With this decision, the Western countries venture to play for high stakes. If all goes well, their decision will calm the oil markets until Saudi Arabia steps in with increased production from its reserve capacity. If things go bad, however, they not only run the risk of injecting even more uncertainty into an already volatile market but also to jeopardize their improved relations with the oil-exporting countries that took years to build up.

Many oil traders will probably have choked on their coffee last week when they heard that some of the strategic oil reserves would be released. The announcement by the head of the International Energy Agency (IEA), Nabuo Tanaka, came indeed as a surprise. Oil prices seemed to have peaked in April, or at least to have stabilized since a few weeks. More importantly, Saudi Arabia and other Gulf states with spare capacity had promised to ramp up their production, even though a majority of OPEC members expressed itself against such a production surge when they met in Vienna on June 8. Nevertheless, the IEA countries felt that they had to act by releasing stocks.

The IEA was established in the aftermath of the first oil crisis of 1973-74 with the primary aim to act as a crisis manager on the oil market. To that end, the agency commands a powerful weapon: each member country is obliged to maintain strategic oil reserves of 90 days. It is only the third time ever that these stocks have effectively been used. The first time was in 1991 after the Iraqi invasion of Kuwait and the second time was in 2005 when Hurricane Katrina wiped out much of the oil production facilities and refineries in the Gulf of Mexico. Both market interventions are considered to be successful.

The western oil-consuming nations have traditionally treaded very carefully with these buffer stocks, which were long considered the “oil market equivalent of a nuclear weapon” as Javier Blas wrote in the Financial Times on June 23. These stocks were never intended to be used as a tool to manipulate the price of crude oil. Instead, they were designed as a last-resort lifeline to be used only in the most extreme circumstances, such as in the case of a severe disruption of oil supplies due to a terrorist attack. The fact that the emergency supplies were not used during major market disturbances such as the Islamic Revolution, the second Gulf War, or the oil price shock of 2008 illustrates the prudence with which the IEA has handled these reserves.

Moreover, in recent years, there seemed to be a gentlemen’s agreement between the IEA and the OPEC countries with spare capacity (mostly Saudi Arabia) with regard to responding to supply shortages. This is remarkable because these two clubs, the IEA and OPEC, were very hostile towards each other until the late 1990s. The agreement was that, when a supply shortage would occur, the IEA member countries would let the OPEC countries act first, before undertaking any actions itself. Sarah Emerson put it very succinctly in a 2006 article in Energy Policy: “30 years of energy security policymaking by the consuming countries of the IEA came to a head in the conclusion that OPEC’s spare production capacity, read Saudi Arabia, would officially be the first line of defense in an oil emergency.”

Today it appears as though the IEA has switched to a new doctrine. For the first time in history, the agency has used its strategic petroleum reserves in a preventive way, not because there is an actual oil supply shortage, but because it believes that such a shortage is imminent. The upcoming summer driving season, the reconstruction of Japan and the end of the maintenance period for many European refineries will push oil demand up in the coming weeks. The IEA has not waited for the shortage to happen, but it has made a bolt move to anticipate it. According to some observers, the decision of last week’s Thursday may be the prelude of a more interventionist oil market policy, in which the western countries will use their buffer stocks to adjust the price of oil.

In such an interventionist policy, however, lies a double threat.

First, while it is true that a stock release can bring temporary relief to a tight oil market, its longer-term effects are far more uncertain. The global strategic petroleum reserves currently stand at record levels but, obviously, they shrink as soon as they are tapped and they will have to be replenished later on (possibly at higher prices). Tapping the reserves for oil price manipulation leaves us with a smaller buffer, which makes us more vulnerable to acute crises caused by unforeseen events, such as terrorist attacks, natural disasters or political embargoes. Uncertainty about the IEA’s doctrine may also increase volatility in the market because it creates confusion with the oil traders. Furthermore, if oil stocks are not used to offset temporary shortages, but to address protracted (structural) oil shortages, the consumers of oil are not forced to adapt their behavior, thus aggravating the underlying problem.

