Roger Baker : Playing ‘Peak-a-Boo’ With the Earth

Part I: Fuel prices and the global oil supply

By Roger Baker / The Rag Blog / June 8, 2011

In recent years, we are used to hearing something about oil in the news nearly every day. With rising fuel prices at the gas pump acting as a constant reminder, it is getting harder for the public to deny that the United States is in big energy trouble.

I have written three essays to explain our current situation, with a focus on transportation. This first one explains the global oil supply situation that has been causing fuel prices to go back up.

This will be followed by an essay documenting and explaining the basic shifts in driving and transportation behavior that are already well under way. It is indeed quite possible that the total vehicle miles driven in the United States has already peaked in 2007. Barring something unanticipated, we should plan to drive less, pay more, and begin to envy those with good transit service.

The road goes on forever, and the party never ends. At least not while the Texas road lobby has its way. — RB

The big picture: The global supply of cheap oil is mostly gone

The USA has, in effect, squandered the decades since the energy crisis of the 1970s in denial of its growing dependence on cheap imported oil. The USA gambled its economic future on the expectation of an eternally abundant supply of liquid fuels needed to power its unusually oil-dependent, low-density suburban lifestyle.

The U.S. energy crisis of the 1970’s was temporarily abated by new Alaskan oil production, and by agreements with the Saudis and other OPEC producers. Market access to cheap OPEC oil was then promised forever, in return for unlimited access to Middle East oil reserves, and for U.S. military protection of the status quo.

Now that the cheap conventional petroleum of our past is in global decline, as reflected in its erratic but stubbornly rising price, keeping the U.S. transportation system functioning as usual is a continuing struggle. Over 95% of the world’s transportation runs on oil-based fuel or its liquid equivalent; essentially all the world’s ships and planes and trucks, and most trains, run on conventional hydrocarbon fuels.

Producing the remaining supply of more expensive nonconventional oil requires that the biggest private companies like BP have to work a lot harder, by going far offshore, by using lower quality sour or heavy oil, or by mining tar sands, etc.

Since most of the richest geological oil deposits have already been located and largely produced, we’re finally getting down to the dregs. Global demand must increasingly be met by these “non-conventional” oil sources, where the energy return on our energy investment from drilling, etc., is much lower than before; perhaps only three-to-one rather than the previous twenty-to-one.

Given the new global oil supply situation, and with especially serious economic and transportation implications for the car-dependent U.S., it is past time to do something. The real issue is how hard we hit the wall as fuel prices keep on rising.

Oil sets a limit on economic recovery

Oil reached its all-time high of $147 per barrel in mid-2008. Since then, the global supply hasn’t gone up much, but demand has shrunk with the recession, and the price has decreased. With a global recovery, a recurrence of another oil price spike is now well underway, to be followed shortly by a second stage of global recession, a continuation or second phase of the Great Recession of 2008.

This time around, after a lot of previous destruction of soft global demand, and due to rapid oil demand growth in China, we should anticipate that oil demand and oil prices will not fall to such a degree as they did in the recession of 2009.

During the entire period from 2005 to the present, the global production of conventional oil has been relatively constant, with oil prices rising and falling with the strength of the dollar and global demand. Global oil demand has been steadily rising during the last year, running up against global production a second time, as reflected in its rising price.

Since about June 2010, we have seen a slow acceleration in price, to the point that Brent crude (the best global price to watch) now sells at about $117 per barrel. Assuming the global economy falls back into recession, oil may get a little cheaper in dollar price, but it will probably keep getting less affordable.

Energy analyst Tom Whipple explains the same situation this way:

There are only a limited number of ways that the current economic recession and the looming prospects of a final decline in oil production can play out. None of these will permit much of an economic revival. The global financial crisis as presently understood is clearly too firmly rooted to be fixed by government bailouts and stimulus packages. The recession will only deepen for the foreseeable future, and the massive deficit financing by the United States and many other countries cannot go on much longer. Although China, with its large reserves of foreign currency, may be able to continue underwriting stimulus packages longer than other countries, it too will succumb to the lack of exports, the need to import energy, and other looming problems

Oil-related thinking and politics at the national level

For anyone living in the U.S., it’s easy to see that we are a car dependent nation. Oil addiction implies a corresponding car addiction. President George W. Bush first used the distressing “A” word toward the end of his term. Obama has now been warning us of the same thing for almost two years, and again last year during the BP spill.

Recently, Obama has proposed a national U.S. goal of reducing oil imports by a third, by 2025. In his words,

The Federal Government operates the largest fleet of light duty vehicles in America. We owe a responsibility to American citizens to lead by example and contribute to meeting our national goals of reducing oil imports by one-third by 2025 and putting one million advanced vehicles on the road by 2015.

This slow pace of of breaking our oil habit, offered here as a top national goal, is one way of admitting that our imported oil dependency will be extremely hard to break.

