SPEAKING
FREELY High prices are here to
stay By Marshall Auerback
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Concern that rising
oil prices could harm the global economy dominated
the recent meetings of world finance ministers and
central bankers who gathered after Wall Street
plunged to new lows for 2005. There were intense
talks about the energy situation at both the
meetings of the Group of Seven major
industrialized countries and the policy-making
committee of the 184-nation International Monetary
Fund.
But is this yet another case of
policymakers closing the barn door after the horse
has bolted? After all, oil prices now look to drop
below US$50 per barrel, having fallen several days
in a row amid concerns of slowing global economic
growth, falling stock markets and a further
unwinding of the great reflation trade (which is
engendering significant liquidation of the
speculative long positions on the oil futures
market).
To be sure, the recent sharp
pullback in oil prices from new record highs is
also the result of a quite understandable
price-sticker shock. Oil and petrol prices are now
five times as high as they were in 1998, when the
world was looking for prices to plummet back to
the lows last seen in the mid-1980s. It is also
true that the psychological backdrop does not
appear conducive to an ongoing bull market in the
energy complex: today's news flow is comparable to
that which arose in the wake of the conclusion of
the Iraq war. Newspapers and brokers' reports
write reams of material describing fatter
inventories, and note that the transportation
bottlenecks which had hitherto afflicted the oil
industry have been largely been sorted out (if the
recent decline in tanker rates is anything to go
by).
Oil has twice pushed to the mid-50s
range and sold off violently, leading many
chartists to assume that a double top is forming.
There are a lot more bulls than there were even
three years ago, when we first started making the
secular case for higher energy prices, and common
sense tells one that no commodity can sustain such
a rate of price increases indefinitely. And, as is
often the case with any apparent speculative
blow-off, there was the widespread publicity
accorded to a Goldman Sachs report, in which the
possibility of $100 oil was mooted for the first
time.
So has oil been put in a conclusive
top? Is all of this market chatter about "peak
oil" simply a function of extreme bull market
psychology?
Given the threats posed to
global growth (in particular, consumption) by
higher energy prices, there is clearly a vested
interest in talking down the price of oil. But as
market strategist Chris Sanders has noted,
"Measured in relative terms, [oil] has not done
that much compared to history. Nominal spot prices
are only $5 or so as of this writing above their
October 1979 peak at $44.60, and deflating spot
oil by the US consumer price index ex-energy
prices, we see a much different picture of its
relative value against other goods and services.
Looked at this way, it has barely retraced half of
the [19]70s bull market run."
Add to this
the simple dynamics of supply and demand, and it
is easy to make the case that the recent weak
price action in the energy complex is but a
temporary downdraft, rather than indicative of a
new, more bearish trend for oil, gas and coal
prices. As always in such circumstances, it is
best to go back to the basics: total new
discoveries have been steadily declining for 40
years, and world consumption has outpaced newfound
reserves for nearly a quarter of a century. The
global economy today now uses more than four
barrels of oil for every new one discovered.
In fact, according to a report by the
industry consultants, IHS Energy, only 50% of the
world's oil production has actually been replaced
by new field discoveries. Annual discoveries have
now fallen behind total consumption every year for
the past 20 years. The consultants reported that
all but three of the top-20 non-OPEC (Organization
of the Petroleum Exporting Countries)
oil-producing countries failed to replace their
production with new discoveries. Russia and Mexico
- the top-two non-OPEC producers, which together
accounted for over 12 million barrels of daily
production in 2003 - replaced just 11% and 10%
respectively in the past 10 years. The report also
shows that the percentage of discovered oil
brought into production has steadily risen since
1975, which means that more and more of the legacy
of past discoveries is being consumed. In 1975,
about 65% of total discoveries were in production.
Through the end of 2003 that figure had risen to
85% of all the oil ever discovered. In total,
about 45% of all the oil found worldwide had been
consumed by the end of 2003, according to the IHS
data.
Worst of all, (from an American
perspective at least), is that the largest new
sources of petroleum are likely to emerge in
countries with interests somewhat inimical to
those of the US. This is not without historic
precedent: in 1970, the seven major international
oil companies thought they owned and thus had tied
up the huge Middle East reserves beyond the turn
of the century. Within five years, the nations
there had taken ownership of their own oil - and
prices had quadrupled.