Second, an interventionist oil market policy could undermine the relations between oil producer and consumer countries. While the IEA move was reportedly made in close coordination with Riyadh, it actually places Saudi Arabia in a difficult position. The IEA kept stressing that its stock release was meant to supply the markets with extra crude until additional Saudi Arabian oil production would come online. If the Saudis succeed in increasing their production within a month, they may infuriate other OPEC countries even more and fuel the dissension within the self-proclaimed oil cartel. If they fail to do so, then they pose the IEA for a big problem because the Paris-based agency will then be under pressure to prolong its stock release.

Importantly, besides being bifurcated between these two allegiances, Riyadh’s room for maneuver is limited in yet another way. Over the past months, it has made huge public expenses to buy off domestic social peace. As a result, the Kingdom now needs a much higher oil price than it did just a few years ago to balance its budget. Whatever action they agree on, the decision-makers in Saudi Arabia are likely to tread on someone’s toes in the coming weeks.

Thijs Van de Graaf, Department of Political Science, Ghent University

The oil markets have been transformed radically over the last ten years, with the following main features:

- 2000-2003 was marked by relative price stability inside a variation band (22-28 dollars a barrel) which had been decided and set up by the Organisation of the Petroleum Producing Countries (OPEC) following the price collapse in 1998 (10 dollars). This variation range was considered adequate, neither too low to meet the financial needs of exporting countries nor too high to avoid the negative effects on the world economy;

- the years between 2004 and 2008 were marked by an explosion in the demand for oil sustained by strong world economic growth, both in emerging countries and in the United States. Prices soared towards 100 dollars without affecting world economic growth too severely;

- at the same time, there was a huge upsurge in financial markets for oil, refined products and, more generally, for commodities . This rapid growth of the financial sphere – with a volume of transactions that would today represent about thirty-five times the oil traded in the physical market – goes hand in hand with increasing numbers of participants, financial products and marketplaces, some regulated (organised markets) and others, of increasing importance, unregulated (over-the-counter – OTC – markets).

- the 2008-2009 period has therefore raised the problem of interactions between the physical and financial elements. It is marked by three successive phases: between January and July 2008, oil prices rose to 145 dollars, which quickly raised questions over the potential role played by financial markets; between July and December 2008, they dropped to 36 dollars, due to a financial adjustment in investors’ positions and falling demand resulting from the economic crisis; during 2009, prices rose to 80 dollars which seems contrary to the state of the physical fundamentals, notwithstanding OPEC’s production cuts.

Oil prices are essentially determined on organised futures markets (American WTI and European Brent contracts) according to both physical and financial fundamentals. The first define the dynamic balance between supply and demand: both feature very low short-term price elasticity, which thus creates conditions of intense volatility. The second go beyond the petroleum market alone and contribute to the operation of financial markets as a whole, where different types of assets, including oil, are constantly competing with each other. Oil therefore creates two distinct demands in the physical and financial markets: a demand for “physical” oil and a demand for “paper” oil.

Players in these markets can have different objectives: price hedging, taking trading positions (speculation), arbitrages over time and between products, portfolio management and risk diversification, especially for indexed funds. One and the same participant can sometimes cover all these objectives.

The complexity of interactions between the physical and the financial therefore restricts any unequivocal explanation of the massive oil price variations in the recent period. In the many published works on the subject, it is difficult to distinguish between the defenders of physical fundamentals (the demand from emerging countries, the fears of a “peak oil”, the economic crisis, etc.) and the defenders of financial fundamentals (the role of exchange and interest rates, the upsurge in “paper” oil, the development of new products like commodity index funds, the “herding” behaviour of investors, the action of arbitrageurs between spot and futures markets and its limits).

