Fracking Irresponsible Development

A year ago, I asked a middle manager at a multi-national liquid fuels company why its sustainability report didn’t contain any discussion of peak oil.  He shot back with a withering “I think we’ve got beyond that.”  I believe he was right, though not in the way he intended.  

Amidst all the outcry and outrage provoked by the prospect of fracking natural gas from the Karoo, insufficient thought has been given to how the fossil fuel resource is intended to be used.  What’s the real motivation behind Big Oil’s attempts to get its hands on those methane molecules?

Energy, of course!  You know, the Energy Dilemma?  The world needs more energy with less CO2, so “we are producing more cleaner-burning natural gas and using advanced technologies to develop new resources” – it says it right there in Shell’s 2010 Sustainability Report.

But let’s examine that statement carefully.  There’s nothing factually incorrect in what Shell says.  Natural gas is the cleanest-burning fossil fuel, and Shell (and many of its Big Oil brethren) is producing more of it year after year.  However, there’s something about the choice of language that might be opportunist at best, disingenuous at worst.

First, it’s hard to take at face value the notion that Shell’s steady drift into natural gas is the result of a deliberate strategic decision to turn away from dirtier fossil fuels.  Consider that the company’s relative growth in gas has occurred over the same period of time that it was investing heavily in the Albertan tar sands.  Far easier to swallow is the idea that Shell has simply not been very successful at finding conventional oil resources – recall the reserves scandal of 2004 – so that over time its portfolio has diversified in both directions: simultaneously growing in cleaner-burning natural gas and filthy bituminous hydrocarbon deposits.  The next time you meet a Shell executive, ask the question: when was the last time your company (or any other oil major, for that matter) walked away from economically-recoverable conventional oil resources because of a strategic decision to focus on natural gas?  They would have a job explaining that one to their shareholders who focus on replacement of reserves as a key indicator of company performance.  

Second – here is the crunch – what do Shell (and Sasol) have in mind for all that Karoo shale gas?  The clue lies in Qatar.  It’s based on an elegant piece of chemical process engineering whereby carbon atoms are stitched together to synthesise the longer hydrocarbon chains that comprise petrol and diesel.  The really neat thing is that, technically, you can use anything containing carbon, including cleaner-burning natural gas, filthy dirty lumps of coal, wood chips, my mother’s bathroom curtains, or even the finest Persian carpet.  The choice of feedstock informs the economics of the process – rug-to-liquids being at the high end of the cost spectrum – as well as the energy required in the conversion steps.  So flexible is this technology platform Shell gave it the label XTL, where X = any source of carbon atoms.  When X = natural gas, it’s called GTL.  Which brings us back to the Karoo.

Why does this matter?  Because in the context of our global Energy Dilemma, what’s important is maximising the energy services – heating, cooling, lighting, mobility, communications – delivered to society while minimising the associated CO2 emissions.  This is where the term “cleaner-burning” appears disingenuous.  True enough, GTL diesel fuel burns with lower sulphur dioxide, lower nitrous oxides, and lower particulate matter than conventional oil-based diesel (based on current fuel quality standards).  This is directionally beneficial in terms of improving urban air quality.  However, exactly the same is true of coal-to-liquids diesel, or rug-to-liquids diesel; the “cleaner-burning” character of natural gas has precisely nothing to do with it.

In terms of CO2 – the most important form of pollution wrapped up in this Energy Dilemma – GTL is essentially no better than regular fuel.  Which is to say: it’s considerably worse, because by far the most rational use of natural gas in addressing the more-energy-with-less-CO2 conundrum is using it to displace carbon-intensive coal to generate lower-CO2 electricity.  In parallel, by investing in electromobility, we simultaneously do away with those nasty tailpipe emissions at a stroke.  If instead we allow natural gas molecules to enter the liquid transport fuel supply via GTL plants, we pointlessly fritter away all the carbon advantage inherent in the resource.  From a climate change mitigation perspective any decision to follow the GTL path is nothing less than irresponsible.