Although the
presence of 140,000 troops in Iraq makes a 1970s
style nationalization a highly unlikely
contingency, most of the major oil producing
nations are close to full production capacity,
notably Saudi Arabia (now producing oil at close
to its maximum sustainable rate of about 10
million barrels per day). Both Henry Groppe and
Matt Simmons, two of the world's leading
independent energy analysts, forecast that in
spite of current pledges to increase production
and investment in infrastructure further, the
Saudis are probably unable to raise their output
significantly over the next 20 years while global
demand, pushed by significantly higher consumption
in the US, China, and India, is expected to rise
by 50%. On the other hand, notes author Michael
Klare, Iran has significant scope to increase its
role as a major swing producer: "Iran has
considerable growth potential: it is now producing
about 4 million barrels per day, but is thought to
be capable of boosting its output by another 3
million barrels or so. Few, if any, other
countries possess this potential, so Iran's
importance as a producer, already significant, is
bound to grow in the years ahead."
Leaving
aside such problematic geopolitical constraints to
easier access to crude (at least from the
perspective of the world's largest energy
consumer, the US), one would also presuppose that
higher prices would lead to improved returns on
investment. But the very nature of depletion
dynamics undercuts this assumption. According to
energy consultants Wood Mackenzie, the value of
new discoveries by the world's 10 largest oil
companies fell well below the amount they have
spent on exploration over the past three years,
which creates a disincentive to increase
investment further. A Financial Times report noted
that companies were spending record levels on
developing known fields to keep pace with the
growing demand. But after 2008, according to
Robert Plummer, corporate analyst at Wood
Mackenzie, "They will need more discoveries to
maintain growth ... the problem is exploration has
not been generating returns."
Add to this
the fact that the world is now losing more than a
million barrels of oil a day to depletion - twice
the rate of two years ago - according to a new
analysis published in Petroleum Review, the oil
and gas magazine of the Energy Institute in
London. The analysis shows that output from 18
significant oil-producing countries, accounting
for almost 29% of total world production, declined
by 1.14 million barrels a day (mbd) in 2003. The
annual rate of decline also appears to be
accelerating, contrary to the widely held view
that depletion progresses slowly. Combined
expenditure of about $8 billion on exploration
last year - down from $11 billion in 2001 -
produced discoveries valued at less than half that
amount.
As a consequence (based on data in
the latest BP Statistical Review of World Energy),
total OPEC production fell from a rate of 24.7mbd
(recorded in 1997) and to 22.1mbd by the end of
2003. "It appears that depletion is now becoming a
much more significant, though largely
unrecognized, consideration in the supply-demand
equation, and may be contributing to the rise in
oil prices," said Chris Skrebowski, editor of
Petroleum Review, who prepared the new analysis.
Skrebowski noted, "Those producers still with
expansion potential are having to work harder and
harder just to make up for the accelerating losses
of the large number that have clearly peaked and
are now in continuous decline."
Global
discoveries for oil peaked 35 years ago while
demand has climbed inexorably higher. Obviously,
there are still parts of the globe to be further
exploited, whether in the deep ocean beds of the
South China Sea, the west coast of Africa, or in
the highly prospective Falkland Islands. But these
regions are the exceptions, rather than the rule.
As Sanders notes, "This cannot last forever,
something has to give, and that something is
production. There are variables: the business
cycle, technology and politics; but these can only
affect the date of the peak, not eliminate the
peak itself." Especially when the date of that
peak has been brought forward by the new demand
variables of China and India; consider that for
China and India to reach just a quarter of the
level of US oil consumption, world oil output
would have to rise by 44%. To get to half the US
level, world production would need to nearly
double. That is a virtual impossibility. The
world's oil reserves are finite.
For all
of the vaunted hopes imputed to new extraction
techniques, it is worth noting that these
processes are more likely to accelerate depletion
rates, rather than expand supply. There quite
simply are not enough new big oil projects coming
on stream anymore to replace the old oil fields
that are running low. It takes an average of six
years from finding new oil to pumping it out, and
the known new fields are not kept secret. In 2000,
there were 16 major discoveries; in 2001 eight; in
2002 just three; and in 2003 zero. The writing is
on the wall.
And the bad news is that
there is no cheap, easy solution in sight:
President Bush has publicly embraced hydrogen as a
solution to the US's looming oil supply shortages.
But, as Cal Tech Vice Provost and professor of
physics David Goodstein has noted, there are only
two commercially viable ways of making hydrogen.
One is to make it out of methane, which is a
fossil fuel. The other is to use fossil fuel to
generate the electricity that is required to
electrolyze water and get hydrogen. The economics
of doing that are such that one ends up using the
equivalent of six gallons of gasoline to make
enough hydrogen to replace one gallon of gasoline.
This "solution" , therefore, turns out to be no
such thing.