Nor do available statistical data establish clearly the links of causality between the open positions of financial investors in futures markets and the prices observed in the spot market.

On the other hand, nothing suggests these links can be excluded. It is therefore reasonable to conclude that:

- speculation by some financial actors has amplified the upwards or downwards price movements, increasing the natural volatility of oil prices;

- it cannot be excluded that such movements occur again in the years to come, with natural volatility joined by that of financial investors who consider oil (and more generally commodities) as a class of arbitrable assets compared with others;

- strong pressure on the prices will appear by the end of the decade, mainly due to physical fundamentals (under-investment in new production capacities);

- the functioning of financial oil markets and the financial logic of their operators include risks which are difficult to control and may generate a systemic risk.

The question of the price of oil therefore ends in the more general problem of financial market regulation.

This conclusion is derived from a working group on oil price volatility, I recently chaired. Our report commissioned by the French Minister of Finances also proposed a genuine oil strategy for Europe which would include:

- developing demand scenarios for petroleum products for the Union, consistent with the medium-term energy guidelines ;

- an active role in monitoring, even regulating physical oil markets, as much for concerns over transparency and competition as to ensure consistency with actions undertaken in the financial commodities markets;

- improve the reliability and shorten the delay for publishing statistics on petroleum products stocks in Europe, before even thinking about increasing the frequency of these publications;

- harmonisation of oil taxation in the context of low-carbon energy issues;

- improved coordination of national energy-environmental policies to manage jointly the construction of a less carbon-intense energy package, with controlling demand for petroleum products playing a central role in these policies;

- cooperation with the Southern countries who are also seeking to reduce their dependency on oil and the volatility of prices.

Jean-Marie Chevalier, Professor at the University Paris-Dauphine and Director of the Centre of Geopolitics of Energy and Raw Materials

The Bush Administration’s energy policy, to the extent that there was any policy, was the former. When petrol prices hit new highs, the administration would send emissaries to Saudi Arabia asking for increased OPEC production. There was little attention paid to increasing fuel efficiency of cars – or better yet – allowing higher prices to do the job by encouraging gas sipping rather than gas guzzling cars. And as far as the Bush Administration was concerned, climate change could wait for the next President.

Candidate Obama’s promise was that he would reverse Bush era policies. But President Obama has discovered that it was one thing to promise as a candidate and an entirely different thing to deliver given a skeptical Congress, powerful special interest groups and pressure from strategic partners.

A case in point was a proposal by Enbridge Energy to build Alberta Clipper, a 1,000 mile pipeline to transport 800,000 barrels of oil extracted from tar sands of Alberta to the US. Environmentalists on both side of the border opposed the pipeline since extracting oil from tar sands is energy-intensive and causes significant water and land degradation. Estimates vary depending on who you ask, but most experts say extracting a barrel of oil from tar sands releases at least 5 times more greenhouse gas emissions as that associated with conventional oil.

A similar pipeline proposed by TransCanada received Bush administration’s blessing in 2008. Environmentalists, hoping that things would be different under the Obama administration, were disappointed when the US state department granted a permit for the project to proceed in mid August.

The project’s opponents point out that allowing the pipeline to be built would be the wrong decision at the wrong time, just months before the Copenhagen conference in December. The critics ask how can the US – or Canada – seriously talk about averting climate change in Copenhagen if one country is willing to ruin its landscape and the other is willing to buy the dirty oil so Joe Plumber can drive his gas guzzling SUV on $3 per gallon oil?

Keith Stewart, director of climate change at World Wildlife Fund Canada was quoted in The Financial Times (11 Aug 09) saying, “Approving new mega projects like Alberta Clipper pipeline would lock North America into the old, high-carbon energy economy,” adding, “We need to invest in the green economy of the future, not pour billions into the Betamax of the energy world.”

By allowing the project to proceed, Obama’s green credentials are tarnished.

F.P. Shioshansi

This post is extracted from EEnergy Informer, September 2009 issue.