Then again, the potential use of natural gas as a lower carbon bridging fuel in the struggle against rising CO2 emissions was never the driving force behind Big Oil’s attempts to open up the Karoo.  They are not in the electricity business, they are in the liquid transport fuels business.  All forms of energy are not the same.  For them, the Energy Dilemma is about securing more hydrocarbon resources and leveraging their enormous chemistry sets to create synthetic petrol and diesel that will be set on fire in desperately inefficient motor vehicles.  I think we’ve got beyond that.  

China’s alternative to an American addiction

This blog first appeared on the Mail & Guardian Thought Leader website

Last week saw the launch of BP’s Statistical Review of World Energy, a rich seam of energy industry stats that journalists, analysts and academics will spend many hours mining for nuggets of data that support their chosen narratives.  The Financial Times led with “China becomes leading user of energy” – hardly a revelation to even the most casual industry observer, though undoubtedly a pleasing melody to those in the US who point to the rise of the Middle Kingdom as a reason to forestall domestic action on climate change.  

Noteworthy in BP’s latest tome is that crude oil remains the number one source of energy, contributing just over one-third of the global total.  In terms of growth, China again leads the way, increasing its consumption by 860 000 barrels a day, or 10.4% over the previous year.  Of course, in per capita terms, China’s oil consumption pales in comparison to the world’s largest economy: at 2.5 barrels per person a year, the average Chinese citizen consumes nine times less oil than its American counterpart.  Nevertheless, China’s growing thirst for oil represents a direct threat to US economic supremacy.  America may have been the first – and remains by far the largest – oil addict in the global village, but as others increase their appetite for the drug – the supply of which is increasingly concentrating in the hands of a relatively few volatile countries – the US must eventually face the prospect of weaning itself.  The only plausible alternative is to brace for military conflict.  

An urban legend goes that early in 2003 while Bush, Cheney and Rumsfeld fumbled around the Oval Office for a catchy moniker with which to rally the nation ahead of their planned invasion, they came up with “Operation Iraqi Liberation” – an obvious riff on the Iraq Liberation Act signed into law by Clinton in 1998.  Just in time, one sharp-eyed White House aide piped up that the initials spelled “OIL”, which was possibly too brazen even for the Bush administration.  With that, “Liberation” was dropped in favour of “Freedom”.  Mission accomplished.

As a thought experiment, let us suspend our voices of cynicism for a moment and imagine – as the urban legend would have us do – that the US-led invasion of Iraq was chiefly concerned with securing oil, specifically the world’s third largest reserves after those sitting beneath the deserts of Saudi Arabia (uncomfortable allies) and Iran (sworn enemies).  Indeed, the number one oil-consuming nation on Earth – reliant on imports for roughly two-thirds of its annual demand – has a strong vested interest in the affairs of the Middle East petrostates.  The Carter Doctrine leaves little room for doubt: the Persian Gulf region is vital to the interests of the US and will be protected “by any means necessary, including military force”.  Put simply, without cheap transport fuels moving people and goods across the urban sprawl and vast interstate network – themselves products of the nation’s now dwindling domestic petroleum bounty – the American economy grinds to a halt.  

Perhaps Jimmy Carter’s 1980 State of the Union speech was nothing more than Cold War posturing, designed to make the Soviets think twice before extending their Afghanistan incursion further westwards to the oil fields of the Gulf.  Taking Carter’s words out of their historical context is unfair; America wouldn’t really go to war over another nation’s natural resources, would it?  Dick Cheney provides a clue when, during his stint as chief executive of Halliburton – shortly before assuming the vice-presidency under Bush Jnr – he addressed an Institute of Petroleum conference in London: “Oil is unique in that it is so strategic in nature. We are not talking about soapflakes or leisurewear here. Energy is truly fundamental to the world’s economy. The [first] Gulf War was a reflection of that reality.”

As the occupation of Iraq winds down (US troops are supposed to withdraw by the end of this year) we might well ask ourselves: was it worth it?  In 2008, economist Joseph Stiglitz put the true cost of the Iraq war to the US at about $3 trillion; more recently he concluded this figure was probably too low.  For the sake of the exercise, we will avoid hyperbole and assume the original estimate of $3 trillion puts us in the right ball park.  Is that a lot?  To provide a sense of scale, consider that since the invasion kicked off in March 2003, the US has burned through roughly 60 billion barrels of oil at a cumulative cost of about $3.5 trillion.  That’s an extraordinary amount of money literally going up in smoke – it’s remarkably close to Stiglitz’s estimated cost of the war – but we are no closer to assessing whether the US will get a decent payback.  

