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Economy restructuring and peak oil

VHeadline.com oil industry commentarist Andrew McKillop writes:  World oil demand is increasing at a probable new long term rate of about 2.8%-3.3% annual, close to two times the average annual rate during the long ‘cheap oil interval’ of 1986-99.

At the present trend rate of demand growth we get to 88-90 million barrels/day (Mbd) as total world production capacity by 2007-2008.

According to an increasing number of oil analysts and experts this may be an effective and absolute ceiling of world production capacity. This effective peak is due on one hand to increasing rates of capacity loss from depletion (around 1.25-1.5 million barrels/day lost each year).

On the other it is also brought closer by decreasing rates of new or expanded capacity being added, for a variety reasons including generally higher capital costs and much smaller average field sizes. In addition, world discoveries trail far behind world consumption on a yearly base (annual consumption is on average far above yearly discoveries, and is running at about 30 billion barrels consumed for 7.5 billion found).

Under any hypothesis, increasing amounts of so-called ‘tertiary, synthetic or extreme environment’ oil production will be needed, at much higher cost and longer lead times, reinforcing the effective limit on peak capacity to around 90 Mbd.

The so-called ‘financial community’ and notably the presidents of the US, European and Japanese central banks claim that high or ‘extreme’ oil prices can only depress economic growth, which would lead to a fall in world oil demand growth, or even to zero growth (or a fall) of world oil demand.

In fact the real world, real economy does not operate this way. Increasing oil prices in fact tend to reinforce and increase economic growth at the world level, leading to further oil demand growth. This process will continue until oil prices greatly exceed US$75/barrel, which in constant dollar terms (corrected for inflation and world purchasing power of the dollar) is far below the most recent peak price attained in 1979-1980.

At the time, and before use of the so-called ‘interest rate weapon’, that is extreme interest rates to strangle economic growth and depress oil demand, world oil demand was increasing at a long-term rate of close to 4%-per-year.

Annual per capita oil demand (PCOD) rates are entirely dependent on economic development, urbanization and personal consumption. Rates are at least 10 – 12 barrels/capita/year (bcy) in the EU nations, Japan, South Korea, Taiwan and Singapore, that is ‘conventional’ developed, high-consumption societies. Only in poor and very poor nations are PCOD rates far below 4.7 bcy (the world average, which is currently increasing, albeit slowly).

Current and conventional economic infrastructures are nearly entirely dependent on oil and gas-based technology and products (from farm machinery, fertilizers and insecticides for food production, to ‘modern’ habitat and transport systems). This results in potential world oil demand being close to ‘unlimited’. If the world was able, by miracle, to attain the US rate of oil demand (a PCOD of about 25 bcy in 2003) world oil demand would at present run at around 445 Mbd. We can note that US oil demand is currently increasing faster than US population growth, raising US per capita average oil demand.

The restructuring need:
It is therefore necessary, and urgent to consider ways and means to reduce world oil demand growth to zero, and then reduce world oil demand, at latest from the date of world peak production and preferably before. On the one hand there is the need to cut oil and gas burning to limit climate change, as embodied by the Kyoto Treaty, but this set of ‘good intentions’ is easily sidelined or denied.

Conversely, the strengthening likelihood of oil prices going well above US$75/barrel when world oil markets are exposed to ‘structural undersupply’, almost certainly by 2009, will powerfully draw attention to study and action for firstly slowing the growth of oil demand, then reducing demand. Increasing shortage of oil supplies will ensure that oil producers are not be exposed to catastrophic falls in the oil price, and especially if producer nations choose to husband their non-renewable resources, and cap their production before reducing it.

In the present, notably due to regional destabilization of the Middle East by the Iraq war and increasing menaces of ‘surgical bombing’ of Iran’s ‘illegal’ nuclear installations by Israel or by US occupation forces in Iraq, oil prices can easily spike to $75/bbl.

Given the current situation, as well as the emerging outlook of world peak production capacity not being much above 90 Mbd, and world demand easily able to attain 90 Mbd by end-2007 at current rates of growth, there is little real chance of cheap oil returning. It is unwise to count on oil prices below $35-$45/bbl ever returning.

