Storm, The (13 page)

There has been evidence, carefully evaluated by Matthew Simmonds, that the big fields in Saudi Arabia, notably Ghawar, the
world’s largest field, which produces 5 million barrels / day, have serious depletion problems, reflected in high water content
in major wells. The Saudis are very secretive, but Simmonds has concluded that production is being maintained only with difficulty
and has peaked. Kuwait has also been found to have exaggerated its reserves. More generally, the big technological ‘fixes’
that have lifted the oil industry in the past may raise production, but they
do not produce more recoverable oil, so the wells deplete that much faster.

Furthermore, the oil companies are an important source of estimates of resources, but, ‘peak oil’ theorists argue, have an
incentive to boost the figures to the maximum in order to inflate their share price. Shell was caught in the act in 2004,
creating a major scandal at the time, and there is a continuing debate as to whether this was a one-off event or a systematic
distortion. There is also an opposite argument, advanced by Richard Pike of the Royal Society of Chemistry, that companies
tend to
underestimate
resources so as to inflate the oil price and hence their share price. He also argues that measures of proven, rather than
probable, reserves systematically underestimate reserves.

There is an equally formidable reply to set against ‘peak oil’ theory – though, since it mainly comes from people described
as ‘insiders’ in the oil industry, it does not have the same ring of publishable authority, with a few exceptions such as
Peter Odell. He claims that conventional oil will not peak until mid-century, and unconventional sources such as Canadian
tar sands not until the end of the century. Morris Adelmen of MIT has argued that ‘the amount of oil available to the market
over the next 25 to 30 years is for all intents and purposes infinite’. This optimism is based on several considerations.

First, proven reserves are reported as having increased by 1.5 billion barrels over the last three and a half decades (though
just over half that amount has actually been consumed), so that predicted years of supply are increasing, not decreasing.
Some of this increase in reserves represents new discoveries, but much of it represents revisions in the light of technological
advances and higher prices (reservoirs have increased their recovery rate from 20 per cent to 35 per cent over that period).
Critics say that oil companies exaggerate, that the big numbers hide gradations of confidence, and that rising reserves may
well coexist with declining production. Nevertheless, the fact is that oil reserves are rising despite unprecedented economic
growth

Secondly, many parts of the world are largely unexplored. India recently produced a substantial field onshore in Rajasthan
and claims that there may be big undiscovered fields offshore. Brazil has identified a large offshore field, and the South
American Atlantic continental shelf is mostly unexplored, as is Africa’s, albeit with several fields already identified and
producing in Nigeria, Angola, Equatorial Guinea and elsewhere. Russia has not been explored with the latest technologies.
There are reportedly numerous potential fields in Iraq (which, even without invoking conspiracy theories, is undoubtedly one
of the reasons for the US presence there). The Saudis argue that there is enormous unexplored potential in the Iraq border
area. The list is long, even without invoking exotic possibilities like the North Pole (a recent survey by US geologists has
suggested that the Arctic may contain a fifth of the world’s undiscovered but recoverable resources, amounting to 90 billion
barrels of oil, enough to supply the world for three years, most of it in Arctic Alaska). It can be argued that depressed
prices over two decades explain the underinvestment in developing this potential. Between 1998 and 2008 spending on exploration
by the top ten oil companies fell from $11.3 billion to $8 billion.

Thirdly, low prices, have caused research and development to be cut back. But enough technology is known and developed for
the companies to be able to say that much more can be extracted from existing fields, as well as new ones, using steam injection
techniques, 4-D seismic analysis, or electromagnetic detectors. And it is now possible to drill deeper underground and underwater.
Development wells are no longer hit and miss but almost 100 per cent accurate.

Then, there is the brave new world of non-conventional oils, now at last beginning to be developed in Canada, which can potentially
multiply reserves many times over. There are some formidable obstacles, not least a highly polluting extraction technology,
the destruction of forests and high costs. But the problem is not geology or chemistry. The oil industry has long argued that
non-conventionals will fill the gap left by conventional oil, just as what is now called conventional oil filled the gap created
by the last ‘peak oil’ problem, when the sperm whale was hunted to near-extinction in pursuit of its blubber in the mid-nineteenth
century.

These are finely balanced arguments, and my own economist’s leanings are with the optimists. It may be, however, that ‘peak
oil’ theory is right for the wrong reason: politics rather than geology. No amount of technology will boost exploration or
production if producing countries are unwilling or unable to utilize it. Several major producers are hobbled by conflict or
political instability – Iraq, Iran, Nigeria and Venezuela – while Saudi Arabia’s political stability cannot be guaranteed.
Even where there is stability, resource nationalism is potent. Nationalized industries dominate in almost every major producing
country outside the Anglo-Saxon world, even in developed countries like Norway. There are moves to close off access to private,
especially Western, oil companies in Russia. And other non-OPEC producers – Brazil, India, China, Mexico, Malaysia – give
a dominant role to state-owned or state-dominated companies even at the expense of access to capital and technology, at least
in the short term. Government-owned companies now control about 73 per cent of world oil reserves, 55 per cent of gas reserves,
and half of all oil and gas production. It may be that these companies will mimic multilateral oil companies – as some already
are doing – by investing overseas, raising capital in international markets, welcoming minority investors and collaborating
over technology. But there is also a fear that corruption, incompetence and politicization will undermine the capacity to
explore and produce.

