Sludge Report #160: The Price Of Oil

Published: Tue 11 Nov 2003 01:53 PM
What's It Got To Do With The Price Of Oil? – MED Provides Quality Advice, Yeah Right! - Let Me Count The Ways This MED Forecast Is Moronic - An Extremely Simple Calculation - There Is 30-40 Years Worth Of Oil Left - What Does This Mean About The Price Of Oil - So Who Else Has Their Head In The Sand On This Issue
NOTE: Authors of this report will be anonymous and wide ranging, and occasionally finely balanced. Indeed you are invited to contribute: The format is as a reporters notebook. It will be published as and when material is available. C.D. Sludge can be contacted at The Sludge Report is available as a free email service..Click HERE - to subscribe...
Sludge Report #160
What's It Got To Do With The Price Of Oil?
"All major oil companies now recognise that world oil production has peaked or is close to peaking. Estimates of when the decline begins – and that is when price begins to rise steeply – vary from 5 to 20 years. What we do know is that we are currently finding 1 barrel of oil for every four we burn. "
- LTMB - Third Reading – Jeanette Fitsimmons Speech
When Green Party Co-Leader Jeanette Fitsimmons made this speech in the House last week a penny of sorts dropped. Not that anyone much noticed, other than Sludge. Nevertheless it was still progress.
Ms Fitsimmons comments were the first public evidence that Sludge has noted of anyone involved in the policy setting apparatus of this government noticing that there is a meaning to the word "non-renewable" that doesn't apply to a climate change context.
But yesterday the emerging evidence of some official cognisance of humanity's greatest challenge for the coming century quickly evaporated.
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MED Provides Quality Advice, Yeah Right!
As regular readers may have by now discerned energy forecasts are something of a hobby horse for C.D. Sludge.
So when the MED's latest Energy Outlook arrived in the inbox yesterday it was opened with more enthusiasm than might ordinarily be expected for such a seemingly dry sounding morsel of brain food.
Late last year Sludge engaged in some correspondence with the author of this particular officials' report to the government, Ministry of Economic Development (MED) researcher Andrew Smith attempting to clue him in a bit about the issue of peak oil.
The correspondence gave rise to an earlier sludge report, published in September 2002 (see…
Sludge Report #141 – Discussing Oil With The Beeb ) in which this column expressed a view on the wisdom of one of the MED forecast's central assumptions.
"…if it is really arguable that there is 35 years or less oil supply left on planet earth, why are the Ministry of Economic Development’s energy boffins basing long term energy forecasts - to the year 2020 - on an assumption of 'oil prices dipping to US$19 per barrel in 2002 before rising US$22 per barrel in 2015 and stable thereafter' ?", Sludge asked at the time.
And to make sure that Mr Smith did not miss Sludge's views on this point, he forwarded him the article, plus a series of links for further research.
Mr Smith responded by mailing some documentation concerning the extent of the undiscovered reserves of oil on planet earth, which according to some may be roughly as big as those already discovered.
But while news of these hypothetical supplies of oil was indeed news to Sludge, it did not change the underlying thesis of the argument presented below, namely: that oil will eventually run out, that the peak in production is rapidly approaching and NZ as a country needs to prepare ASAP.
In this context you can perhaps imagine the surprise when on opening the latest MED forecast, Sludge discovered that the latest officials' assumption on long-range oil prices have barely changed.
Now, says the MED, we can expect. "Oil prices rising from $US20 a barrel in 2004 to $US25 a barrel in 2020 and constant thereafter."
As the wits over at Lion Breweries might say, Yeah right!
And, just in case you are inclined to think, "oh well, so what, nevermind", please consider the following.
The combustion of oil is the single largest source of energy consumed in New Zealand. The price of oil is a component in the price of everything that is transported, and that means everything.
Oil is a component of hundreds of thousands of products from plastics and paints to agri-chemicals and household cleansers. All NZ's exports are shipped around the world on boats and planes powered by oil.
If the price of oil were to rise to $60 a barrel or $100 a barrel (and petrol prices to $3 or $5 a litre) how would that affect your choice of transportation mode? What would it do to the export industry? And what about tourism?
And for that matter - and this is where Jeanette Fitsimmons recent comments were directed - does Auckland need a second harbour crossing? Does it need an $8 billion eastern corridor with a sheduled completion date 2010-12? Does Wellington need Transmission Gully?
And finally, a question that Ms Fitzsimmons also asked, why exactly was it that the United States invaded Iraq again?
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Let Me Count The Ways This MED Forecast Is Moronic
In this context we need to look closely at what the MED is telling us.
"Oil prices rising from $US20 a barrel in 2004 to $US25 a barrel in 2020 and constant thereafter."
Firstly there is the wee matter of the current oil price. According to the spot crude oil price is now US$28-$30 a barrel, depending on your variety. This is 50% higher than the forecast assumption. That is, according to the MED forecast the price of oil will fall 33% in the next few months.
So are current oil prices really just a blip? Perhaps the MED is correct about the long term price of oil – "post-WWII oil prices have averaged just under US$20 a barrel and spiked significantly over that only during war or crisis in the Middle East," said a Ministerial spokesman in response a query on the MED's figures.
So what are the recent trends? And for now we can set aside the observation that the United States foreign policy seems to be to maintain a permanent state of crisis in the Middle East in order to secure control over the oil supplies.
According to OPEC the August 2003 basket of crude oil price was $29 a barrel. At that time the average price had been over $25 a barrel since August 2002, and for most of 2003 it had been around, or over, $30.