Donald Trump’s recent suggestion to simply take the oil as compensation for the cost of the invasion makes sense from a narrowly-defined financial perspective.  According to BP’s latest data, Iraq’s oil reserves measure 115 billion barrels, which would keep the US ticking over for 16 years at current rates of consumption.  Translated into dollars at today’s oil price, Iraqi reserves are worth some $12 trillion, not including the cost of development. Now it starts to look more interesting: that represents a four-fold return on the investment!  Except of course that Trump’s proposition – a bit like a burglar justifying the theft of your home cinema system as recompense for the outlay on his crowbar, eye-mask, striped T-shirt, and hessian sack bearing the word “Swag” – is morally reprehensible to any right-minded human being.  

Setting aside grand larceny, perhaps another way to think about it is this: how else could the US have spent $3 trillion to address its eye-watering dependence on oil, simultaneously the cause and the result of decades of foreign policy negligence?  It is remarkable to ponder that for every man, woman and child in the US a whopping $10 000 could have been invested in measures to avoid oil consumption, such as developing the type of safe, clean, efficient and effective mass transit solutions that many European and Asian citizens enjoy, or investing – as China has – to establish a world-leading electric vehicle industry that by its nature is independent of oil, and by its far-sightedness will probably eat America’s lunch in the coming decades.  

Instead, during the 8 years of the war, US citizens set fire to some 1.15 trillion gallons of motor gasoline, much of it in obese “sports utility vehicles” with fuel economy ratings that should be a source of national embarrassment and would have finished Detroit were it not for the federal bailouts of 2008.  It was only fair: Washington was complicit in the predicament that Motown found itself in after years of profiting from feeble business-as-usual energy policy, while Beijing was busy plotting a domestic automotive industry based on electricity.  The astounding fact is that while it remains political suicide for a US administration to consider a meaningful tax on gasoline – thereby encouraging more frugal driving habits – it is politically acceptable to place at risk the lives of young American soldiers in the Middle East in order to secure flows of the very oil that it is impossible to tax back home.  

Impossible to tax transparently, that is.  The $3 trillion cost to the American taxpayer of projecting military force in Iraq translates to a phantom tax of $2.69 on every gallon of gasoline consumed in the US since 2003 – effectively doubling the average pump price to more than $5 a gallon over the period of the war.  To put it another way, if instead of agreeing to invade a sovereign state Congress had slapped a 100% tax on gasoline back in 2003, its citizens would be no worse off financially and the federal coffers would have been boosted rather than drained to the tune of $3 trillion.  With most Europeans already paying north of $8 a gallon of petrol and diesel, it is both difficult to sympathise with the American motorist and easy to appreciate why Europe’s automotive fleet is twice as efficient as that on the other side of the North Atlantic.  

Of course, all of this is simply a thought experiment based on the notion that Operation Iraqi Freedom was all about the oil.  To swallow that, you would have to believe the words of every US president since Lyndon Johnson, one by one gravely warning of the national security implications of dependence on foreign oil, while successively failing to offer any plausible means of addressing it beyond securing more resources at home and abroad.  

For the majority of global citizens living in the developing world, a straightforward question demands a straightforward answer: should we seek to emulate the oil-drenched model of economic development pursued by America and its allies for the last century and a half, thereby embracing a doctrine of expensive military interference in faraway desert lands?  Or might China – for all its shortcomings and pressing development challenges – offer a less dystopian vision of the future?  Returning to the BP Statistical Review we discover that not only has China surpassed the US in total energy consumption, it is also now the world’s leading generator of carbon-free electricity from wind turbines.  With its planned 45,000 km of high speed rail by 2015, burgeoning renewable energy sector and more than 120 million electric bicycles plying Chinese roads today, it is for good reasons that we are increasingly refocusing our attention from west to east.  

Are we starting to ‘get’ the oil question?

