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The peak oil crisis: it’s not adding up!

In the last week, the three official forecasters of the supply and demand for oil, the IEA in Paris, the EIA in Washington, and the OPEC Secretariat in Vienna, released new forecasts of what they believe will happen to global oil prices and the availability during the next two years. As everybody should know by now, this may be a critical time for global oil production which is hardly growing at all; and consumption in some parts of the world has been increasing rapidly.

Of late, interest has centered on demand for oil with some scattered concerns about how much spare capacity OPEC really has. With global supply close to stagnant, very little growth is expected in the global oil supply in the next two years with the possible exception of the Saudis turning on what spare capacity they have ready to go.

On the demand side, the most interesting case still belongs to China which has consistently shown its ability to throw the oil markets into turmoil by suddenly increasing or decreasing its imports. An unexpected growth spurt in China's economy during 2010, led to a bout of inflation that has the Chinese government and foreign observers worried. For two months now, China has been raising interest rates and bank reserve requirements while at the same time adhering to the mantra that its GDP will grow by 8 or 9 percent this year. Chinese oil demand which increased by over 10 percent last year is widely seen as falling to less than a 5 percent increase in 2011 - maybe.

Some, mostly foreign, observers are saying that China is overdue for an economic setback any day now. China, however, is different from most other countries in that it has 1.3 billion people and a government free from many of the political constraints that inhibit actions in the rest of the world. Beijing, however, has shown the ability to adroitly manage its way through many situations. While eventually, the mightiest must fall, such an event may not be in Beijing's immediate future.

A more important factor in determining the size of China's demand for oil may be the state of its coal industry which has tripled production in the last 15 years. There are already signs of trouble in the offing and without a hefty growth in electric power, 70 percent of which comes from coal, China is unlikely to achieve its goals for economic growth without importing still more energy in some form.

Now for the numbers. This week, the IEA in Paris announced that it was raising its projected global demand for 2011 by another 320,000 barrels a day (b/d). The Agency now says that total global demand for oil in 2010 was 87.7 million b/d, an increase of 2.7 million b/d during the year, and likely will likely increase by another 1.4 million b/d to 89.1 million during 2011. The unexpected increases comes on increased global economic growth and unusually cold weather across the northern hemisphere. In Washington, the EIA says that global consumption in 2010 grew by a smaller 2.2 million b/d to 86.6 million. Such differences are normal in a world where oil production and consumption are often State secrets. Both organizations, however, are looking at an increase of 1.4 million b/d in 2011.

China has the ability to throw the oil markets into turmoil by suddenly increasing or decreasing its imports.

Leaving aside the issue of whether the annual increase in global demand will actually fall by 50 percent in 2011 vs. 2010, we have the current global supply numbers which the IEA says fell slightly in December to 88.1 million b/d. Keep in mind that only about 74 million b/d of this production is real crude oil coming out of a pipe in the ground. The rest is a mixture of lighter hydrocarbons extracted from natural gas, ethanol from plants, and tar sands. These either have much lower energy than real crude, or consume prodigious amounts of energy in their production which amounts to the same thing. Thus, the last 14 million or so of our 88 million b/d is producing much less useful work than if it were real crude oil, and likely is slowly contributing to the increasing demand.

The official bottom line is that IEA's conservative estimate says the world will be consuming 89.1 million b/d this year, while currently producing 88.1. There are only two places the extra oil can come from if we are not to have another damaging and demand killing price spike. Either we draw down global stockpiles or the Saudis increase production. Presently both of these phenomena are underway - OECD stocks fell by 8 million barrels in November and another 33 million in December, not to mention a substantial fall in unofficial floating storage held by speculators. Without fanfare, the Saudis seem to be slowly ramping up production - at least for now.

There are two obvious holes in this rosey scenario that has oil creeping past $100 a barrel this year (It is currently only a couple of dollars away), but not so high as to stunt global growth. First, the problem is whether demand growth this year will be constrained to only a 1.4 million b/d increase vs. the 2.2-2-7 million b/d increase we witnessed last year and near-universal estimates of economic recovery. The other is whether the Saudis really are able or willing to push up production by a million or more b/d to keep prices under control.

Unless these questions are answered in the affirmative, the prospects for a price-spike free year do not look good. The IEA says that China's oil consumption climbed to pass the symbolic 10 million b/d level to 10.2 million b/d in November as Beijing shut down power plants to reach year-end efficiency goals. While everyone seems to be predicting some sort of drop in the torrid pace at which China's demand for oil has been increasing, the question is whether it be as much as the IEA and EIA are forecasting. The Agency's director recently said that OPEC must continue to be alarmed that the recent ascent to near $100 oil is more than just a cold winter as speculators. We all should be alarmed too.

Tom Whipple is a retired government analyst and has been following the peak oil issue for several years.

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