Peak Oil Flip-Flop

There’s a new twist in the “peak oil” debate. Is it good news for the climate?

Peak Oil Question Remains, Debate Continues

Ever since M. King Hubbert advanced the theory of peak oil in 1956, experts and non-experts alike have been debating about timing and relevance. (See herehere, here and here.) Hubbert’s argument seems like a no-brainer. Oil is a finite natural resource, so there must come a time when oil production peaks and begins to decline. The question is, when? And for a world economy that is largely fueled by oil, that “when” question is quite germane. If peak oil hits while oil demand is rising, it could spell worldwide economic disaster.

The world of oil punditry is replete with predictors of an imminent arrival of peak oil. (See hereherehere and here.) Folks bullish on oil, on the other hand, have long held that that time is way in the future, that there is plenty of oil in the ground and that whenever supply begins to be outstripped by demand, new technologies will be developed to get at what had been deemed to be economically unrecoverable.

History Shows That When Oil Prices Rise, Oil Production Responds

The historical verdict, so far, seems to be in favor of the oil industry bulls. Each time dwindling supplies and/or surging demand have caused oil prices to rise, the economics of high oil prices have spurred the development of new sources to quell the imbalance.

The latest ups and downs in the economy and the oil industry seem to follow that scenario. Remember the skyrocketing gasoline prices of 2005 and 2006 before the July 2008 peak? As in previous oil shocks, there were warnings that peak oil had arrived and that we should all get ready for even higher prices at the pump.

But that didn’t happen. First we were “saved” by the economic crash of 2008 — which some argue was actually “a direct result of peak oil.” The crash caused demand for oil and therefore prices as well to fall. Lots of folks, myself included, assumed that the reprieve from the economic slowdown was temporary and that oil prices would rise, possibly even more sharply than before once the global economy got going again.

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Fortunately that hasn’t happened. The economic recovery, while tepid, is underway. And while oil prices have recovered somewhat, they have not hit the July 2008 peak, let alone shot above it. (See related: “Outlook for U.S. Gas Prices: A Bit Lower This Summer“)

So what’s going on? As you might expect, there are a variety of opinions. Some continue to warn that a spike in prices at the pump is just around the corner — for example see these predictions (here and here).

Others claim that we are seeing the same demand-and-supply response that we’ve seen in the past. The runup of oil prices in 2007 and 2008 sparked new investments that have increased production and moderated prices. And this argument is supported by data showing an approximate 10 percent uptick in world oil supplies since 2009.

A New Paradigm Proposed

But now two new reports — “Global Oil Demand Growth — The End is Nigh” by Seth Kleinman et al. of Citigroup and “The End of an Era: The Death of Peak Oil” [pdf] from Robin Wehbé et al. of the Boston Company — argue that something entirely different and rather unprecedented is underway. Both reports argue that we have entered a new era, one characterized not by the spectre of a supply peak, but by a demand peak that will assure that demand will not outstrip supply for quite some time to come.

The reasons for peak oil demand:

  1. Fuel economy. Recall the new fuel efficiency standards (known as CAFE, short for corporate average fuel economy) promulgated by the Obama administration with the support of the automotive industry? They will certainly have a moderating influence on U.S. oil demand. But the United States isn’t alone. Fuel economy standards are tightening throughout the world, including in China, the European Union, Japan and Canada. Fuel efficiency is expected to rise for trucks as well. The net result — global fuel efficiency on cars and trucks, which has languished for decades, will increase annually by about 2.5 percent.
  2. Substitution of natural gas for oil. The authors project that the revolution in natural gas supplies wrought by shale extraction will have a major ripple effect on the oil industry. Huge new supplies of natural gas [pdf] will continue to lead to low prices in natural gas and that in turn will lead to substitution of natural gas for oil. (Indeed this has already begun.) As a result. we’ll see a shift in the following:
    • Transportation, especially for trucks and other large vehicles currently powered by diesel.
    • Power generation. Though not very common in the United States, oil is still used to generate electricity. For example some 8 percent of New York State’s electricity is generated from oil, and in 2008, worldwide, about a trillion kilowatts of electricity (out of a total of 19 trillion kilowatts) was generated from oil. Kleinman et al. predict that is about to change as old oil-fueled power plants are replaced by gas-fired ones.
    • Petrochemicals too. Currently the petrochemical industry primarily uses oil as a feedstock. But natural gas, especially so-called wet gas, contains ethane, which can also serve as a feedstock for chemical synthesis. Low natural gas prices have already begun the substitution that the authors predict will accelerate into the future.