Along with the difficulty of reducing our import habit through painful economic restructuring over time, a domestic culture of denial persists, giving way to frustration and anger. We like to blame big oil companies like Exxon for holding back on production, or for causing high gasoline prices in some other way that they could easily reverse. It would be better to focus on the long term structural oil dependence of our society that these major producers have encouraged for decades, and which is arguably their major corporate sin.

Of course Republicans like to blame Obama for not encouraging more domestic drilling to hold down our driving costs. The reality is that no possible domestic energy policy can make much difference any more. Adding any plausible amount of new American production can scarcely sway the price on the huge global oil market. The guys still drilling in Texas or the Gulf are not likely to give us much of a price break since they can sell it to Europe for even more.

Oil has become more expensive globally, due to supply and demand in the world oil market — of which the USA is now only about 20%. We might like to blame oil speculators for the oil price bubbles, but they are not a major factor on their own; they can’t move the markets for very long without support from real market supply and demand forces.

The true adequacy of supply is revealed when and if tankers full of Arab oil arrive from the Middle East to undercut the speculative portion of demand. Even speculators have to sell the oil they buy, and they didn’t get to be important players by making stupid bets.

The International Energy Agency — the top energy adviser to Europe — now concedes that global conventional oil production, the ordinary oil you drill for on land, peaked about 2005 and is now in decline. The end of the cheap oil is automatically shifting the market toward more expensive and lower quality oil.

In fact, the IEA is now pleading with the OPEC cartel to raise its oil production enough to prevent a renewed economic crisis. The IEA can see what is happening. Faced with stagnating global oil production and the inability of low grade Saudi oil to make up for Libyan sweet crude losses, the IEA is asking OPEC to increase its oil exports — enough to keep the global economy from slipping back into recession:

In an unusual development, last week the IEA’s governing board called on oil producers to increase their output to “help avoid the negative global economic consequences which a further sharp market tightening could cause.” The Agency’s position is in stark contrast to that of OPEC, and in particular the Saudis, who maintain that the oil markets are adequately supplied and that there is no need for a production increase at this time.

The statement released by the IEA cited a “clear, urgent need for additional supplies.” This time around the IEA seems to be taking the lead in warning that ever since the Saudis pulled back from replacing the lost Libyan exports last month, global demand for oil has been exceeding supply with the difference coming out of stocks.

With respect to world oil supply problems, many experts are now conceding that the days of cheap oil, and cheap driving, are over. The British are starting to face up to their own serious and rapidly worsening energy import problem, which parallels U.S. oil dependency in many respects, though it is not as severe.

By the time the general public understands the problem well enough to trouble the politicians, the situation it will be terribly difficult to deal with because of the long advance time needed to make an economic transition. We saw this during the long energy crisis of the 1970s.

The Hirsch report, published in 2005, concluded that to avoid major disruptions, we need to plan 20 years before the arrival of the oil peak, and that we just don’t have.

The key role of Saudi oil

The Saudis by themselves, by means of their unmatched reserve production capacity, and with their almost 9 million barrels a day in oil exports, or about 10% of the world supply, are the key oil export source. The world has relied on them since the 1970s — to keep the world oil price as low and stable as it is now. Any big loss in Saudi exports, perhaps through spreading “Arab Spring” political instability, would rapidly plunge the world into a global depression.

Since they have already produced their best and cheapest oil, the Saudis are having to produce heavier and more sour crude oil, which is harder to refine. The Saudis are now struggling to maintain even their current level of oil exports to hold down the world price.

“The easy oil is coming to an end,” says Alex Munton, a Middle East analyst for the Scottish energy consulting firm Wood Mackenzie. The major oil fields in the Gulf region, he says, have pumped more than half their oil — the point at which production traditionally begins to decline.

The U.S. Energy Information Administration said earlier this month that world-wide oil consumption would hit a record 88 million barrels a day this year. Turmoil in Libya, combined with slowing production growth in Western countries, will keep supplies tight, boosting prices, the federal agency said. It projects oil prices will average $103 a barrel this year, up 30% from last year, and will be even higher next year.

Meanwhile, there is a growing suspicion that OPEC is holding back on oil production to keep prices high:

There appeared to be signs of growing panic behind the latest declaration from the International Energy Agency. The statement calls on oil producing countries to increase production and reduce costs in order to avert economic crisis. To date Opec members have been insisting that the market is well supplied and that prices are being driven by speculation. Saudi Arabia actually reduced production substantially in April on claimed lack of demand.

However, it is becoming clear that high oil prices are currently attractive to Opec leaders confronted with social unrest as it allows them to increase subsidies and other financial transfers to their populations.

It is mainly the unverified claim of Saudi oil reserve production capacity that the world has been depending on to keep global transportation costs affordable. Thus any move to raise oil prices by withholding production would be bad news. From an economic point of view, $90 oil acts like a new universal tax that puts a floor under the costs of all globally traded goods and commodities.

