Commentary: Global Energy Drivers in a “Black Swan World”
(Note: Commentaries do not necessarily represent ASPO-USA’s positions; they are personal statements and observations by informed commentators.)
On July 23, Tom Petrie—co-founder of Petrie Parkman & Co., an oil-industry analyst group which was purchased by Merrill Lynch in 2006 and merged into Bank of America last fall—gave a presentation to a group called Boulder Tomorrow. The following write-up was gleaned from Petrie’s power-point slides as well as from his general remarks there and pre- and post presentation comments; while every effort was made to be very faithful to his presentation, this is not a word-for-word summary. Petrie will be speaking at the ASPO-USA conference in Denver on October 13th.
Last year the global credit crunch and its knock-on effects precipitated the sharpest oil and gas price declines in over two decades. Despite the recent $100+/ Bbl price implosion and subsequent partial recovery, we have now entered an historic inflection point—call it “practical peak oil”—in the global balance of conventional energy supplies due to:
1) undeniable conventional resource maturity—an aging infrastructure above aging oil fields;
2) entrenched resource nationalism;
3) realigned economic and national security interests—the resource base could accommodate further growth if the oil were not in the hands of countries acting increasingly in their own self interest; and
4) environmental sensitivities.
Due to recent low prices, we have seen evidence of powerful self-correcting forces regarding the future supply outlook for oil and gas. To cite just one example, given investment trends we thought two million barrels of production from the Canadian oil sands was likely by 2011. With slowdowns due to low prices and other concerns, 2 mb/day is more likely by 2014-2015. And this is just one example of many around the world.
What spiked prices last year? In part, there is an under-appreciation of how much the world changed on the demand side. Back in 1980, large chunks of the world population were living under oppressive government regimes. Consider that there was systematic impoverishment of Indian and Chinese populations. When that changed, it laid the foundation for large demand growth. When combined with some level of price subsidies in developing nations, that meant it took a much bigger price spike to trigger demand elasticities in the developed world. Right now it’s too soon to know if the current demand reduction is a one-to-two year or three-to-five year or multi-decade event.
One important point related to oil price spikes: A key difference between the recent price spike and those of 1973-74 and 1979-80 is that back then we still had new fields to bring on stream to keep the oil supply both cheap and growing. Not so today.
“Practical peak oil” is a reality. It will rear its head again. World oil production won’t come down super-fast. But three or four years of coming depletion won’t be offset by new production investment. You can make a really good case that in the future we won’t significantly exceed last year’s level of world oil production.
A black swan event, from Nassim Taleb’s book The Black Swan, is an event deemed to be low probability by most people—be they in markets or elsewhere—that ends up having high impacts on those same people and many others. An example is the way market players and homebuyers assumed that the probability of housing prices dropping steeply was a low-probability event. And the depth and rapidity of the recent oil price crash could be viewed the same way. From the high oil prices of the spring and summer of 2008, I expected we would hit a low, but one not nearly as low as that which we experienced. In the world as it’s now evolving, the risk of a series of petroleum “Black Swan” events needs serious consideration in capital allocation decisions.
“Peak Gas” concerns could somewhat lag “Peak Oil” challenges. Right now, natural gas is actually a bright spot in an otherwise troublesome energy world. There should be good availability of natural gas going forward, despite the self-corrective forces that are kicking in right now—with much lower prices driving down the number of active drilling rigs. For the next couple of decades, the natural gas supply picture is pretty positive. It should provide a much-needed and substantial bridging function as we build up the other alternatives over the next 15-20 years.
We’ve entered a period of long-term change. During this transition, prices changes will probably be more important and have more impact that policy changes. Every president since Nixon has talked about reducing oil dependence and every one has failed.
Energy policy can be approached as a Rubic’s Cube in which sequence matters. Sequence can determine whether you will be successful or not. When it comes to fuel efficiency and alternative fuels, you tend to get what you incentivize for; we worked to keep energy prices low, compared to the Europeans, which is why our energy efficiency dropped off during the second half of the 1980s and all of the 1990s. However, despite all the incentives, biofuels has not been and probably will not be a big game-changer. Archer-Daniels-Midland seems to claim that “if we need more fuel, we’ll grow it,” which is a half-lie.
Electrification of a meaningful portion of the U.S. transportation network appears to be a worthwhile potential target. To cite one example, plug-in cars could be a real game-changer if we can achieve the necessary breakthroughs in battery technology. If the industry can make plug-ins that achieve 20 to 40 mile ranges in electric mode, that can lead to cars achieving the equivalent of between 70 and 100+ miles per gallon. That could lead to oil import reductions in the US of 3 to 5 million barrels a day, and globally perhaps a 10 million barrel/day reduction. But there are plenty of problems here. For starters, the batteries are not there yet, and it takes well over a decade to turn over the fleet. If you started seriously with plug-in hybrids in 2015, the real changes would occur during the 2020s time frame.
What about nuclear? It has very long lead times. I can’t imagine any new plants up and running within eight years or less. But in my view, if we want to run plug-in hybrids and generally electrify transportation, nuclear has to be part of the equation. Yet it’s no panacea; in fact, there isn’t any panacea anywhere.
If you combine a push for plug-ins with a push to use natural gas in fleet vehicles, you can come up with a notion of 15 to 25 million barrels-a-day reduction in world oil consumption in a couple of decades. But to make this happen, the combination of U.S. and Chinese leadership would be critical. We need an understanding on the commonality of interests here. If we resort to resource wars, everyone loses.
Dealing with cap-and-trade legislation is going to be tough. Intuitively, I can’t buy the notion that the impact will be only $175 per family per year, based on the massive give-away of emission credits in the current House bill. The Senate will probably start over with a version completely different from Waxman-Markey. I believe we need something like cap-and-trade or a carbon tax, but I’m much more for the latter. I worry about future fraud and future scandals that could be created with cap-and-trade. But when it comes to gasoline taxes, it’s pretty hard to get elected with a platform of “I’m here to picket your pocket” with new taxes.
We are finally entering into a period of meaningful, and probably prolonged (as well as painful), downward adjustments in oil consumption. Real oil price developments are likely to be as (or even more) important than governmental policymaking in shifting demand patterns. While game changer options are now identifiable, their full implementation is likely to prove challenging, expensive, and at least somewhat disruptive over a several decade period. US Energy policymaking failures have plagued most post-Vietnam presidencies that have taken it on as a priority; President Obama’s expected efforts are more ambitious than those of any of his predecessors. The risk of a series of energy “Black Swan” events needs serious consideration in determining both capital and portfolio energy investment allocation decisions.