy and transport infrastructure. No alternative energy source is fully substitutable for oil, considering its versatility as both a fuel and a petrochemical feedstock, as well as its high energy density. Natural gas is expected to peak within a couple of decades, while coal is highly polluting, not least in terms of harmful greenhouse gas emissions. Switching to an economy based on renewable and nuclear energies will require massive investment, and take several years to begin making an appreciable difference.

The crux of the matter is whether new energy and transport investments can be undertaken before the peak of oil production is reached; after the peak, economic conditions will be far less conducive.
On the down slope of the Hubbert curve, the world faces an endless sequence of supply-side oil shocks, causing the oil price to fluctuate around an upward trend. This will fuel inflation and increase uncertainty. Central banks are primed to respond by raising interest rates, which will put a brake on global economic growth. If the oil price continues to rise gradually and monetary authorities tolerate higher inflation to allow prices to adjust, reflecting the increasing scarcity of fossil fuels, an economic meltdown may be avoided.

However, there is a strong likelihood of a sharp spike in the oil price, either when the peak is reached or when a critical mass of investors wakes up to the inevitability of the peak. This realisation could spark widespread panic, with potentially devastating effects on financial markets and the global economy. In 1979, a mere 4% reduction in the world oil supply led to a near trebling of the oil price, and the monetary policy response caused a severe international recession. Conservative estimates of the post-peak depletion rate are about 3% every year.

Certain sectors are particularly at risk to oil depletion. First, transport costs will rise dramatically, hitting commercial aviation and tourism especially hard. Second, oil scarcity will push up food costs and reduce output as modern agriculture is highly dependent on oil for tractors, transportation, and chemical fertilisers and pesticides. This may have serious food security implications, especially for food-importing countries. Third, the volume of manufacturing production will be hurt by rising energy prices, especially in the petrochemical, plastic and pharmaceutical sectors.

Competition over dwindling energy and food supplies will raise geopolitical tensions and may precipitate increasing resource wars. It is also reasonable to expect increasing terrorist activity, especially considering more than half the world's known oil reserves lie in the volatile Middle East. Terrorism can have serious consequences for the global economy and financial markets by raising risk aversion and reducing consumption, investment and trade.

The days of taking oil-based growth for granted are over. We urgently need to consider the likely consequences of peak oil, and invest in alternative energy and transport infrastructure.
Successful management of the threats posed by peak oil arguably will require both mitigation and adaptation strategies, involving a mix of market signals and government intervention. Crucially, delaying appropriate responses in the short to medium term will merely compound the problems in the long run.