This article first appeared in the South African business newspaper Business Day on 7th April 2011

History doesn’t repeat itself, but it does rhyme.  A little less than three years ago, within the space of a few weeks, oil prices hit a record $147/bbl, Lehman Brothers collapsed into the largest bankruptcy in history, and the global economy fell into a ravine from which it has scarcely emerged.  A recent article by Jacob Weisberg in Slate magazine discussed the cause of the economic crisis by examining “the 15 best explanations for the Great Recession”.  Surprisingly, the price of oil did not feature in that long list of persuasive explanations.  It’s surprising because in the prevailing economic system oil is the economy.  

As unrest in North Africa and the Middle East enters a fifth month since the first sparks of the Tunisian Revolution last December, oil prices are starting to dominate the political discourse.  In the UK, Energy Secretary Chris Huhne warned of a 1970s-style oil shock that could cost the UK economy £45 billion over two years.  Closer to home, last week’s Financial Mail cover story on oil – the three letters that threaten economic growth – argued that a sustained high oil price threatens to completely stall the global recovery.  

Until quite recently, many economists and the mainstream financial media didn’t seem to ‘get’ the profound significance of oil.  True, it was widely acknowledged that economic slowdowns – particularly in the United States, the largest oil consumer on earth – tended to be preceded by spikes in the oil price.  But the clear correlation between high oil prices and recessions did not, in itself, prove any causal relationship.  As far as 2008 was concerned, surely Wall Street’s wizardry and former US Federal Reserve chairman Alan Greenspan’s laissez-faire approach to regulation were the real culprits.  Surely the rising oil price was just another ‘derivative’ of the bewildering world of credit default swaps and collateralised debt obligations.  Better still, by pinning it on these suspects we could even appear to be clever by pretending to comprehend the unintended consequences of ‘innovative financial products’.  

Though we live in an increasingly fast-moving, interconnected and complex world, it remains a truism that the simplest explanations are often the best ones.  First, consider that the economy is ultimately about the movement of people and stuff.  Expressed as GDP – the market value of goods and services produced – it is difficult to envisage economic activity taking place to any great extent without people and things moving around.  Whether it’s raw materials being hauled from the point of extraction to a processing plant, or from there being distributed onwards to retailers, whether it’s customers accessing goods, or employees getting to and from their places of work, very little of our globalised economic system functions without motorised transport.  

Second – and here’s the rub – worldwide, 95% of the primary energy that moves people and stuff from place to place – in cars, vans, trucks, buses, trains, boats, and aeroplanes – comes from a single source.  Transport is uniquely dependent on oil, meaning the economy is uniquely dependent on oil, or rather on the liquid transport fuels – such as diesel, petrol (or gasoline), kerosene – that we obtain from oil refineries.  So when the oil price goes up, the price of transport fuels increases and virtually everything that counts towards economic activity is impacted, either directly or indirectly.  Of course, in the case of oil companies, rising oil prices have a beneficial effect, at least in the short term… more of which later.  

Intuitively it’s easier to understand this effect on the cost of physical goods that actually get shipped around.  But why should high oil prices impact the service economy, and aren’t advanced economies more service-oriented than ever?  Again, the simple answer may be sufficient for our needs.  As household transportation costs increase – and, crucially, they are inelastic because most of us cannot or will not change our abode or place of work according to the forecourt price of petrol – all discretionary expenses experience downward pressure.  Food bills climb as oil-dependent agricultural commodities track the price of crude, an effect exacerbated by the gasoline substitution potential of corn-based ethanol in the US.  Debt repayments are more or less fixed, give or take fluctuating interest rates.  What remains is a shrinking domestic budget: quieter shopping malls, fewer evenings at the restaurant, one less trip to the hair salon.  Economic activity experiences a general slowdown – this is the very definition of recession, and not an ‘innovative financial product’ in sight.  

Anyone doubting the importance of liquid transport fuel to the health of the prevailing economic system – and therefore to maintaining social cohesion and political stability – need only recall what happened in the UK in September 2000.  Truckers and farmers protesting the relatively high pump price of diesel staged blockades of refineries and fuel terminals.  Diesel and petrol supplies slowed to a trickle as the public queued at forecourts to top up their tanks “just in case”.  Within a few days, 90% of filling stations were bone dry, just-in-time supply chains unravelled and people were fighting over loaves of bread among bare supermarket shelves.  The UK had staged a compelling if entirely accidental social experiment.  

