Reports of Cheap Oil's Death Are Not Greatly Exaggerated

February 16, 2012

With new sources and methods of global petroleum production coming on stream — shale fracking, ultra-deepwater drilling and new fields in Africa, to name a few some energy analysts have argued that reports of the death of cheap oil have been greatly exaggerated. In this week's CIGI Interview, Thomas Homer-Dixon takes issue with these "oil optimists," saying that the petroleum our global economy can afford to consume is indeed running out, and that we need to be much more aggressive in developing alternative energy sources.

CIGI: In a recent op-ed you defend the peak oil theory against “oil optimists” who argue new sources of global production can stabilize the price of petroleum. In an age of fracking, deepwater production and tar sands, why do we still need to be worried about the short- to medium-term viability of oil as a global energy source?

Thomas Homer-Dixon: Let’s get the timeline right. Short term is a year, medium term is 10 years, long term is 30 to 40 years. I think we’re likely facing trouble in the intermediate short term — two or three years, maybe even sooner. But as we go out to a 10-year horizon, the probability of an oil crisis rises sharply.

The people who think we don’t have a problem, like Dan Yergin, characteristically don’t talk about two things: the decline rate of mature oil fields around the world, and the declining energy return on investment. The decline rate is a big deal, and it’s obscured in most energy conversations. Most people think that if we have 74 million barrels per day of conventional production this year, we’ll have the same next year, and to meet increased demand all we have to do is add an increment above 74 million barrels. But production won’t be the same next year, because 60 percent of the world’s conventional oil fields are mature, and they’re losing about four million barrels of production a day annually. Within a short period of time that adds up to a big decrement: in five years, we’re talking about two Saudi Arabias of production.

Ultra-deepwater wells and fracking from shale oil have the capacity to fill that gap, but their oil is really expensive — $50 to $90 per barrel. And it’s not going to get cheaper, because these sources all require complex drilling and refining technology, with commensurate environmental damage and higher rates of failure. What it becomes, then, is not a geological argument, but an economic one. The incremental cost of additional production will eventually have a depressive effect on economic growth; we may be close to that economic threshold at this point.

CIGI: Why do the optimists such as Yergin sometimes characterize peak oil as actually running out of oil, then?

THD: To be blunt, people that lack intellectual integrity often set up straw men. No sensible analyst who thinks we’ve got an oil problem is saying we’re going to run out of oil. For the “optimists,” the label “peak oil” has become a dismissive pejorative. But the bottom line is that a barrel of oil currently costs $100 in a global economy that is staggering along and in which demand for energy overall is not robust. One can’t dismiss that fact.

CIGI: In that same op-ed, you mention the situation in Iran as creating a “risk premium” that has kept oil prices high, despite weak global economic growth. Given the spike associated with the recent war in Libya, is there any way of knowing how severely a conflict in Iran could affect global markets?

THD: The important thing about risk premium is that it doesn’t matter any more exactly what the risk is — whether it’s the loss of Libyan production, an oil worker strike in Nigeria or the closing of the Straits of Hormuz — it’s that global liquids supply is now inelastic. Anything that could threaten supply produces a dramatic price response. There isn’t much slack left in the system. The real issue, then, is that these relatively minor supply shocks — with the exception of a war with Iran, which isn’t minor at all — now produce a much larger impact on price than they did a decade or so ago.

CIGI: So you don’t believe that the Saudis could increase production to compensate, as they’ve hinted they would if Iran tried to shock the global market?

THD: Saudi Arabia may be having trouble maintaining its current levels of production; in fact, the country recently decided not to increase its maximum production capacity. The country has claimed a 260 billion barrel reserve for the last 30 years, all the while pumping six to 10 million barrels a day. The numbers don’t add up — there’s no credibility in Saudi reserve figures, just as there’s no credibility in Canadian reserves figures. We say we have 170 billion barrels of oil — after counting the oil sands — but to produce that oil we will need to invest the equivalent of at least 40 billion barrels of oil energy. Liquids from the oil sands are not the same as Saudi oil. The oil sands are junk energy, not remotely equivalent to the still relatively easily available oil in places like Saudi Arabia.

CIGI: To bring the conversation back to North America, then — with Canadian companies engaged in controversial proposals to build "mega-pipelines" to bring petroleum resources closer to markets in the United States and Asia, what does it say about the willingness of oil-producing countries to deal with carbon?

THD: The energy elites in Canada aren’t willing to deal with the carbon problem, or even acknowledge it. It’s as simple as that. It’s not true for the entire country, but the political high ground at the federal level in Canada has been captured by deeply embedded and powerful vested interests in the carbon-based energy sector. In the Canadian public policy discourse on energy, it’s become distinctly unpatriotic to criticize these export plans, the oil sands, or even talk about climate change.

CIGI: Is this political marginalization of climate unique to Canada, or has it also been the case in other major players in global oil markets?

THD: I think it’s true in the United States. There’s no discussion of climate there either, but for somewhat different reasons. It’s not true in Europe. In North America we’ve had one the warmest winters on record and nobody’s talking about climate change. There’s kind of an Orwellian groupthink developing here, and it’s creepy.

But nature marches on. The climate is being perturbed by humanity’s release of 35 billion tons of carbon dioxide each year, and it’s sending us signals. It will continue to do so, regardless of our discourse.

CIGI: Given the inevitability of gradually exhausting the global supply of cheap oil, what are the policy shifts that should be occurring to reduce vulnerability?

THD: We should be much more aggressive in developing alternative energy sources. There’s a sequence of polices, such as those discussed at the Equinox Summit, that provide a clear strategy for moving to zero-carbon energy sources. At the top of the list is ultra-deep geothermal — which I’ve advocated for years — but there are many things that we can do. Given the vulnerabilities of many countries around the world, we should be much more aggressive in pursing a national and global alternative energy policy.

The opinions expressed in this article/multimedia are those of the author(s) and do not necessarily reflect the views of CIGI or its Board of Directors.