The study found that:

• An abrupt and extended fall in the global oil supply and the resulting higher prices would seriously disrupt U.S. economic activity, no matter how much or how little oil the United States imports.
• Oil-export embargoes have been ineffective in advancing the foreign policy goals of oil exporters.
• Oil-export revenues have enhanced the ability of rogue states, such as Iran and Venezuela, to pursue policies contrary to U.S. interests.
• Terrorist attacks cost so little to perpetrate that attempting to curtail terrorist financing through measures affecting the oil market will not be effective.
• The United States might be able to save an amount equal to between 12 and 15 percent of the fiscal year 2008 U.S. defense budget if all concerns for securing oil from the Persian Gulf were to disappear.

The United States would benefit from policies that diminish the sensitivity of the U.S. economy to an abrupt decline in the supply of oil, regardless of its import dependence. The United States would also benefit from policies that would push down the world market price of oil by curbing demand or increasing competitive alternative supplies. U.S. terms of trade would improve, to the benefit of U.S. consumers; rogue oil exporters would have fewer funds at their disposal; and oil exporters that support Hamas and Hizballah would have less money to give to these organizations. The United States might also benefit from more cost-sharing with allies and other nations to protect Persian Gulf oil supplies and transport routes. The United States could encourage allies to share the burden of patrolling sea-lanes and ensuring that oil-producing nations are secure.

Andreas Goldthau

P.S. The RAND study was sponsored by the Institute for 21st Century Energy, which is affiliated with the U.S. Chamber of Commerce, and can be found here.

Some energy analysts are concerned that the world will soon face a global crisis due to dwindling petroleum resources and a peak in oil production. To shed light on the subject, we have assessed the threat that depletion poses to the availability of petroleum resources by estimating cumulative availability curves for conventional petroleum (oil, gas, and natural gas liquids) and for three unconventional sources of liquids (heavy oil, oil sands, and oil shale).

Our analysis extends the important study published in 2000 by the U.S. Geological Survey on this topic by taking account of (1) conventional petroleum resources from provinces not assessed by the Survey or other organizations, (2) future reserve growth, (3) unconventional sources of liquids, and (4) production costs.

The figure below shows the cumulative availability curve for conventional petroleum,
heavy oil, oil sands, and oil shale. The curve has three relatively wide blocks, each representing an unconventional source of liquid. The combined future volumes of conventional petroleum, heavy oil, oil sands and oil shale total 29.9 trillion BOE.

Global Cumulative Long Run Availability Curve for Conventional Petroleum and Unconventional Sources of Liquids Including Heavy Oil, Oil Sands and Oil Shale

The life expectancies for any particular energy resource depends on three factors—its future volumes, its current production, and the growth over time of its production. In the case of conventional petroleum, for example, we calculated that with production growth of 2% a year (which is somewhat above the average annual growth in production over the past several decades) future volumes from assessed provinces, assuming no future reserve growth, would last for 47 years. Adding in future volumes from unassessed provinces increases this figure to 55 years and considering future reserve growth pushes it to 70 years.

The table below shows that the life expectancy of 70 years increases to 87, 104, and 132 years when future volumes from heavy oil, then oil sands, and finally oil shale are taken into account. If we consider all three unconventional resources, but a future growth rate of 0%, the life expectancy of 132 years increases to 651 years. Alternatively, the table shows that assuming 5% future production growth reduces the life expectancy to 70 years.

Life Expectancies

In conclusion, even if conventional petroleum peaks, as some predict will happen soon, this does not necessarily mean a ‘hard landing’ with sharply increasing prices and declining consumption. Rather society may rely increasingly on unconventional resources, including heavy oil, oil sands, and oil shale as well as non-fossil sources of energy. Should non-fossil fuels become more important, some of the higher cost fossil fuels including conventional petroleum resources may never need to be exploited. These implications suggest that expectations of a sharp rise in real oil prices over the next decade or two may be misplaced. Indeed, a case can be made that the high prices observed over the past several years for conventional oil are not sustainable given the available conventional and unconventional energy resources that can be exploited at costs below current market prices and substantially below mid-2008 prices.