Conclusion: five days of petroleum separate an advanced civilisation from savagery.  Note that we didn’t even run out of oil, we merely panicked!  

Returning to the companies that maintain our oil flows: perhaps uniquely in the global economic village, they do rather well when oil prices are on the up.  For instance, in 2008 – the year in which oil spiked to $147/bbl – ExxonMobil posted an annual profit of $45 billion, the largest in corporate history.  That same year, oil companies accounted for six of the seven largest global corporations, as measured by revenues.  (The outlier was Wal-Mart, an enterprise utterly symbolic of the economy’s dependency on relatively cheap and free-flowing transport fuel.)  

In this context, it should not surprise anyone that oil companies are somewhat reluctant to allow the Oil Age to draw to a graceful conclusion, as the transport system inevitably electrifies to become several times more energy efficient and compatible with the full range of sustainable renewable energy sources.  Not vested in the electricity generation game, oil companies continue to lead us astray.  BP recently argued that biofuels are “the only game in town”, the only major way to decarbonise road fuel, possibly contributing around 12% of the road transport fuel mix by 2030.  Or to put it another way, within twenty years if BP have their way the transport sector will be only 88% dependent on oil.  

BP is missing the point, of course.  The question is not only how we can decarbonise the transport sector, rather it is how we can achieve this while meeting the primary objective: gaining independence from oil.  How can we divest ourselves of turmoil in the politically fragile oil exporting regions of the world, and insulate our economic and social stability from events over which we exercise no control?  Ultimately, independence from oil means getting off liquid transport fuels, which won’t be achieved by shifting to 12% biofuels over the next two decades.  

To paraphrase BP, electricity is the only game in town.

UN-Substantiated Claims

This blog first appeared on the website of think tank and strategy consultancy SustainAbility

I made a resolution recently, one that I had to break within a matter of days.

Quick digression: in my former life on the Mobil Oil graduate programme, we used to enjoy a game called Buzzword Bingo (there are some rather more colourful names for it).  I’m sure it’s familiar across the corporate world – a quick Google search for “buzzword+bingo” returns more than 90,000 hits.  For the uninitiated, each player starts with a grid consisting of words and phrases that sound thoughtful but tend to be vacuous – things like “synergy”, “low-hanging fruit”, or “hit the ground running”.  Each time a particular word or phrase is used, players will strike it off their grid until all have been eliminated – HOUSE! – following which the maverick will stride confidently out of the room and into the dole queue.  

Back to my resolution.  Having attended and participated in countless sustainability-related conferences over the last 5 years, it struck me that too many words and phrases are parroted without a second thought for their true meaning, much less their plausibility.  So I resolved that the next time I’m attending a conference and I hear someone assert with confidence “the world will have 9 billion people by 2050”, I’d shout HOUSE! and then head for the fire escape.

Foolish of me, in retrospect.  Within days, at the World 50 sustainability forum in London, I heard both Patrick Dixon and Nick Stern trot out the “9 billion people” assumption-masquerading-as-fact, yet I couldn’t bring myself to walk out on either of them.  They’re both utterly brilliant and it was a real privilege to listen to them outline their views of the human development challenges facing us over the next forty years.  I’d have been cutting off my nose to spite my face.

But it did concern me that two great minds would have us accept this projection as pretty much inevitable.  Why has it become such a resilient piece of conventional wisdom, unchallenged and unchallengeable?  Is it because it comes from the United Nations?  I decided to check the assumptions that underpin the UN’s population projection.  From the website of the UN’s Department of Economic and Social Affairs, I found this revealing statement: 

 To project the population until 2050, the United Nations Population Division uses assumptions regarding future trends in fertility, mortality and international migration.

Three trends – fertility, mortality, migration – play out over the next four decades to deliver 9 billion people by 2050.  But what are the other implicit assumptions that underlie this projection?  For instance, that oil supply will continue to expand to meet rising demand?  

