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Energy transition and final energy crisis

VHeadline.com oil industry commentarist Andrew McKillop writes: World commercial energy demand, overall, is well over 90% based on non-renewable and environmentally damaging fossil fuels (only 8% is hydropower based, while capital intensive nuclear power depends entirely on non-renewable uranium, thorium and other minerals).

The current ‘oil price crisis’ in reality reflects an emerging and permanent supply crisis for oil and gas (which currently provide about 65% of world commercial energy).

Initially, this will concern ever slower net additions of world production capacity in the face of strong demand growth, and will manifest itself as continued oil price rises, and continued gas price rises.

For oil, the myth of OPEC always being the ‘supplier of last resort’ has in 2004 already been discredited if not finally destroyed. Soon after the present and short-term ‘price crisis’ ... which can only intensify in the 2005-2008 period ... and within at most 10 years, both oil supply and natural gas supply will enter into constant and terminal decline, due to physical depletion.

This is to some, small extent admitted in a grudging way by so-called ‘leaderships’ of the business and political, financial and economic ‘communities.’ Opinion formers and policy makers in late 2004 now admit that ‘oil prices will remain high’ because of fast demand growth and slow growth of supply, but add brave claims that oil prices ‘will fall to normal levels,’ perhaps by the end of 2005, without explaining which normal levels and why!

In fact only two factors can bring down oil and gas prices (which in any case are interdependent and related through same-market trading): increasing supply or falling demand.

For the first, increasing supply, the outlook is bleak. Worldwide oil depletion is now running at about 1.25-1.5 million barrels/day (Mbd) of capacity lost each year, and net additions to world oil production capacity are small, slow, high cost, and irregular.

On the demand side, because of strong industrial growth in China, India, and also in East Europe, West Asia and Latin America, oil and gas demand is growing at its fastest percentage rate since 1975-80.

In many non-OECD countries experiencing fast industrial and economic growth, typical annual growth rates of demand are 5%-9% for oil, and 8%-12% for gas.

World demand growth is admitted by the IEA to be running at 3%/year or more and will stay strong unless world economic recession is triggered through OECD countries racking interest rates to double-digit highs, or by runaway oil price rises to well over US$100/barrel (US$/bbl), equivalent to gas prices at US$16/million BTU, causing an inflation outburst, first and mostly in the OECD countries.

This ‘price crisis’ could occur at almost any time, especially due to further and more intense destabilization and conflict in the Middle East, or through stoppages, accidents, or weather-related damage to very large oil and gas production, refining or transport systems anyplace in the world. We can note that current oil prices, at around US$50/bbl, are in real terms equivalent to only about 60% of the peak price they briefly achieved in 1979-80, over 24 years ago.

Oil crisis then and now: The ‘oil crisis’ of 1979-80 was due to the Iranian revolution cutting supply to world oil markets. The physical supply shortage or undersupply was equal to about 5%-7% of daily needs, for a period of over 4 months.

In today’s terms, with world oil import demand running at around 46 Mbd and growing very fast (at over 3 Mbd per year), an equivalent supply cut would be about 2.5-2.75 Mbd.

This assumes that ‘normal’ levels of spare supply capacity exist, but in fact today’s margin of spare capacity has been deeply cut with the loss, or effective sabotage of Iraq’s oil export capacities (around 2.4 Mbd prewar) through military invasion and destabilization by the US and UK, in what UN Secretary-general Kofi Annan describes as an illegal war.

When this illegal war was decided in 2003, Iraq’s export capacities of around 2.4 Mbd were likely equivalent to 60% or 65% of world ‘spare’ capacity. Today, 18 months later, this spare capacity margin has dramatically shrunk to probably less than 1 Mbd, because of demand growth and effective loss of Iraqi oil export capacities, ongoing depletion losses, and slow growth of new oil production capacity at the world level. Relative to current oil demand, this 0.75-1 Mbd margin is equivalent only to about 4 months of world demand growth, or 3 months of world import demand growth.