Two other factors may inhibit the growth in production necessary to break free from ‘peak oil’. The economics of collective
monopoly, or cartel, behaviour do not suggest that it is in the interests of producers to maximize production. Particularly
the rich and less populous OPEC countries have every incentive to keep oil in the ground if they calculate that the resulting
appreciation in price will exceed the return they can obtain by producing, exporting and holding income-yielding securities.
Another is that most oil-producing countries have had experience of the negative effects of oil: the so-called ‘curse of oil’.
Oil brings riches, but it can also bring massive waste, corruption, unsustainable spending and over-concentration of power.
Overvalued exchange rates make manufacturing and agriculture uncompetitive. Smarter governments now channel much of their
oil income into ‘stabilization funds’, distributing the proceeds slowly. Others simply do not produce as much. Peak production
may not be a function of geology as much as of these political and policy constraints. The practical implication is that when
the world economy recovers from the current slump in growth, and oil demand, it may hit up against oil supply constraints
quite quickly, and we may find that the main oil producers are not at all accommodating.

The discussion so far has been conducted on the assumption that the energy price shock has been exclusively about oil. Actually,
world demand for primary energy is, very roughly, equally divided between coal, oil and gas (with non-fossil fuels having
about 20 per cent). The other primary fuels have also been subject to the same demand factors pulling up prices. Coal may
present environmental problems, but not the concerns about peak supplies and restriction of supply that apply to oil; only
a relatively small proportion of coal that is used is internationally traded; supplies are vast relative to current demand;
and the big exporters, notably Australia, have no inhibitions about supplying the market. If the ‘peak-oil’ theorists are
right that we are heading for tight oil supply and high prices, one consequence may be an environmentally unfriendly switch
to coal as well as dirty non-conventional oils. Gas supply is potentially more problematic.

Until recently, gas attracted little attention. It was seen as essentially worthless or, at best, a side product from oil
development. To this day, large volumes of gas are flared off, rather than used
productively, most controversially in Nigeria. But the attractions of gas as a relatively clean fuel have grown, since it
produces less pollution than coal and less carbon per molecule than oil or coal. Other than piped gas for domestic heating,
gas has substantially displaced coal for power generation in the UK, Germany, Japan and the USA. It is also being turned into
liquids with potential as a transport fuel. Unlike oil, however, gas is not easily transported without large infrastructure
and logistics investment, which meant that, until recently, markets were essentially regional rather than global. Transporting
gas to remote markets requires compressing and cooling it and shipping it as natural gas. It is only within the last few years
that LNG ‘trains’ (that is to say, ships) have been developed to supply significant gas importers like Japan, the UK, the
USA, India and China.

What has promoted gas from the footnotes to the main text is the fact that one quarter of world reserves, and just under a
quarter of production, originates in Russia and is controlled by its majority state-owned gas company, Gazprom. Russia is
the dominant supplier of gas to eastern and western Europe, through big pipelines across Belarus and Poland, with another
through Ukraine and the former Czechoslovakia. Germany now takes 30 per cent of its gas from Russia; France and Italy are
major customers; and the UK may become so after around 2015. Although the USSR proved to be a reliable supplier of gas during
the Cold War years, the worry has begun to grow either that Russia will seek to exploit a dominant supplier position to extract
higher prices or that politics will intrude, with gas becoming a ‘strategic’ weapon. The cutting off of supplies to Ukraine
and Georgia for what appeared to be political reasons has fuelled this anxiety. Such concerns have undoubtedly played a role
in persuading the British government to support new nuclear power. A calmer analysis would suggest that these fears are greatly
exaggerated. It is possible to secure a wide diversity of gas supplies (for the foreseeable future, Britain’s supplies will
be from the British, Dutch and Norwegian North Sea, and increasingly from LNG). There is
a severe dearth of the storage capacity that would, if built, enable the economy better to withstand shocks – as is already
the case in Germany, Italy and France. Gas price surges – which took prices from under 40p per therm in January 2007 to 100p
per therm in mid-2008 – have much more to do with the poorly functioning EU market than the global market, or Russia. Russian
(and other) gas exporters have as much interest in security of demand as importers have in security of supply. The separate
– and almost certainly exaggerated – fears about gas supply nonetheless amplify the political disquiet about energy supply.

The collapse of oil prices in the latter part of 2008 did, for the moment, remove worries about the impact of an oil price
shock on consuming countries. It is possible that, as in the 1980s, the issue will recede into the background, allowing the
world economy to recover from the financial storm and recession. But that is optimistic. There remains the capacity for further
serious disruption if production fails to expand. Indeed, the collapse of oil prices makes that more likely than not. Some
OPEC countries could be plunged into political instability, which would disrupt production. State oil companies will have
their coffers raided in order to keep their governments’ budgets afloat. The oil multinationals will cancel investment projects
that are no longer viable. When the world economy next recovers, there may not be the capacity to respond. The recovery of
crude oil prices from $40 to $80 in late 2009 suggests that only a moderate revival in growth will have a big impact on prices.