Friday, May 07, 2004

When Is the Crunch?
Paul Krugman's New York Times editorial today is titled "The Oil Crunch." His theme is the impact of growing oil demand from China and industrializing Asia competing with the growing US appetite for gasoline, against a backdrop of tighter supply in the future. His inevitable conclusion is higher oil prices, perhaps starting now, perhaps later.

In one key respect, his thesis echoes mine: the physical peak of oil production is not the key future event of concern; rather it is the point at which prices go only up, not down, because supply cannot keep up with demand. And his final assertion, that we can "neither drill nor conquer our way out of the problem" is ultimately correct. Where I think we part company is over the crucial issue of timing.

The reason this is so important is that it dictates the kind of response or adaptation that is possible. If the crunch is imminent or already here, then our responses are constrained to efficiency improvements and the increased exploitation of other hydrocarbons, such as gas and coal, plus a continued rapid growth of renewables. But let's be clear about the near-term potential of the latter. If we rapidly doubled the total amount of wind and solar power in use today, we would still cover only about 2% of the world's total primary energy demand.

On the other hand, if we face a decade or more of volatility with as much downward as upward price movement, or even a reversion to the mean oil price of the last decade or so, then many more options become available, including the start of a transition to hydrogen. This is probably the scenario most oil analysts believe, since oil company stock valuations currently reflect an underlying oil price below $30/barrel.

The other missing factor is the location of reserves. While it may be true that no major oil fields have been discovered since 1976 (though this depends heavily on your definition of "major", since a number of fields containing 500 million to 1 billion barrels have been found in that period, plus several over 1 billion), this ignores the number of large, known oil fields not presently being tapped, most of which are in OPEC countries. That implies a long-term increase in OPEC's market power.

And even though geology is not necessarily destiny, it can still provide useful hints about what to expect here. The current mean estimate of the total original conventional oil endowment, the amount of oil that was in the ground before we started drilling, and that can be accessed with current technology, is about 3 trillion barrels. To date, we have produced under 1 trillion barrels of this. That suggests that we still have a ways to go before we reach the midpoint of production, at which the adherents of King Hubbert's theories say production will start to fall.

So what should the average person make of all this? It is certainly confusing and potentially worrying. Right now, based on all the evidence and arguments, I think one should be equally skeptical of those saying that the end of oil is just around the corner and of those saying that the status quo (with growth) can be maintained indefinitely. That says that as a society we should be buying options on large-scale alternatives, but only exercising those that are "in the money" or close to being economical, today.

And what would the prospect of a revolution or catastrophic terrorism in Saudi Arabia do to all of this careful reasoning? I think you can guess, and that's part of what has the oil market unsettled at the moment.

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