* Any supply cut-off, of not much above 1 Mbd and for any reason will in these conditions rapidly lever up oil prices -- and by ‘contagion’ effect gas prices -- in a very short period of time.

Iran attained its ultimate peak oil production more than 20 years ago. Since 1975 its population has nearly tripled, and today it has one of the fastest growing car fleets in Asia (after China), leading Iran to become a large and growing importer of refined products, and a declining exporter of crude.

When or if Iran’s so-called ‘illegal’ nuclear installations are of course ‘surgically’ bombed by Israel or by US forces stationed in Iraq, another Iranian oil crisis, this time by Iranian embargo, would very surely and rapidly drive oil prices well beyond US$100/bbl.

This would again be through political decision, but the emerging and short-term prospect is of near-simultaneous peaks for world oil and then world gas production being attained in the 2008-2018 period. This will bring structural physical shortage and permanent undersupply. We are in fact entering a terminal energy crisis for ‘cheap and abundant’ oil and gas supplies, and recognition of this requires urgent attention and immediate action for energy transition.

In this new and emerging context, there is ever less need or reason for political action, embargo, or war damage -- that is ‘geopolitical risk’ -- to be considered the sole cause of oil and gas prices attaining ‘extreme’ levels. This is due to the ‘pincer action’ of increasing depletion losses and slower annual additions of new capacity in a context of fast energy demand growth. This first limit concerns oil, but within a period no more than 10 years after ‘peak oil’ is attained, the same will occur for world gas production capacities. In addition, and because of ‘peak oil,’ world gas demand will increase very fast through massive demand shift from oil to gas.

Faced with structural under-supply until and unless economic restructuring and energy transition are implemented on a worldwide basis, the final energy crisis will surely test leaderships of the big consumer and importer nations and groups of nations, now including nuclear armed China, India and Pakistan as well as the EU and USA.

Action and goals for energy transition: The Kyoto Treaty and ‘Kyoto process’ for implementing fossil energy saving, reduction of CO² and other climate-changing gas emissions, and development of renewable energy-based, sustainable infrastructures -- that is “clean development” -- will in theory and by about 2012 bring falls in oil and gas demand of some ratifying countries.

Other ratifying countries, such as Germany and Denmark, which have developed large wind electric capacity and are slow growth/high unemployment economies, will not need to target large falls in their fossil energy burn or purchase of tradable licenses to pollute. These licenses or permits essentially transfer nominal responsibility for oil, gas or coal burning from richer, oil- and gas-intensive economies to low income, presently energy-lean or energy-extensive economies.

This effectively ‘exports oil and gas demand,’ entraining faster conventional or ‘classic’ economic growth in the recipient country.

Overall and in fact, Kyoto Treaty implementation starting in about 2008 will result in only marginal, or no total and overall reduction of world fossil energy consumption by 2020-2030.

In the near-term, certainly to 2010-2015, world total fossil energy demand will likely increase even faster than today, because of accelerated ‘conventional’ economic development by the newly emerging industrial superpowers, China and India, and several other large population, fast growing economies such as Brazil, Pakistan and Turkey.

This creates nearly sure ‘trends continued’ outlooks of world demand for oil and gas continuing to expand, perhaps as fast as today, until physical rationing and allocation of fossil fuel supplies becomes the last option and only solution, because of physical depletion.

Oil and gas price rises are totally sure, and the ceiling prices needed before the present market trading system is abandoned is hard to estimate.

Extreme prices for oil and gas will in fact first impact the world’s most oil-intensive and gas-intensive economies -- that is the OECD group of countries. This will surely start causing severe economic difficulty within the very short-term near future, in the 2004-2006 period. This makes it of strict national interest for OECD countries to set plans for physical rationing and supply allocation, and start implementing programmed cuts in oil and gas consumption, and development of renewable energy output capacities over and above any Kyoto process requirements, which in any case will not start being applied much before 2008.