I’ve yet to see any business plan that starts with the assumption: the sun rises in the morning and sets in the evening.  That would be silly – that’s just the way the world is.  And for the last 150 years since E. L. Drake struck oil in Titusville, Pennsylvania, oil supplies have risen more or less continuously (barring the odd political intervention) to meet growing demand.  That’s just the way the world is.  Along the way, agriculture has mechanised, delivering humanity a huge endowment of arable land for food production rather than husbanding of draft animals.  In parallel, this has liberated millions from back-breaking manual labour – we can leave all that to our personal “ghost slaves”, or barrels of oil – enabling rapid urbanisation and the associated social complexity that characterises modern civilisation.  And, of course, a human population that has grown more than six-fold from just over one billion in 1850 to almost seven billion today.  

The global population will be 9 billion by 2050, and oil supplies will continue to grow to satisfy rising demand.

HOUSE!

BP: Tainting by Numbers

This blog first appeared on the website of think tank and strategy consultancy SustainAbility

At the time of writing, it appears BP’s desperate attempts to contain the Deepwater Horizon spill are drawing to a close.  Although the oil seepage would appear to have been halted for good, it seems wholly inappropriate to label this a success.  As Exxon found with their Valdez spill (which was ‘only’ one-fifth the size of this episode), the full scale of the tragedy won’t be known for many years to come – and it may yet culminate in what would have seemed ludicrous at the start of this year: the disappearance of the BP brand.  

So many thousands of column-inches have been dedicated to the disaster over the last few months, what more can be written about the estimated 5 million barrels of oil that escaped into the Gulf of Mexico?  Well, I thought it might be interesting to visualise this headline number – 5 million barrels – in terms that are meaningful to the majority of folk left cold by the oil industry vernacular.  When numbers get serious, as Paul Simon sang, we see their shape everywhere.  But sometimes we need a little help to appreciate their scale and significance.  For instance, companies are fond of presenting their energy efficiency gains and greenhouse gas reductions as “like taking 175,000 cars off the road”, or “equivalent to closing a coal-fired power station”.  

With that in mind, here’s my take on 5 million barrels of oil.  I invite readers to continue adding to this list – it might even be a cathartic experience: 

5 million barrels of oil…

  • Amounts to 210 million gallons – or 800 million litres – of liquid black gold
  • Which is enough to fill 320 Olympic-sized swimming pools
    • or half fill the old Giants Stadium (which is more than the Red Bulls ‘soccer’ team ever managed)

5 million barrels of oil…

  • Would produce in a typical US refinery around 100 million gallons – or 350 million litres – of motor gasoline
  • Which is enough to drive a Ford Focus roughly 4.3 billion miles – or 7 billion km
    • or more than 9,000 return trips to the moon (assuming the roads were nice and clear)

5 million barrels of oil…

  • Would have fetched around $735 million at the July 2008 record high oil price of $147/bbl
  • Which is equivalent to ~18 hours worth of BP’s 2008 revenues
    • or the entire annual GDP of The Gambia

5 million barrels of oil…

  • Contain roughly 8 TWh of energy
  • Which is equivalent to 2 × 500 MW coal-fired power plants running non-stop at full capacity for a year
    • or the energy consumed annually by 320,000 average UK households

The Future of Oil

This article, co-authored with John Elkington, first appeared in China Dialogue and was repeated on the Guardian Environment Network

The race for the world’s remaining oil reserves could get very nasty.  Recently, Nigerian militants announced their determination to oppose the efforts of a major Chinese energy group to secure six billion barrels of crude reserves, comparing the potential new investors to “locusts”.  The Movement for the Emancipation of the Niger Delta (MEND) told journalists that the record of Chinese companies in other African nations suggested “an entry into the oil industry in Nigeria will be a disaster for the oil-bearing communities”.  

Whatever the facts, the end of the first decade of the twenty-first century is likely to be seen by future historians as the beginning of the final chapter of a unique, unrepeatable period in human development.  Even oil companies now see the Age of Oil in irreversible decline – even if that decline spans decades. International oil companies (IOCs) increasingly accept that they must transform themselves completely – or expire – by mid-century.  