Roberto F. Aguilera (IIASA), Roderick G. Eggert (Colorado School of Mines), Gustavo Lagos C.C. (Catholic University of Chile), and John E. Tilton (Colorado School of Mines and Catholic University of Chile)

P.S. More on this research is available from our forthcoming paper, “Depletion and the Future Availability of Petroleum Resources” (The Energy Journal, Vol 30, No. 1, 2009).

It has often been said that the recent rise in prices is not comparable to that of 1973, the first oil crisis having been triggered by a reduction in supply whilst the present oil price increase could be attributed to runaway demand. Note, however, that during the 1960s, worldwide consumption of petroleum products increased by 7 to 8% annually, but production capacities did not increase at the same rate. The events associated with the Israeli-Arab conflict (i.e., the Yom Kippur war) accelerated the rise in prices, but that rise would most likely have occurred anyway, although spread out over time as it has been the case since 2000.

In short, the rise in prices over the past few years, as in 1973, reveals the need for consuming countries to make decisions to promote energy savings and the development of alternative energy technologies. As in the seventies with the French nuclear program, several steps have already been taken, in favour of biofuels for instance. In spite of growing nationalism and a lack of opportunities for international oil companies, investment in exploration and production is increasing. Note, however, that the major part of this increase in investment is due to the inflation of costs, only a small part corresponds to an increase in activity.

In the absence of geopolitical events, it is possible that production capacities will be restored if all development projects are realized as planned. We might then see a stabilization or an erosion of prices for a few, or several, years. However, if demand continues to grow, these recent measures may prove to be not sufficient. Then, even if the “oil peak,” strictly speaking, only occurs around 2030, it is likely that the production of natural hydrocarbons will be unable to follow demand as early as the beginning of the next decade. Before prices return to a new long-term equilibrium which could be about $100 to $ 150 a barrel (in constant dollars), it is highly likely that an additional “crisis” will occur, similar to the 1979-80 crisis, with price levels of $200, $300 per barrel or more for several years. These high prices will probably be necessary to promote an inevitable energy transition, for investments to be made both on the supply side as well as on the demand side in order to develop renewable energy sources without major subsidies, to stimulate the production of synthetic fuels, to renew nuclear programs, etc.

Last but not least, we should bear in mind the role played by expectations and how forecasts can be self-destructive in the oil industry. One especially relevant example relates to the 1985 price drop. Political and industrial decisions resulting in energy efficiency, substitution, exploration and production of “difficult” oil in non OPEC regions occurred not simply because the price of crude was high but because it was considered unlikely that prices would not continue to rise. Consequently, the most effective factor for avoiding the coming crisis of a dual shock scenario would be a consensus about its arrival. In this context, the fact that the 5-6 year forward price of oil is at present reaching a hundred dollars is probably to some extent rather good news.

Denis Babusiaux, Pierre- René Bauquis

This post is derived from “Depletion of petroleum reserves and oil price trend” a report we wrote for the French Academy of Technology. You can dowload the report in French here and the English version here.

The Russian market is dominated by ten vertically integrated oil companies, which control 95 percent of Russia’s crude production and more than 80 percent of its refining capacity. While the Russian state now controls a significantly higher share of the domestic oil industry than it did during the 1990s, state-controlled companies at present make up only around 25 percent of the country’s oil production and around 16 percent of its refining capacity, thanks to a series of takeovers of private companies by state-owned Rosneft and Gazprom. 2 The domestic Russian oil market is fairly competitive, with prices determined by world markets and by the taxation policies of the Russian government.

