For the first time, the global oil system has no margin for error. Any significant supply disruption will send prices skyrocketing.
By Ryan McGreal
Published August 22, 2005
Are we in peak oil today? It's too early to tell, although the market does show signs of being close to an absolute production limit. In all likelihood, the "peak" will be stretched across several years, as the price of oil spikes, plateaus, dips, and jigs in response to a complex interplay of factors.
This summer's relatively high oil prices (which still have plenty of room to go up - inflation-adjusted prices are still below the 1980 peak) are superficially due to the summer driving peak, the threat of supply disruptions due to hurricanes, instability in Saudi Arabia during the transfer of power to King Abdullah, the ongoing Iraq debacle, fear of military action against Iran, and an aging North American refinery infrastructure that is prone to breakdowns.
However, these conditions were all true the past four years. The difference was that the system as a whole had capacity to spare in the past, and could accommodate the supply disruptions of an exceptionally busy hurricane season, as in 2004, or the geopolitical instability of the Iraq invasion in 2003. (Looking back further, during the Gulf War of 1991, Saudi Arabia was able replace the five million barrels a day taken out of production when Iraq closed its spigot. That would be impossible today.)
Global demand for oil is growing at around two percent a year. This might not sound like much, but that small increase causes a doubling every 35 years.
Legendary oil tycoon T. Boone Pickens is betting that conventional oil production is maxed out around 85 million barrels per day (bpd). He is investing heavily in Alberta oil sands production, even though it is expensive and technically arduous to extract oil from the sands. The energy return on energy invested (ERoEI) for the oil sands is about 3/2, meaning three units of energy are returned for every two units of energy invested. Technology improvements may raise oil sands' ERoEI to 2/1, but not much more.
There's plenty of oil in the sands - more, in fact, than in Saudi Arabia, giving Canada officially the world's biggest oil reserves - but the rate of extraction is never going to be very high, due to the technical obstacles involved.
For oil sands investments to pay off, the market price for oil has to remain high. Pickens clearly believes that conventional oil, which has a much better ERoEI and is much cheaper to extract, will not be able to keep up with demand over the next several years. In that scenario, oil sands production steps in to replace declining conventional sources at a price that makes it profitable.
Pickens has plenty of reason to believe his investment will pay off. In the 1980s, OPEC had spare pumping capacity of 15 million bpd. Since then, global demand has increased by about 20 million bpd, and OPEC's spare capacity has shrunk to zero.
This year, non-OPEC oil production has been growing more slowly than the International Energy Agency's projections, possibly because North Sea oil, which peaked a couple of years ago, has declined more rapidly than expected. OPEC has to pick up the slack, but the OPEC spigot is already wide open.
For the first time, the global oil system has no margin for error. Any significant supply disruption - a major refinery outage, a hurricane across the southern Caribbean, a terrorist attack on Saudi oil infrastructure, missile strikes against Iran, whatever - will shock the global oil market and send prices skyrocketing. For the first time, Saudi Arabia can no longer function as the world's swing producer.
This means the world won't be able to increase its consumption of oil without bringing enough new supplies on line to cover depletion of existing mature wells and add new net capacity. It's not clear where those new supplies will come from.
Michael Wittner, head of energy market research at Calyon Corporate Investment Bank, explains, "The upstream and downstream [supply] constraints are real and long-term and we're seeing almost daily examples of them."
Long term investments hope to bring more oil supplies on-stream in the next several years, but this may not be enough to lower prices. Demand continues to grow, and many existing fields are past peak and declining. In Saudi Arabia, for example, plans to add 1.5 million barrels per day to its output by 2010, but this will barely keep up with projected demand growth, never mind replacing declines elsewhere.