By 2015, it will be urgent to consider ways and means to reduce world total oil and gas demand on a year-by-year basis. Given the vast scope of such a program, and the need for the OECD countries to act in the immediate short-term of 2004-2008, the action and goals of a world energy transition program should be proposed, discussed, decided and start being applied from 2004-2005. Currently there is almost no movement towards to setting frameworks and agendas for this very urgent task.

Geopolitical risk: In the mid-term and long-term there is recognized need to cut oil and gas burning to limit climate change. More importantly in the short-term there is an increasingly urgent need to limit and head off oil and gas price explosions able to trigger ‘great power rivalry’, that is armed conflict for remaining reserves of oil and natural gas between the world’s economic superpowers, motivated by ‘national economic survival.’

World regions most exposed to this risk are evidently the Middle East and Central Asia, and to a lesser extent Africa. We can note that threats of using military invasion, or actual invasion -- of Iraq in 2003 -- did not in any way ‘facilitate and improve’ oil supplies to the large consumer countries and groups of countries.

In fact the exact opposite: the US-UK invasion of Iraq has effectively sabotaged or neutralized Iraq’s oil export capacity for many years.

Any international plan and program for energy transition, perhaps modeled on or incorporating the Kyoto Treaty, must ensure that oil producers are not exposed to military invasion, nor catastrophic falls in the oil price and their export revenues, when or if they choose to husband or conserve their non-renewable resources, and cap their oil or gas production before reducing it, instead of waiting for resource depletion and exhaustion to do the same job. No “obligation to supply” a depleting, non-renewable resource exists.

The risk of great power rivalry for remaining oil and gas reserves is high. Even the most unconditional believers in “unlimited oil and gas reserves” accept that covering depletion loss, and adding net production capacity takes time and is increasingly costly to develop.

The risk, or threat of large nations or groups of nations ‘jumping the queue’ and taking oil and gas production capacity wherever it already exists -- leading inevitably to armed resistance, as in Iraq -- is real.

Certainly since 1973, political deciders in the US have considered that any embargo or ‘unreasonable’ reduction in supplies of oil, by exporters, is hostile to US vital interests -- opening the way to retortion or revenge by military invasion, to restore the ‘free flow of reasonable priced oil’ ... as it was called by George Bush-1 at the time of the ‘liberation’ of Kuwait in 1991. Any other large oil-importer nation, or group of oil-importer nations with nuclear weapons capability can adopt the same ‘oil supply security’ doctrine.

Participation in faster development and construction of non-oil, non-gas renewable energy alternatives to fossil fuels, and especially substitutes for oil, will therefore reduce invasion risks for oil and gas exporter countries. The same effort will also reduce ‘threats to economic security’ of the large oil importer nations and groups of nations.

As noted above, current and future oil and gas ‘supply gaps’, causing undersupply to markets, will become structural. This will raise the risks from failed attempts at obtaining oil reserves or production capacity through military invasion, as in Iraq.

Logically, this should lead to renouncement of the ‘military option’ for obtaining oil and gas production capacities.

The non-option of military invasion as a ‘respose’ to declining supply and rising prices should urgently be replaced by international cooperation and action for energy transition, featuring concerted near-term multilateral action to first limit growth, then reduce world total oil and gas utilization, while rapidly developing larger-scale renewable energy systems.

The double-edged sword of oil and energy prices: On the one hand higher oil prices increase world oil demand until very high prices are attained, as is very simply verified by checking world oil demand growth, and growth of oil prices through 1999-2004. On the other hand, much higher oil and energy prices are obligatory for rationalizing and justifying replacement and substitute energy sources, systems and strategies in the energy economy.

Neither of these two propositions are accepted.

The so-called financial community, notably the presidents of the US, European and Japanese central banks, and the IMF’s Chief economist have in 2004 repeatedly claimed, without presenting any coherent evidence, that high or ‘extreme’ oil prices can only depress economic growth.