From these few facts, three simple considerations can be deduced. First, given that the Russian state does not hold a majority in domestic oil production despite recent takeovers, the Kremlin is able to “steer” the oil industry for political purposes only indirectly, i.e., via tax incentives, export regimes, pipeline access, predetermined auctions on new fields, and the like. While these are by no means negligible instruments, they hardly render Russian oil an effective foreign policy tool. Second, Russian oil companies — state- or nonstate-controlled — trade their oil on a global market. Unless a majority of Russian crude is bound in bilateral contracts, a rather unlikely scenario in the foreseeable future, Russian oil companies do not have great leverage over individual consumers. Whenever Russia decides to cut oil supply to a consuming country, it will have no major effect, as the targeted country can purchase the shortfall on the spot market and circumvent the “blockade” (unless all producer countries, i.e., opec, decide collectively to block oil supply to their customers — which is unlikely to happen, especially if a non-opec member pushes for it). In case of some Central European countries like Slovakia, where the existing pipeline infrastructure does not allow replacing Russian crude oil in the short run, potential cut-offs can be largely absorbed by using alternative transport routes such as railroads.

Third, and related, the Russian state may well initiate further renationalizations of oil assets and expand state control over the oil industry in the future. But such moves will only diminish the performance of the Russian oil sector and reduce output growth rates, as similar experience in other countries has shown. Yet they will not affect oil markets as such, nor are they likely to render oil an effective foreign policy tool.

That leaves gas. True, Russia holds the world’s largest gas reserves, and it has emerged as the most important supplier country to Western and Central Europe, where it covers up to 100 percent of imports for some countries. And, true, this dependence will become even more pronounced in the near future, when depleted European resources need to be compensated by higher imports — also from Russia. Despite this apparent dependence of European gas customers, however, there is no real case for an “energy weapon” for two reasons, both of which lie in the nature of the gas market. First, since exploration of gas fields and pipeline construction are extremely expensive and time-consuming, producers and consumers engage in long-term contracts that usually cover 20 years or more and entail destination clauses prohibiting secondary trading. Based on these take-or-pay contracts, the producer is able to invest in a multibillion-dollar project, as there is a constant and reliable return on investment. The consumer enjoys a guaranteed supply for several decades, thus reducing uncertainty and costs. Second, gas is a regional play, as it is almost exclusively transported via pipelines. 3 Hence, if either the producer or the consumer wants to opt for exit and start dealing with an alternative contractual partner, he has to make a high additional investment, i.e., build a new pipeline. Given extremely high upfront costs, it becomes very costly for either involved party to leave an established bilateral contractual gas relation. A quick look at the dense pipeline grid connecting Europe and Russia reveals that neither side can be interested in dumping all the money each have invested; nor do they have a real choice.

Russia does not have the option to sell its gas to, say, China, since the existing infrastructure is insufficient, at least in the short run. Nor can the Europeans simply turn away from their Russian provider. In other words, both sides are mutually dependent, from the very moment they have committed to a contract. What follows from the structural logic of the gas market is that there is only a limited possibility for Russia to use natural gas as a foreign policy instrument and unilaterally cut gas supplies to a consuming country without significantly and immediately affecting its own budget revenues. This does not look like an attractive move for a country whose largest share of federal budget income stems from hydrocarbon sales.

This is qualified somewhat with respect to small purchasers like Moldova or Georgia, where a cut in gas supplies hurts the affected country much more than the implied loss of revenues hurts Russia. This asymmetry provides Russia with a certain amount of leverage in the short run. As the past has shown, however, attempts to exploit this asymmetry have not caused major policy change in the affected countries. A strong limitation for Russia to make use of the asymmetry lies in the fact that many smaller purchasers are at the same time transit countries. This implies that a cut in gas supplies always affects the consumers on Western European markets — a market Gazprom aims at serving reliably, and which it has already severely threatened by the cutting of supplies to Ukraine.

