What's new in production

 Vol. 233 No. 8

There was a story that circulated a few years ago, and was picked up by the popular press, to the effect that the “oil industry saved the whales.” The idea was that the greatest threat ever faced by large whales was the rising world demand for illumination. Whale oil had displaced wax and other forms of vegetable oils for lamps, because it was abundant, efficient and made a good light. One whale could produce tons of oil, and that oil commanded a good (but not prohibitive) price. Hence, wooden ships set out crisscrossing the sea with harpoons and murderous intent.

As whales got shyer and harder to find, the yield of whale oil dropped. The price rose, and more ships began pursuing fewer giant aquatic mammals, driving Moby Dick and friends to the brink of extinction.

So Dr. Gesner’s discovery of a superior lamp fuel called kerosene, combined, a few years later, with Colonel Drake’s Pennsylvania gusher, came just in time to pull the rug out from under the whale-oil market before the market ran out of whales. There is some truth to that, but the real story is more complex. As whale oil prices rose throughout the 1850s, innovators scrambled to find cheaper substitutes. Two strong competitors were found in coal gas and coal oil, so by the time petroleum was discovered to be abundant, the market for whale oil had already shrunk to one-sixth of what it had been. Nevertheless, when petroleum arrived, the whaling industry was caught flat-flooted. (What did they do? They did what any red-blooded American industry would do—they asked for subsidies.)

Peak what? The basic problem of crude oil supply is not especially controversial. But the extremes are far apart and worth examining. On the one side, we have the Peak Oil theorists, who assert that oil has begun (or will soon begin) an inexorable decline, leading to dwindling supplies and higher prices, and bad economic consequences for the world. Production innovations, such as extended-reach drilling, better EOR and oil sands development will improve supply, they say, but can never do more than slow the inevitable decline.

A couple of years ago, Deutsche Bank released a report, “The Peak Oil Market—Price dynamics at the end of the oil age,” which argued that the issue was not peak oil but peak demand. Peak oil proponents (“peakists”) are looking at one part of a three-part problem, they said. When price and demand are factored in, spurring innovation and significant changes in human behavior, then demand will fall, and, hence, price. This would put expensive-to-produce oil out of the running. Canadian heavy oil would be an obvious victim of the price squeeze. (Just a few days ago, one company, Canadian Oil Sands, announced that operating costs had risen to over $50/bbl, due to lower production volumes and higher turnaround costs.)

Peakists can point out that world production has increased only incrementally despite enormous investment, only recently reaching or surpassing 74 million bopd after recovering from the world slump of ’08. Others would argue that even if demand does not recover from the OECD countries, continued growth outside the OECD, particularly China and India, will more than make up lost demand.

So, when? Deutsche Bank suggests that peak demand could be reached as soon as 2016. A more recent study by Ricardo Strategic Consulting suggests that demand will peak before 2020, arguing that even the developing nations will implement strong programs to reduce oil consumption, seeking to avoid price volatility and shocks. The study predicts that by 2035, demand will be 3% less than it was in 2010.

In a recent report from Statoil, “Energy Perspectives 2012,” oil demand is projected to peak by 2030, with almost all the increase coming from outside the OECD. By 2040, the report predicts, OECD countries will contribute just one-third of world demand.

Technology is moving ahead on two separate-but-related fronts: EOR technologies are allowing us to go after the left-behind and the hard-to-produce liquids. This is allowed by continued demand and sustained high prices. At the same time, there is a strong incentive to move away from oil, by substitution with other hydrocarbons, by renewables and nonconventional sources, and by increased efficiency, driving down demand. While these trends seem to be working at cross-purposes and racing in opposite directions, both are happening with great effort and enthusiasm.

So, who’s going to win? Everybody, probably. Oil demand will peak at some point, but it won’t drop off like a rock. It will taper slowly toward an energy transition sometime later this century. Oil is too useful to ignore. The same is true for coal and natural gas. They will be with us for a long, long time.

However, the smartest thing the developed world could do is plan for a post-oil world. A provocative book by Amory Lovins called Reinventing Fire (with a foreword by Shell president Marvin Odum) argues persuasively that the business case for a transition away from hydrocarbon liquids is overwhelming. The cheapest energy “source” is needing less of it. He points out that by 2009, increasing efficiency was “the biggest energy source in the U.S. economy.” Improvements in transportation, industry, buildings and power generation mean less capital leaving the country, and reduced vulnerability to price shock. Lovins sees a plausible path to an oil-free economy by 2050, with coal and natural gas being phased out after that. The rewards would be enormous, not the least for companies like Shell that want a slice of whatever comes. However, as Odum says, “our biggest impediment to reinventing fire may be our own economic and technological inertia.”

Even though the end of the oil age will assuredly come to pass, I seriously doubt if there will come a time in the foreseeable future when oil producers have a whalers’ moment—sitting around with mouths agape, asking “what happened?”