This loss of cheap oil will not in any way compromise conventional economic growth -- because higher priced oil, at least to about $75/bbl, will in fact increase world economic growth -- but it will also and inevitably increase the ‘visibility’ of, and support for economic restructuring. This will necessarily be international and multilateral, the Iraq war proving, if proof is needed, that war and military occupation are not effective ways to increase oil production by, and exports from Iraq or any other Middle Eastern producer country.

Globalization and autarchy:
It is important to understand that any kind of economic factor limit or constraint (e.g. increasing energy costs) does not instantly place the world economy into an ‘either-or’ context of either total globalization or total autarchy, defined here as local, national or regional self-reliance.

Emerging oil supply, and then natural gas supply limits will however impose a very different form of ‘globalization’ from that of today, and will also encourage or enable a different form of ‘autarchy’ from that described by economic historians and theorists, including both Ricardo and Marx. Study will necessarily include scenarios where de-integration or reverse globalization of the world economy can occur with the minimum friction and conflict. This is for the simple reason that current or ‘conventional’ globalization accelerates urbanization, energy-intensive agriculture, and increases dependence on transport.

In short, ‘conventional’ globalization generates near unlimited potentials for the increase of personal energy consumption and the ‘ecological footprint’, or space and natural system resource demand, of each person.

World population growth rates are falling, quite rapidly and consistently since their all-time peak of the 1960s, and annual world population increase by number of additional persons has fallen quite fast from its all-time peak of 1995 (at around 95 million additional population, worldwide).

Despite this, and as noted above, world oil and energy demand per person is increasing, and the ‘ecological footprint’ per person, in the high-energy, urban industrial nations, has attained extreme levels that are unsustainable and impossible to replicate at the world level.

This can be understood by noting that a 10% cut in oil demand by the OECD group of countries would cut world oil demand by about 5 Mbd, while a 10% cut in the combined oil demand of China and India (with a total population over two times that of the OECD) would reduce world demand by less than 0.9 Mbd. One scenario can therefore feature continued economic growth but at lower rates than present, in the developing world.

This can be understood through closely analyzing economy-wide (not sectoral) energy intensities of GDP, which are far lower in low income countries, helping to explain why these countries are not ‘the first victims’ of higher oil prices.

Conversely, economy restructuring in the OECD group, to accommodate the oil production capacity ceiling, is unavoidable and urgently necessary. World oil prices rising beyond $75/bbl will certainly trigger huge interest rate hikes in the OECD countries, leading to monetary inflation, increasing economic or factor cost inflation, and result in deep recession.

Reducing average PCOD in the advanced industrial nations will necessarily attract attention when oil prices rise to $50-75/bbl, but few studies and analysts set out the range of possible targets.

These targets will necessarily be ‘heroic’, that is very high. One example would be a target of reducing per capita oil demand of the USA by 50% in 10 years, and reducing EU-15 (the highest energy members of the EU-25 group) PCOD by 33% in 10 years. It can be noted that ‘Kyoto compliance’ for a few EU nations which have experienced quite fast economic growth through the 1990s to date (all EU nations have ratified the treaty), such as Ireland and Spain, will require these countries to reduce their oil and gas burn by as much as 30%-35% in the ‘compliance period’ of 2008-2012.

We can note that ‘Kyoto compliance’ also includes ‘tradeable licenses to pollute’, that is the potential for buying credits from low-energy, low-polluting nations. This is effectively the same process generated by delocalization and outsourcing of industrial production (the net result being export of oil and gas demand). It is questionable if this form of globalization can generate sustained reductions in world oil demand, and will likely tend to increase world average PCOD.

International energy cooperation:
The most important aspect of energy restructuring is the treatment of the ‘demand side’, rather than attempting to find ‘supply solutions’. World average PCOD is only about 4.66 bcy in 2004, and well over 70% of the world’s population utilizes less than 3 bcy. This low or ‘modest’ oil consumption in fact shelters the economies and societies of low-consumer nations from the impacts of ‘oil shock’, again reinforcing the argument that reducing average PCOD inside the OECD group of countries is the most urgent task and priority -- for the strict benefit and interest of OECD citizens.

Economic and technical solutions to over-dependence on oil and gas (and electricity) in the OECD nations may in fact be found in the low-consumer, non-OECD countries, and will necessarily include more extensive (instead of intensive) agriculture, more collective forms of transport, and utilization of biomass, solar, and other renewables.