Dr Andreas Goldthau, Transatlantic Fellow RAND Corporation and adjunct Professor at George Washington University

P.S. Another 4 myths about Russian Energy Inc. are critically examined in my recent paper in Policy Review.

International Energy Agency (IEA) projects that world demand for energy will grow by 53% from its 2004 level under a business-as-usual scenario. Assuming aggressive policies to dampen growth might cut this to 37% – a big if. But regardless of the growth, fossil fuels – and the accompanied carbon emissions – will meet the bulk of demand, at 77%, slightly below today’s 80% if one assumes aggressive growth in the share of renewable energy and massive new investment in nuclear capacity to replace the existing aging units.

Those who are concerned with carbon emissions will have to contend with more than a 50% increase in emissions during the same period under a business-as-usual scenario. Assuming green governmental policies, this may be reduced to 33% or so, still not a pretty picture.

As far as oil prices are concerned, the demand appears to be growing unabated, notably in developing countries. There are no short-term substitutes for oil particularly in the transportation sector – hence little demand elasticity. Supplies are tight as many exporting countries are facing mature and/or depleting fields and prospects for finding major new fields cannot be taken for granted. China and the growing economies of the Middle East alone have added over 800,000 bbls/day to world oil consumption in 2007.

In contrast to prior oil shocks, prices are now rising not because of a supply disruption but because demand is growing faster than current reserves and inventory. Describing the current oil market dynamics, William Ramsey, deputy executive director of IEA, says, “What we have had in the market is a demand shock, not a supply shock and the system reacts differently.

Rising with demand
Recent milestones in price of oil, $/bbl in nominal dollars
Source: Thomson Datastream and others

Posing and answering his own question, Mr. Ramsey adds, “The market would not react in this way if it was relaxed. Why is it not relaxed? Because it is tight …. When markets are that fragile, they react dramatically.” Sadad Al-Husseini, an oil industry consultant was quoted in the press predicting a $12/bbl price rise for every million barrels increase in demand.

A sign of market’s expectations for further price increases is the growing volume of call options for oil at $120, $150, even $250 at NYMEX and other exchanges. Consumers and speculators are taking option contracts that would insure them against further rises in oil prices in the coming months. Ironically, the frantic rush to buy call options – contracts that gives the holder the right to buy oil at a predetermined price and date – is among the reasons for further increases in oil prices.

F.P. Shioshansi

This post is extracted from EEnergy Informer, December 2007 issue.

Such fears come in many stripes, but the threat industry has sounded the alarm bells especially loudly in three areas. First is the rise of China, which is poorly endowed with many resources it needs – such as oil, gas, timber and most minerals – and has already ‘gone out’ to the world with the goal of securing what it wants. Violent conflicts may follow as the country shunts others aside. A second potential path down the road to resource wars starts with all the money now flowing into poorly governed but resource-rich countries. Money can fund civil wars and other hostilities, even leaking into the hands of terrorists. And third is global climate change, which could multiply stresses on natural resources and trigger water wars, catalyze the spread of disease or bring about mass migrations.

I analyse to what extent these three phenomena pave the way to resource wars in my recent paper published in The National Interest.

David G. Victor

Here’s how Campbell puts it.

“A decline in the supply of cheap oil-based energy will have an unavoidable and far-reaching impact on the economic prosperity of the World. It may on the other hand have a positive impact on the environment generally. For example, climate change concerns might evaporate.” —C. J. Campbell, 2003.

Now don’t get me wrong. These guys are geologists, and I’m not; so for all I know, they could be exactly right about how much oil is in the ground. But one things puzzles me. Their analysis, as they claim, is pure geology. But their prediction is about “oil production,” and pumping oil is not a geological process. This is not just a matter of rock science. In fact they seem to have overlooked a rather important factor in oil production—money. Any theory of oil production that ignores money just could be off kilter.