As the Saudi oil gets harder to produce, the scale of new capital investments needed to keep up production from the aging Saudi fields apparently establishes a new price floor of about $91 per barrel on their oil.

Saudi seen needing $91 oil to fund gov’t spending plans
Bloomberg, arabianbusiness.com, 13 May 2011:

Saudi Arabia, the world’s largest crude exporter, needs oil to trade at about $91 a barrel this year to cover the cost of government programmes, according to the Centre for Global Energy Studies. The country has “ratcheted up” spending and requires high prices to maintain the commitments, CGES chief economist Leo Drollas said on Friday at the Platts Crude Oil Markets conference in London

The latest oil production numbers

The latest world oil production figures show that global oil production has fallen back from a recent high of about 88 to about 87.5 million barrels per day. Nobody can say for sure yet if this is the peak, but these latest global oil production figures are only slightly above the previous global production peak of 2008, when global production reached about 87 million barrels per day, and the price hit $147 a barrel.

Is there any relief from high fuel prices on the horizon? Frankly no. The world economy has now recovered to the previous peak of global trade in 2008, just before the “Great Recession.” With trade recovery comes a parallel recovery in demand for oil. Lacking any fuel alternative, an expansion of global trade implies a proportional expansion of the supply of fuel needed to move the traded goods.

If global oil (or other liquid fuel) production doesn’t increase, then global trade cannot expand (barring perhaps a global readoption of sailing ships, etc). Since trade has recovered, oil has to expand in step, or market demand will raise global oil prices high enough to kill the recovery, as it did in 2008.

There is speculation that global trade has managed to recover (to the degree that it already has) only by tapping into the stockpiles of oil reserves already on hand. Unless world oil production increases to its previous peak of about 88 million barrels per day, something has got to give before too long, likely by the end of this year.

How soon till we hit the peak oil price wall?

How soon before things suddenly get a whole lot worse, as opposed to gradually worse? Probably by sometime in 2012, oil prices will spike high enough to shut down the U.S. economy and send it into recession again. This may be happening already. If you think times are hard now, expect worse next year. Here are some specifics offered by Martenson in this snip from his longer essay, well worth reading to fully appreciate the gravity of the current global oil supply situation.

How the major economies can continue proceeding with a business-as-usual mindset given the oil data is really quite a mystery to me, but that’s just how things happen to be at the moment. At any rate, with Brent crude oil having lofted over $100/bbl at the beginning of February and remained above that big, round number for four months now, we are already in the middle of a price shock. It may not be a perfect repeat of the circumstances of the 2008 oil shock, but it’s close enough that the risk of an economic contraction, at least for the weaker economies, is not unthinkable here. Japan, now in recession and 100% dependent on oil imports, comes to mind.

Looking at the new data and reading even minimally between the lines of recent International Energy Agency (IEA) statements, I am now ready to move my “Peak Oil is a statistically unavoidable fact” event to sometime in 2012, which tightens my prediction from the prior range of 2012-2013.

Upon this recognition, the next shock will drive oil to new heights that are currently unimaginable for most. First, $200/bbl will be breached, then $300, and then more. And these are in current dollar terms; any additional dollar weakness will simply be additive to the actual quoted price. By this I mean that if oil were to trade at $200 but the dollar lost one half of its value along the way, then oil would be priced at $400.

As we now see here, the U.S. economy does appear to be headed down into a double dip recession, with private job creation in serious decline. What bank wants to lend into a faltering recovery, involving a consumer population greatly burdened by existing mortgage debt, high unemployment, and rising food and fuel prices? The biggest banks can do better investing in profitable deals backed up by U.S. government guarantees:

There’s no money going to the private sector. There are no loans, no leases, no venture capital, no anything. It’s another day in the United Socialist States of America, where bankers are paid well for borrowing at 0.25% from the government and lending at 0.5% to the government.

Risk-taking? Never heard of it! Why should anyone take risk, when you can get a tax-advantaged 7.4% yield on the preferred securities of banks who are too big to fail? And why should the banks take risk when they can make a decent living doing nothing?.

If there is no economic recovery and no relief from high oil prices either, it means working longer hours and cutting discretionary spending elsewhere to just support our car habit — no matter what our dollars are finally worth next year.

Next time: Peak Driving and Peak Cars.

[Roger Baker is a long time transportation-oriented environmental activist, an amateur energy-oriented economist, an amateur scientist and science writer, and a founding member of and an advisor to the Association for the Study of Peak Oil-USA. He is active in the Green Party and the ACLU, and is a director of the Save Our Springs Association and the Save Barton Creek Association. Mostly he enjoys being an irreverent policy wonk and writing irreverent wonkish articles for The Rag Blog. Read more articles by Roger Baker on The Rag Blog.]

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