If this happened, it would lead to a fall in world oil demand growth, or even to zero growth of world oil demand, with actual contraction of demand being possible if the ‘hard landing’ continued. In fact the real world, real economy does not operate this way. Increasing oil prices tend to reinforce and increase economic growth at the world level, leading to further oil and energy demand growth.

* Through the period 1999-2004, as oil prices have increased, world oil demand growth rates have consistently increased -- not decreased.

To accommodate this distressing ‘reality gap’ between official mythology, and measurable economic reality, so-called ‘experts’ now add that ‘extreme priced oil’ will not hurt economic growth until about 12 months have elapsed, enabling the ‘real but delayed action’ negative impacts of high priced oil to work through the economy. This fantasy economics is unlikely to translate to reality unless interest rates in OECD countries are hiked to double-digit rates.

Higher priced oil will almost certainly continue to drive world economic growth until oil prices attain at least US$75/bbl.

In addition, the first slowing impacts on economic growth of much higher oil and energy prices will occur not in low income oil-importing countries, as repeatedly claimed by official economic mythology, but in the most oil-intensive economies and societies of the OECD group of countries. Oil saving is therefore of basic interest, concern and utility to the most oil-intensive, oil-wasteful economies and societies.

Development of renewable energy systems has in general been slowed first by derisorily low and volatile prices for competing fossil energy sources through 1986-99, ‘hidden’ infrastructure subsidies for fossil-based energy and nuclear power, and by high capital costs and long lead times for proving, then developing large scale renewable energy systems. In addition, renewable energy is often low-intensity and needs wide area conversion, making necessary the integration of energy-only production and output with other forms of local or regional economic development (e.g. agriculture, sylviculture, mariculture, horticulture etc). For all of these reasons, high and stable fossil energy prices are needed to make renewable energy systems competitive and feasible using conventional cost-benefit analysis.

For the oil and gas exporter countries ... whether OPEC members or not ... there is also at least mid-term, and surely long-term national interest in developing and proving substitutes and alternatives to fossil fuels.

One major reason (apart from reducing invasion risk) for their active participation in oil- and gas-saving and fossil energy replacement by renewables is to conserve their non-renewable economic resources and limit environment damage, and economic resource misallocation caused by maximizing extraction.

Oil saving and personal oil consumption: Annual personal or per capita oil demand (PCOD) rates are entirely dependent on economic development, urbanization and personal consumption. Rates vary in the OECD developed, high consumption, oil-intensive economies, where car ownership rates range from about 40-75 cars/100 population.

The ultimate peak for the OECD group is about 25 barrels/capita/year (bcy) in the USA and Canada, and is around 10-12 bcy in the EU nations, Japan, South Korea, Taiwan and Singapore.

Conversely, the low income but fast growing, high population, industrializing countries including China, India, Pakistan and Brazil, with under 5 cars/100 population, currently use only about 1.25 - 2.5 bcy.

Due to extreme consumption in the OECD nations, world average PCOD (about 4.7 bcy and increasing, albeit slowly) is well above per capita oil demand in the new and emerging industrial superpowers, and over 8 times the average PCOD of rural populations in the low income countries of Africa, Asia and Latin America.

Total commercial energy demand is in general 2-3 times the above rates for oil-only demand and consumption, depending on development and utilization of pipeline gas and LPG, the use of domestic and imported coal, and the size and output of installed non-oil electric power capacities.

In many low income countries, so-called ‘non commercial’ energy, that is biomass source energy specially in rural areas, contributes up to 30% or more of total national energy consumption. Urban migration and urban industrial development, driven by and causing further rural-urban migration, inevitably shifts energy demand from ‘non-commercial’ to commercial energy.

The net result is to increase national average PCOD, making it necessary to prioritize sustainable rural development not only to assure food supply and conservation of bio-resources, but also to limit national oil and gas demand growth.