Yesterday the New York futures market was anticipating the price of crude oil rising next month not falling. At the time of writing Bloomberg had a future price on crude oil of $31.10 for December delivery.
And then there is the Organisation of Petroleum Exporting Countries' official policy on prices. By virtue of their control over the lions share of the market OPEC effectively control the level of supply for crude oil globally – and through that the price - although it has been noted by many writers that the invasion of Iraq is possibly a bid to do something about this.
Officially OPEC has stated that their target price for oil is $25 a barrel. This, you will recall is the price that according to the MED oil is supposed to rise to by 2020. (You may well think it might have been a more obvious starting point to use as a base price, I couldn't possibly comment.)
However, what OPEC says and what it does is not always the same thing. On the basis of recent conduct all indications are that OPEC is getting used to an oil price above $28 a barrel and that it intends to help it stay there.
So to put this in perspective, then what MED is doing here would be the equivalent of Treasury providing the government with an economic forecast in which they calculate the cost of the weekly food bill at $200 a week rather than $300 a week, and that they hold onto this forecast in spite of a clear statement from the supermarket owners that they intend to keep the price of food at $250 a week or higher.
Ok, so much for the base price assumption. What about the MED projections for the future price of oil?
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An Extremely Simple Calculation
- There Is 30-40 Years Worth Of Oil Left
The following simple calculation was contained in the earlier Sludge report forwarded to the MED forecast's author in response to the last Energy Outlook paper.
OPEC's fact sheet on current oil production - August (See.... shows that oil production is presently approximately 77 million barrels per day.
77 * 365 = 28105
i.e. Current global oil production is 28 billion barrels per year.
According to the US department of energy (See.. there are 1018 billion Barrels of oil in global oil reserves.
1018 / 28 = 36
i.e. At current levels of oil production we will run out of reserves in 36 years.
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What Does This Mean About The Price Of Oil
So what does the prospect of oil running out mean in relation to the price.
Well to be fair to Mr Smith his assumptions are presumably coloured by the notion of the further 1 trillion barrels of as yet undiscovered oil that he referred to.
On the other hand the US Department of Energy – upon whose advice Mr Smith seems to place a great deal of weight - is also projecting a 40% increase in oil demand in the US alone in the coming 25 years or roughly 2% growth a year. Globally you might expect demand to grow even faster than this, particularly in India and China.
But plugging these fairly conservative figures into a spreadsheet we discover that if there really are 2 trillion barrels of oil out there to be recovered, and that if growth in consumption continues at 2% per annum, then we run out in 45 years.
Either way the end of oil is within the lifespan of the average human, and well within the life-span of the average road or railroad.
But of course that is not how it will happen when it happens.
A statistician by the name of Hubbert, who spent lots of time studying oil supply made some discoveries about how oil wells produce oil over time. What he discovered is that any given oil field produces oil over its lifetime in a shape approximating a bell curve. As the oil reserves in the field get lower it gets harder and harder to extract the oil.
Hubbert then extrapolated his discovery to show that all the world's oil wells added together would do the same thing. He called this theory Hubbert's peak. And back in the 1970s the theory received a great deal of coverage, it was then postulated that the peak would occur around now.
What this theory means is that at some point global oil production will stop growing, and will instead begin to decline. The decline will start gradually and then accelerate. The important point to note in this is that once the decline has started it will quickly become unstoppable.
The above graph (often referred to as the "Hubbert Curve,") is based on an Ultimate Recovery of conventional oil of 1750 Gb (Giga = Billion barrels), and depicts alternative scenarios of production. The Swing Case assumes a price leap when the share of world production from a few Middle East countries reaches 30%. This is expected to curb demand, leading to a plateau of output until the Swing countries reach the midpoint of their depletion, when resource constraints force down output at the then depletion rate. [from The Twenty First Century, The World's Endowment of Conventional Oil and its Depletion, by Dr. Colin Campbell, 1996]
Now the price of any good, we are taught by Adam Smith, is a product of supply and demand. When demand exceeds supply prices rise.
Now, as it happens – and you will find if you have a close look at the OPEC link above – it is quite possible that global oil production has already plateaued. Certainly there has been no significant growth in global production in the last two years, though that maybe more to do with economic reasons than production limitations.
If production has peaked then the price of oil is set to begin rising anytime soon. If it hasn't peaked yet then it almost certainly will in the next few years.
Consequently any long-term energy forecast that suggests that the price will lower in 17 years time than it is today is pure nonsense.
Asked why the idea of stable prices for oil is used as an assumption in his forecast, Smith replied that the assumption was based on credible information from the International Energy Agency and the US Department of Energy.
At which point we can probably conclude that these two organisations too cannot be relied upon for sensible advice on these questions. Either that or they have a great deal of faith in the ability of the United States to extract cheap oil from Iraq at gunpoint.
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So Who Else Has Their Head In The Sand On This Issue
In researching this story Sludge is pleased to note that "off-the-record" NZ officials are now beginning to take this issue seriously.
Quite why their concerns remain "off-the-record" is a bit of a mystery, but it is encouraging nevertheless that an understanding of what "non-renewable" means is beginning to permeate some of the orifices of NZ officialdom at least.
But that said, when asked who had input into the MED Energy Outlook, Andrew Smith was quite quick to identify a number of other official ostriches in the bureaucracy.
His report, Smith said, was produced in consultation with the Ministry for the Environment, the Department of Prime Minister and Cabinet, the Energy Efficiency and Conservation Authority and Treasury.
And on that basis we may probably conclude that while the truth about the price of oil may eventually sink in, there is still considerable work to be done.
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Anti©opyright Sludge 2003

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