Of course for this to happen on a global scale, natural gas must become a global commodity that can be traded and transported from producing regions to consumers. No problem, say Kleinman et al. — the answer will be liquid natural gas (LNG). They opine:

“[O]nce the next wave of LNG export projects comes to market … global LNG markets should loosen materially. This raises the prospect of lower spot prices, and a greater incentive for gas for oil substitution to spread and accelerate globally. Hence, the assumption that substitution outside of the US starts to accelerate post 2016.”

But that’s not all. The Boston Company goes even further, arguing that the emergence of peak oil demand is being also driven by an unprecedented shift in consumer behavior. For years the accepted wisdom has been that consumer demand was inelastic with respect to price — in other words, even if prices change, demand remains much the same. The Boston Company report points to data since 1970 showing that each time the price of oil rose above 3 or 6 percent of gross domestic product, demand was reduced or quickly curtailed. Thus, they argue, price, not supply, now limits demand.

Suffice it to say — and I’ll note this is par for the course when it comes to the peak oil debate — not everyone agrees with these predictions (see chart).

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Citigroup forecasts a very modest increase in demand that plateaus near 2020 (see also Fig. 1, page 2) while BP and the International Energy Agency (IEA) project a larger, steadily increasing demand of 0.7-0.8 percent. I expect the projected demand growth in the U.S. Energy Information Administration (EIA) forecast will be revised downward in the report due out this spring. ExxonMobil projects a 1.5 percent annual increase in demand from 2010 to 2025. (See End Note for sources.**)

Could Climate Be a Winner?

At least on the face of it, the projections of Citigroup and the Boston Company if they pan out would be good news for the climate. The world is replete with hydrocarbons and it may very well be true that, as the oil bulls have been telling us, technological innovation will make it possible for us to economically pull all the hydrocarbons in their various forms out of the ground to burn them if we so choose. And it certainly seems like advances in fracking and horizontal drilling have moved us a big step closer in that regard.

The questions we should be asking ourselves are: Do we want to pull all this stuff out of the ground, and How much is too much before the climate price is too dear to pay for cheap oil?

The fact that oil demand may be flattening out is a positive sign for the climate; at least the near-term pressure to pull all the oil out of the ground as fast as possible has lessened. (A caveat here: some of the oil demand flattening is due to switching from one fossil fuel — oil — to another — natural gas, which while cleaner than oil, still puts carbon dioxide in the atmosphere when burned.)

Interestingly enough, this peak oil demand phenomenon, if it comes to pass, will have occurred of its own accord without a global accord on carbon emissions. Is the system somehow correcting itself on its own? If so, the “system” better get busy because there’s a lot more to do — not just flattening demand but actually turning the demand curve downward, and not just for oil but for all hydrocarbons. Tall order. Maybe the “system’s” response will be to engineer a global climate treaty. And if that happens, who gets the credit?

End Note
** Sources for chart: “Global Oil Demand Growth — The End is Nigh,” Seth Kleinman et al., Citigroup, March 2013. Energy Outlook 2030, BP, January 2013 (data [xls]). North America leads shift in global energy balance, IEA says in latest World Energy Outlook, International Energy Agency, November 2012. “International Energy Outlook 2011,” U.S. EIA, September 19, 2011. “The Outlook for Energy: A View to 2040,” ExxonMobil, 2013.