Natural gas could be a very
good substitute for oil. Cars that are not very
different from those driven today can run on
compressed natural gas, and it is a particularly
clean-burning fuel. But if we turn to natural gas
in a major way to replace diminishing supplies of
oil, it will only be a temporary solution. The
Hubbert Peak for natural gas is only a decade or
so behind Hubbert's Peak for oil (in fact, in the
US, natural gas production peaked in 1973).
And natural gas also puts Americans face
to face again with the uncomfortable realities of
the Iranian regime. According to Oil and Gas
Journal, Iran has an estimated 940 trillion cubic
feet of gas, or approximately 16% of total world
reserves. (Only Russia, with 1,680 trillion cubic
feet, has a larger supply.) As it takes
approximately 6,000 cubic feet of gas to equal the
energy content of one barrel of oil, Iran's gas
reserves represent the equivalent of about 155
billion barrels of oil. This, in turn, means that
its combined hydrocarbon reserves are the
equivalent of some 280 billion barrels of oil,
just slightly behind Saudi Arabia's combined
supply. At present, Iran is producing only a small
share of its gas reserves, about 2.7 trillion
cubic feet per year. This means that Iran is one
of the few countries potentially capable of
supplying much larger amounts of natural gas in
future, although presumably a pre-emptive attack
in response to Iran's ongoing uranium enrichment
activities could disrupt this supply (as well as
any inconvenient and growing ties between Iran and
America's leading competitors in the global energy
market, China and India).
Wind and solar
power are also being discussed as viable
alternatives to oil. And they are, but only to a
limited extent. Power generated from waves,
windmills, and solar panels is weak, intermittent,
and expensive - at least twice the cost of
electricity produced from coal or gas. When it is
cold or dark, solar panels don't produce energy;
when it is calm, wind turbines don't turn.
Moreover, in regions like northern Europe, where
fossil fuels are very expensive and the wind is
strong (and, hence, a viable alternative to rival
hydroelectric power as a source of energy), other
obstacles remain: places such as Scotland have
been marked by protests developing over the
"eyesore" wind farms being built over the pristine
Highlands. Similar protests are emerging over
plans to build Britain's biggest wind farm along
the borders of the Lake District National Park on
the grounds that it will destroy one of the
country's most treasured and inspirational
landscapes. Even allowing for resolution of these
conflicts, there are relatively few places on
earth, like northern Scotland or England's Lake
District, where the wind blows strongly and
steadily enough for it to be a dependable energy
source, leaving aside the question of engendering
political support to build these aesthetic
monstrosities.
In recent years, the debate
over nuclear power has revived, and to judge from
the tremendous rally in the price of uranium and
various uranium stocks, the market has already
concluded that nuclear power is firmly back on the
political agenda again. Nuclear power has
undoubted attractions, as it would facilitate
compliance with the Kyoto Treaty. But its
replacement potential for oil is still limited. To
produce enough nuclear power to equal the power
derived from fossil fuels, would entail production
of 10,000 of the largest possible nuclear power
plants, according to Goodstein: "That's a huge,
probably nonviable initiative, and at that burn
rate, our known reserves of uranium would last
only for 10 or 20 years."
Eventually,
scientists, geologists and entrepreneurs may
develop or discover entirely new sources of energy
- for example, geothermal, biomass, or
hydrogen-based systems - but at current rates of
development, none of these alternatives will be
available on a large enough scale to provide a
cheap, affordable alternative to the 20th
century's generally low prevailing energy prices.
The recognition of oil's depletion dynamics
neither means that oil is in imminent danger of
running out, nor that no more will be discovered,
that alternative technologies cannot be invented
and deployed as substitutes.
It does mean
that the single most important and chemically
unique storehouse of energy on the Earth is finite
and cannot be relied upon to deliver infinitely
extended growth on its own, and the global economy
will have to adjust to significantly higher energy
inputs for the foreseeable future in spite of the
recent price weakness recorded in the markets.
This likely implies lower aggregate growth (and,
by extension, corporate profits) and, from a
geopolitical standpoint, a growing tension between
the forces binding the world more tightly together
into a global financial and production system and
the forces competing to control the resources that
fuel that production.
Marshall
Auerback is an international strategist with
David W Tice & Associates, LLC, a US Virgin
Islands-based money-management firm. He is also a
contributor to the Japan Policy Research
Institute. This article has been republished with
permission from PrudentBear.com
(Copyright 2005 PrudentBear.com)
Speaking Freely is an Asia Times
Online feature that allows guest writers to have
their say. Please click hereif you are interested in
contributing.
