Delusions of Energy

Triple-digit oil prices are doing their damage across the world. With airlines strugglin to survive, the Business Travel Coalition issued a stark press release warning of bankruptcies by the end of the year.

High prices at the pump have forced Americans to rethink their love for gas-guzzling SUVs, pickup trucks, and Hummers. More importantly, the high price of oil has inflated the price of food, which has led to food riots and export restrictions in poorer countries across the world.

With high oil prices looking to be permanent, the topic of peak oil has gone mainstream, but that doesn't seem to be the case in Japan. Aside from daily reports in newspapers on the fluctuating price of oil and the rising cost of food, there is virtually no mention of peak oil in the press and broadcast media. Japan's leaders offer a good example of their blindness to peak oil.

Akira Amari, the head of METI:

Calling rising oil and food costs "intolerable," trade minister Akira Amari on Monday urged major energy-consuming nations to cut use and oil-producing countries to increase production capacity.

"Recent oil prices are at an extraordinarily high level," Amari told reporters at the Ministry of Economy, Trade and Industry ahead of a meeting of Group of Eight energy ministers slated for this weekend in Aomori.

"We'd like to discuss what caused the speculative investment that boosted recent oil prices, and come up with measures to avoid further oil price hikes," he said.

"I feel that oil-producing countries have not yet regarded the issue (of price hikes and their impact on the economy) as their problem. But we are all involved with the issue and we all need to share the view and take action worldwide."

Finance Minister Nukaga Fukushiuro:

"Expectations of inflation could make it even more difficult for financial authorities to manage their economic policies," Nukaga said in a speech in Tokyo at the Foreign Correspondents' Club of Japan. "If the recent higher oil prices continue, it could largely affect corporate profits and household consumption worldwide."

June 17 editorial in the Asahi Shimbun:

The two oil crises in the 1970s and '80s were triggered by production cuts and price hikes by Mideast oil producers. At the time, the world still had ample crude oil supplies. But the present "third great oil shock" could be seen as a warning by the market of future supply shortages.

However, there may be no need to be overly pessimistic about potential energy shortages. If crude prices remain sky-high, oil-sands exploration and large-scale exploitation of deep-sea oil fields, which were previously viewed as unsound investments, will likely start up.

First, it's odd that Amari seems to think he can tell oil-producers to open their spigots a bit more. US president George Bush asked Saudi Arabia the same thing three times this year. He begged the Saudis to pump more oil in January and March and was told "No." He tried again in May and came away empty-handed, although they have recently changed their minds and agreed to pump an extra 500,000 barrels per day.

What is also notable is how the blame is externalized. It's the fault of speculation, a falling dollar, or oil producing nations not pumping enough oil. Fundamentals such as stagnant production and increasing demand receive little or no attention.

The prevailing wisdom in Japan is that high oil prices are an aberration, but what exactly is an appropriate or fair price for oil? The thinking is that all would be right in the world if only oil-producers would pump more oil.

Moreover, where is this new oil supposed to come from? The easy-to-drill oil has already been found. New discoveries peaked around 1964 and has been declining ever since. While new fields have been discovered, they tend to be small and ultimately contribute little to easing supply.

Take, for example, the debate in the United States over offshore drilling and drilling in the Arctic National Wildlife Refuge (ANWR). A couple of studies by the Energy Information Agency show that drilling will do nothing to increase supply and lower prices.

On drilling in the ANWR:

With respect to the world oil price impact, projected ANWR oil production constitutes between 0.4 and 1.2 percent of total world oil consumption in 2030, based on the low and high resource cases, respectively. Consequently, ANWR oil production is not projected to have a large impact on world oil prices. Relative to the AEO2008 reference case, ANWR oil production is projected to have its largest oil price reduction impacts as follows: a reduction in low-sulfur, light (LSL) crude oil prices of $0.41 per barrel (2006 dollars) in 2026 in the low oil resource case, $0.75 per barrel in 2025 in the mean oil resource case, and $1.44 per barrel in 2027 in the high oil resource case. Assuming that world oil markets continue to work as they do today, the Organization of Petroleum Exporting Countries (OPEC) could neutralize any potential price impact of ANWR oil production by reducing its oil exports by an equal amount.

The two key points here are time and money. It will take nearly 20 years before drilling lowers the price per barrel by a less than a dollar.

The outlook for drilling off the US coast is also not very encouraging:

The projections in the OCS [Outer Continental Shelf] access case indicate that access to the Pacific, Atlantic, and eastern Gulf regions would not have a significant impact on domestic crude oil and natural gas production or prices before 2030. Leasing would begin no sooner than 2012, and production would not be expected to start before 2017. Total domestic production of crude oil from 2012 through 2030 in the OCS access case is projected to be 1.6 percent higher than in the reference case, and 3 percent higher in 2030 alone, at 5.6 million barrels per day. For the lower 48 OCS, annual crude oil production in 2030 is projected to be 7 percent higher—2.4 million barrels per day in the OCS access case compared with 2.2 million barrels per day in the reference case (Figure 20). Because oil prices are determined on the international market, however, any impact on average wellhead prices is expected to be insignificant.

As with drilling in ANWR, no new oil would been seen until 2030 and even then it is not expected to have any significant impact on prices.