The End of the World is Nigh (How Peak Oil Solves Global Warming)

Richard C. Duncan, the third most popular Peak-Oil prophet on the web, and an electrical engineer, has done a great service by providing a graphical representation of the peak-oil hunch, which he calls the “Olduvai Theory” of energy, population and industrial civilization. As shown in the illustration above, total energy per capita will drop sharply after 2008. According to the theory, “world population peaks at 6.9 billion circa 2015, and thereafter declines to 2.0 billion in 2050.” In the process 4.9 billion people die for lack of oil.

Now it should be admitted that these geologists actually do think about money, and this is their theory of economics: “There is no way spending money can make more oil appear underground.” Brilliant. But economists are still puzzled. They believe that those with the most money at stake make the best predictions and so they watch what those people do. Saudi Aramco, Exxon, BP, and the other big oil companies have plenty at stake and hire the worlds best experts. They are not acting like the world is coming to the end of oil.

In 2007 oil is worth about $65 per barrel, but Olduvai theory says ten years later people will be dying like flies due to an oil shortage. What will the price be then? Surely people would pay $10 a gallon for gasoline, and surely the oil companies would charge that much. That’s about $440 per barrel of oil, which is seven times more than now. So here’s the catch. By keeping the oil in the ground, they could earn an 83% rate of return on their oil for the next 10 years. That’s more than fabulous; that’s unheard of. No one would sell oil now, if they could make that much money by keeping it in the ground. But instead, all of them are producing as fast as they can. Economists conclude that those with their money on the table, who have hired the best teams of experts and have access to the most private data, don’t believe the peak-oil geologists.

But let’s assume the peak oil crowd is completely right about the “geology” of oil production. What then? Will we die like flies or will we fight back? People spend about a trillion dollars a year driving, and if you charged them three times the current price they would mostly pay it rather than stop driving. They would not be happy, but there would be three trillion dollars available to whoever found an oil substitute. After a few years that begins to add up.

But is technology up to the challenge? Can it make gasoline out of something besides oil, and is there enough of that something to power a billion automobiles? Sounds like a tall order. But the strangest part of the whole peak-oil nonsense is this. The answer was discovered 80 years ago and is well known to every one of the leading lights of peak oil. The answer is coal and the Fischer-Tropsch process of turning it into gasoline.

This is not a theory; this is what powered the German Luftwaffe during WWII, and much of South Africa when their oil was embargoed. In 1938 Germany consumed 44 million barrels of oil of which 10 million barrels was synfuel from coal. By 1943 their synfuel output had increased to 36 million barrels. That was their response to an oil shortage.

Of course, the process has been much refined, and today Montana could produce gasoline for the equivalent of about $55 per barrel of oil. This has not yet happened because investors are afraid the price of oil will fall back below $55 as soon as they build a coal-to-gasoline plant. Last time oil was this expensive, the price did drop back to $20/barrel for a decade, so their fears are justified. But if we start running out of oil, they would know the price would not drop back below $55, and would build synfuel plants just like the Germans did sixty years ago.

Making gasoline is possible, but is there enough coal? Deffeyes assures us that “Worldwide coal reserves are large enough to continue present rates of production for a few hundred years.” Since world coal production provides two thirds as much energy as world oil production, that’s enough to get by for quite some time. Deffeyes (the Princeton geologist) has now realized that this is what will happen if oil runs out. The last sentence in the coal chapter of his second peak-oil book reads as follows:

“I hate to say it, but we likely will be forced to choose either increased pollution from coal or doing without a significant portion of our present-day energy supply”. —Kenneth S. Deffeyes, Beyond Oil, 2005.

I congratulate him for being the first peak-oil expert to name the real dilemma. What he must also know is which option we would choose. The world will not seriously curtail its driving habits but will choose instead, without blinking an eye, “increased pollution from coal.” There is no energy shortage in this century, and we will not be saved from climate change by running out of oil. Coal will again be king, and its high ratio of carbon to energy will hasten global warming.