Specifically concerning hydropower, it is noted that the very highest-possible ‘net energy yield’ (total energy output against energy required to build and operate installations) is with hydropower, and the lower-income, lower-energy countries have the greatest reserves of presently undeveloped hydro potential.  Large-area, world regional electric power grid supply is therefore both rational and feasible, especially where smaller scale, more sustainable but higher capital cost hydro installations are built.

It can be noted that OTEC or ocean thermal energy conversion is yet again a ‘tropical country resource’, or potential resource especially suited to integration with ocean fish farming or mariculture. Current interest in, and development effort in both these domains (large-scale regional hydropower, OTECs and mariculture) are almost non-existent but this in now way reduces their huge potential, as with geothermal energy. Energy infrastructures will by necessity become ever more multiform or polyvalent, that is integrated with food and habitat support systems, requiring more detailed and integrative study of costs and payback.

Laisser-faire solutions are the road to ruin:
Alternatively, we can wait for oil depletion signals to cause runaway price rises, triggering ‘panic’ or ‘defensive’ interest hikes in the OECD bloc. This will be a quick acting process leading first to monetary inflation, and then to economic inflation.

The final result, which will also come rapidly, will not only be economic recession, but long-term economic depression similar to the 1929-36 period.

Entry to long-term depression will surely cut world oil demand growth to zero, but actual contractions in demand will not in fact be very significant. This can be appreciated by the ‘oil-shaving’ impacts of the 1980-82 recession, which was second only to the 1929-31 entry to, or slide into the Great Depression by the rate at which economic activity, business profits, employment, and merchandise trade were slashed.

The 1980-82 recession yielded ‘only’ about 9.6% less oil demand at the world level over 3 years. After peak oil it is likely that world oil supply will fall at around 3%-3.5% annual for several years, before accelerating to much higher annual rates.

Of course history ‘never repeats itself’, and the 1929-36 Great Depression may or may not have made World War 2 inevitable. Given the current and certainly continuing ‘clash of civilizations’ it can be suggested that subjecting the world economy to another great depression would be like throwing oil on an already bright-burning fire.

If there is any lesson to learned from fast emerging limits on world oil and gas supply it is that oil is too precious to waste on fanning the flames of war

Conclusions:
Increasing oil and gas prices, up to levels around $75/bbl or barrel-equivalent ($10-13/million BTU) will certainly be called ‘extreme’, but will not in fact choke off world energy demand.

The likely net impact of price rises to $75/bbl, if interest rates in the OECD countries are not ‘vigorously’ increased to double-digit base rates, will be increased world oil demand due to continued and strong economic growth. This ‘perverse’ impact of higher prices will therefore tend to reduce the time available for negotiating and planning energy and economic transition.

Only at genuinely ‘extreme’ oil prices, well above US$100-per-barrel, will the pro-growth impact of increasing real resource prices be aborted by inflationary and recessionary impacts on the world economy.

This will come too late to offer any chances of organized and efficient economic and energy restructuring, especially in the OECD economies and societies, which are the most oil-dependent due to their high or extreme average per capita rates of oil demand.

Laisser-faire scenarios will necessarily include a new ‘Great Depression’ to a backdrop of already serious tension and low-level international warfare (‘war on terror’). Increased local self-reliance or ‘autarchy’, and de-globalization will necessarily feature in longer-term restructuring of the world’s energy and economic systems.

The sooner that frameworks and structures for managing transition can be set and agreed, on a world wide basis, the more fossil energy resources can be retained for smoothing adjustment in the necessarily long-term projects and programs that will be needed for achieving sustainability.

Making the case for energy transition and sustainable development is difficult, if not impossible, with political leaderships in the richworld drugged by the irrational slogans of ‘New’ Economics and the supposed inevitable and welcome effects of ‘conventional’ globalization.

The likely, near-term oil spikes and shocks due to emerging supply deficits (which also apply to natural gas) may break the policy stranglehold that has descended like night on serious study, and following action to head off irremediable crisis.

Andrew McKillop  is a former expert-policy and programming, Division A-Policy, DG XVII-Energy, European Commission, founder member, Asian Chapter, Intl Assocn of Energy Economists. Currently in Paris (France) he is available for cunsultation and research assignments.  You may contact Mr. McKillop by email at xtran04@yahoo.com

More VHeadline.com commentaries by Andrew McKillop

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