Current and conventional urban-industrial economic infrastructures are close to 100% dependent on oil and gas energy, thermal electricity, and hydrocarbon based raw materials, as well as derived products (for example gas and oil-based fertilizers and insecticides for food production, materials utilized for building, and energy needs of operating ‘conventional’ habitat and transport systems).

Economic growth, worldwide, is at present entirely dependent on increased oil, gas and electric power consumption. This results in potential world oil and gas demand being effectively close to ‘unlimited.’ If for example the world was able, by miracle, to attain the extreme heights of US oil consumption (about 25 bcy) world oil demand would run at around 445 Mbd. This production capacity -- very simply -- will never be attained on this planet. No energy agency, data source or ‘expert’, however optimistic or illuminated, will provide claims that world oil production capacity can ever exceed about 120-150 Mbd before ‘peak oil’ is attained.

Despite this reality, US politicians claim that US-style ‘prosperity and wellbeing’ are global objectives and can be attained for example in militarily invaded and occupied Iraq: if this occurred, Iraq’s current 25 million population would require about 1.75 Mbd, or well above Iraq’s present total, war damaged oil production capacity !

Energy transition imperatives: The first imperative can be understood from the above: with the world’s current population of around 6.4 billion, and maximum likely oil production capacity of around 90 Mbd, world average PCOD will probably never attain more than a short-term peak of around 5.25 bcy.

* After this peak, average PCOD will decline at about 3%/year, as oil and gas depletion sets in after 2008 while world population continues to grow, albeit at ever shrinking rates.

The decline rate of 3%/year for average PCOD can be split as around 1.5%/year for the fall in net oil production, and about 1.5%/year due to remaining population growth. From about 2010-2015, depletion will accelerate the annual decline of world oil production to 3.5% or more, and world gas output will at that time peak out, before starting to decline.

Current rates of oil and gas demand on a per capita basis in the OECD group, especially the US and Canada, are therefore impossible to sustain and must be reduced by large amounts in a short period of time.

Conversely, the low and medium income nations and economies can target some small increase in their national average PCOD, during transition. In all cases the role of oil and gas prices will be significant in entraining and directing economy restructuring for energy transition.

It is 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 world oil production peaks, and preferably well before. This requires the OECD countries to set targets for oil demand reduction able to accommodate short-term increases in the PCOD of the emerging industrial powers, still in demographic transition and rapidly developing their economic infrastructures.

Overall, this results in targets for OECD national oil demand cuts, and within a short period gas demand cuts, at rates up to 10%/year, depending on national demographic trends.

For evident geological and environmental reasons, the fossil fuels will phase out, and must be replaced by reduced overall energy needs, and by increased supply of renewable energy. The second imperative, therefore, is for large-scale multilateral program for rapid, cost-effective development of sustainable economic infrastructures based on renewable energy sources.

Conclusions: The strengthening likelihood is that oil prices will easily exceed US$75/barrel in the absence of any war, sabotage or hostile action, solely because of ‘structural undersupply’ and almost certainly by 2008. This itself will powerfully draw attention to study and action for firstly slowing the growth of oil and gas demand, then reducing demand for these fossil fuels.

Only at genuinely ‘extreme’ oil prices, well above US$100-per-barrel, will there be a rapid and uncontrolled fall in fossil energy demand, firstly in the OECD countries, triggered by economic crisis.

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 but increasing international conflict and warfare focused on the Middle East (‘war against terror’ and ‘war for oil’).

De-globalization, or increased self-reliance will necessarily feature in longer-term restructuring of the world’s energy and economic systems.

The sooner that internationally agreed targets, frameworks and structures for managing energy transition can be set, the greater is the chance of avoiding endgame energy resource conflicts, and achieving long-term sustainability.

The likely, near-term oil shocks due in final analysis to emerging supply deficits will be ‘salutary crises’ if they bring coherent 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 France he is available for consultation and research assignments. You may contact Mr. McKillop by email at xtran04@yahoo.com

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