Oil prices mark the need for alternative energy sources
June 11, 2008
By Etienne Swanepoel
The price of oil hit the news recently. Oil is a finite resource. The more oil is produced, the less stays in the ground. Therefore, at some time the world will run out of oil.
There is now a rising concern that the world could, in the next 15 to 20 years, experience the tipping point, more popularly known as peak oil, at which half the total known reserves of oil would have been extracted and consumed.
Peak oil is twofold. It refers to new discoveries and production. Currently, annual discovery of new oil reserves amounts to about 5.5 billion barrels. The world passed its peak rate of oil discoveries in the 1960s, despite advances in discovery technology since then. By comparison, annual production and consumption amounts to 31 billion barrels. In other words, oil is consumed at a faster rate than new discoveries. The difference is "funded" by past discoveries.
Currently, daily consumption amounts to some 86 million barrels per day (bpd). This will increase to about 119 million bpd by 2025. The question is: how will this increase of 33 million bpd be "funded". Up to 2015, Opec will provide half of the additional supply. Thereafter it will provide more than two-thirds. The balance of 11 million bpd (currently only 2.6 million bpd) will by 2025 come from unconventional liquids production such as coal-to-to-liquids and oil sands. Half of the future increases by Opec, about 11 million bpd, will have to come from Saudi Arabia. It is the only country capable of increasing its output by this amount.
Of all the oil that Saudi Arabia has ever produced, 90 percent has come from seven giant fields. These fields have unfalteringly produced oil at record pace for 50 years.
To date Saudi Arabia has been a so-called swing producer. This means that it is able at very short notice to produce and place an additional 2 million to 3 million bpd into the market to "short" supply disruptions which arise elsewhere in the world. In this way, the market is kept wet and prices remain relatively stable.
In a very influential 2005 book, investment banker Matthew R Simmons argues that, far from being capable of increasing its output, Saudi Arabia is about to face the exhaustion of its giant fields and, in the relatively near future, will probably experience a sharp decline in output.
The moment Saudi production goes into permanent decline; the curtain will start closing on the Petroleum Age. Oil will still be plentiful and available, but not in the same abundance and at the same prices.
In any event, it's not a matter of running out of oil but of hitting a production peak. Since 1900, world oil production, that is, the number of barrels that can be pumped from the ground, has risen in near-perfect step with world oil demand. At some point, however, production simply won't be able to match demand.
Probably, this point will not happen suddenly. It will take place over an extended period, much like the old cliché about boiling a frog in water. During this time, a series of events will indicate that we are entering a period of transition: from relative abundance to relative scarcity. Global oil production will also remain at, or near, current levels, but crucially will fail to satisfy future demand at those prices which prevailed until fairly recently.
The world has experienced oil price shocks in the past. These were caused by supply shocks and they were rectified by restoring supply. Then, importantly, prices generally recede to levels before the shock.
This time it seems to be different. The current shock may be demand driven. If so, following a demand shock, economic theory suggests that markets regulate scarcity by means of higher prices to restore equilibrium. It is far too early to tell whether this is the case now. Crucially, it also seems as if Saudi spare capacity is beginning to service increased demand.
Whether the oil price will decline to levels prior to the current oil price shock is impossible to tell. It is likely that current price levels are indicative of a price spike that inevitably will decline temporarily before the onslaught of steeper future prices. This is especially the case if what is said of Saudi reserves is correct.
Whatever the outcome, the reality appears to be that the world is rapidly running out of a resource that in many ways is irreplaceable, taking into account current technology and innovation.
The supply and demand balance is only one of myriad factors currently driving the oil price and we are entering a time of great energy uncertainty. In any event, philosophically, even if a giant oil field was discovered on Main Street today, from a climate change perspective, the world needs to reduce its dependence on oil.
Etienne Swanepoel is a partner at Webber Wentzel. The views expressed are not necessarily those of the firm
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