As for the Asahi's desire to tap into oil sands, presumably Canada's since it has the largest reserves in the world, environmental costs and limited water resources mean that only a small portion of Canada's reserves may ultimately be extracted:

In conclusion, tar sands are an economically and energetically viable, although hardly ideal, approach to maintaining liquid fuel supplies. The most severe problem is probably their local and global environmental impact, and they are already impacting Canadian CO2 releases significantly. But the tar sands are unlikely to make a large impact on overall supply of liquid fuels because their supply is likely to be rate, rather than total resource limited. If the maximum rate were to grow to about 2 billion barrels a year this would approximately meet Canada’s demand and could leave relatively little for export if Canada’s production of conventional oil continues to decline. Achieving even this rate of production from tar sands is uncertain because of growing concerns about environmental impacts downstream and insufficient hydrogen and water.

With this in mind, here's a sample of the discussion that has yet to make its way to Japan:

Matt Simmons on Bloomberg News (March 4, 2008)

Money quote:

Host: "Is there anything the government could or should do to effect prices?"

Matt Simmons: "No"

Robert Hirsch on CNBC (May 20, 2008)

Money quote:

Host: Dr. Hirsch, there are a lot of people when we talk about peak oil who say there are going to be technologies that are always developed. There will be new ways to get oil, whether it's from coal, whether it's from the oil shales, and they say that means we will never actually hit peak oil. What do you say to those people?

Hirsch: They're incorrect, and the reason that they're incorrect is that they don't understand the magnitude of the problem and how long it's going to take to bring substitute liquid fuels on and to introduce energy efficiency on a massive scale. That's something that we analyzed and it takes decades. And the reason, simply, is that the magnitude of the problem is enormous.

[McTeer says we should drill more.]

Host: Dr. Hirsch, what do you say to that--the idea that we should be drilling in places like ANWR and drilling offshore. Would that solve this problem of a plateau in oil production?

Hirsch: There's no single thing that's going to solve this problem because it's as massive as one can possibly imagine. And the prices that we're paying at the pump today I think are going to be the good old days because others who watch this very closely forecast that we are going to be hitting $12 and $15 per gallon. And then, after that, when world oil production goes into decline, we're going to talk about rationing. In other words, not only are we going to be paying high prices and have considerable economic problems, in addition to that, we're not going to be able to get the fuel when we want it.

T. Boone Pickens on CNBC (May 20, 2008)

The disconnect in thinking could not be clearer. On one hand, you have a Texas oil tycoon urging alternative energy, and experts saying we won't be able to drill our way to cheaper oil and that government is powerless to do anything about high oil prices. In Japan, on the other hand, you have the government wishing for or expecting more oil to be drilled. Then there is the Japan Association of Travel Agents and their campaign to boost overseas travel (forget about those ticket prices and fuel surcharges!) and the government urging the public to take shorter baths. If this is the extent of their thinking on how to address high oil prices, they are clueless--peak oil will blindside Japan.

Asahi Shimbun June 18 editorial

Crisis over oil prices

Soaring crude oil prices prompted British Prime Minister Gordon Brown to remark last month that the global economy is now faced with "the third great oil shock of recent decades." Crude futures on the New York market have risen 40 percent since January, and oil prices are nearing $140 per barrel.

Price hikes for oil products triggered riots and street demonstrations in developing nations. Airlines and transportation companies have begun downsizing. In Japan, soaring gasoline prices are squeezing consumers and businesses alike, while fishing industry organizations are considering severe cutbacks in their operations because of high fuel costs.

Purely in terms of supply and demand, crude oil should be valued at around $60 per barrel, according to the Ministry of Economy, Trade and Industry. Governments around the world are incensed at the way speculative money has grossly inflated the value of crude oil.

Some U.S. financial giants are projecting that crude prices could soon hit $150 a barrel. Thus, there is good reason to believe that prices will continue to rise.

Volatile hedge funds as well as annuity funds, which traditionally operate with long-term objectives in mind, have recently been investing in the crude oil market.

This is causing concern among oil-producing nations. Saudi Arabia, a key member of the Organization of Petroleum Exporting Countries, will host an emergency summit meeting of the leaders of oil-producing and consumer nations on June 22.

But OPEC's ability to increase output is no longer what it was. On the other hand, there is no question that demand will grow exponentially in the world's newly emerging powers such as China and India. This explains the decision by annuity fund operators, who have turned to the crude oil market because they see a long-term demand trend.

The two oil crises in the 1970s and '80s were triggered by production cuts and price hikes by Mideast oil producers. At the time, the world still had ample crude oil supplies. But the present "third great oil shock" could be seen as a warning by the market of future supply shortages.

However, there may be no need to be overly pessimistic about potential energy shortages. If crude prices remain sky-high, oil-sands exploration and large-scale exploitation of deep-sea oil fields, which were previously viewed as unsound investments, will likely start up.

The challenge, though, is that global warming has to be tackled at the same time.

The International Energy Agency recently released a study on how to slash greenhouse gas emissions by half by 2050.

According to the study, the following must be installed around the world every year: 32 nuclear power plants, 17,500 wind turbines, about 200 million square meters of solar panels, and 55 power stations equipped with carbon capture and storage (CCS) devices that are currently being readied for commercial application. And this list is based on the precondition that 1 billion electric vehicles or fuel cell vehicles will have been in operation by 2050. The study estimates the total investment for this at close to 5,000 trillion yen.

This is the direction in which long-term investments of annuity funds should be encouraged to go. Initiatives to this end must be worked out at the Group of Eight summit at Lake Toyako in July and other forums before high crude oil prices destroy the global economy.