Superficially, the so-called “super majors” appear to be in good health. Fortune’s Global 500 list places the “big six” – Shell, ExxonMobil, BP, Chevron, Total, and ConocoPhillips – among the seven largest corporations in the world, as measured by 2008 revenues.  In third place, Wal-Mart stands alone as the only top seven company not dedicated to finding, extracting, processing, distributing and selling the liquid transportation fuels that drive the global economy, although few business models are as dependent on the ready availability of relatively cheap oil. 

Worryingly for such companies, 2008 may prove to have been the high water mark for the global oil industry, with geological, geopolitical and climate-related pressures now creating new market dynamics.  The oil question is now, more than ever, a transport question.  Cheap and reliable supplies of transportation fuel are the very lifeblood of our globalised economy.  So it matters profoundly that we are entering an era in which oil supplies will be neither cheap nor reliable. 

For the likes of Shell, BP, and ExxonMobil, whose rates of liquid hydrocarbon production peaked in 2002, 2005, and 2006 respectively, the current economic paradigm requires them to replace reserves.  Investors primarily value IOCs on this basis, as well as their ability to execute projects on time within budget.  A key problem for the IOCs is that petroleum-rich countries feel increasingly confident in the ability of their own national oil companies to steward their domestic resources.  So generous concessions once offered to IOCs in return for technical and managerial expertise are now deemed unnecessary.

The imperative to satisfy investor expectations fuels an increasingly risky growth strategy, which drives IOCs towards energy-intensive (and potentially climate-destabilising) unconventional oil substitutes, such as tar sands (in Canada), gas-to-liquids (in Qatar), and coal-to-liquids (in China and elsewhere).  These pathways are not chosen as ideals: they are more or less reflexive responses to external market pressures.

Meanwhile, the uncomfortable fact is that our economies are addicted to liquid hydrocarbon transport fuels, the consumption of which creates a catalogue of negative side effects.  And we cannot hope to address this addiction by way of our “dealers” developing even more damaging derivatives of the same drug. 

As if that were not enough, there is the hot topic of “peak oil”, defined as the point at which global oil production reaches a maximum rate, from where it steadily declines.  The basic principle is uncontroversial: production of a finite non-renewable resource cannot expand endlessly, and this has been demonstrated in practice at national level all over the world.  The heated debate centres on the point at which the peak in global oil production is likely to be reached. 

“Early toppers” argue that the peak has already been passed, and that the world will never produce more than 85 million barrels per day.  By contrast, “late toppers” point to the huge scale of unconventional reserves – for example, Alberta’s tar sands resource is vast – that remain untapped, as well as the potential bounty locked away in frontier regions such as the Arctic Ocean, where global warming is opening up new areas for oil and gas exploration. 

Unfortunately, what matters is not the absolute size of these unconventional and frontier resources, but the rate at which they can be developed and brought to market.  By definition, this is the “difficult” oil.  Production rates are determined by a series of significant financial, social, and environmental constraints that raise grave concerns for the viability of a global economic system made possible by liquid transport fuels. 

At the same time, leaders of all the major economies finally acknowledge what scientists have long been warning: to avoid catastrophic climate-change impacts, the global average surface temperature increase must be limited to 2° Celsius compared with the pre-industrial era.  To stand any reasonable chance of avoiding a 2° Celsius rise, our best understanding of the climate change science suggests that global greenhouse-gas emissions must peak within the next five to 10 years, and then decline by more than 80% on 1990 levels by 2050.  Realistically, meeting this requirement will demand that we engineer a transition to a zero-carbon energy system by mid-century. 

So what might a zero-carbon energy system look like?  As well as dramatic improvements in the energy efficiency of buildings and appliances, and massive deployment of sustainable renewable energy technologies, we will no longer be allowed to burn fossil fuels without capturing and sequestering the carbon dioxide emissions.  This implies that we must restrict our use of fossil fuels to stationary facilities, such as power plants, where carbon capture and storage (CCS) is practical (see “Outlook and obstacles for CCS”).  Strikingly, a zero-carbon energy system will also mean that no liquid hydrocarbon fuels, with the exception of biofuels, can be consumed in mobile applications such as transport. 

This does not make pleasant reading for international oil companies.  Their core business today may be described as: digging geological carbon resources out of the ground, converting those resources into liquid fuels, then marketing those fuels to consumers who set them on fire in internal combustion engines to move around.  By 2050, these activities will all be considered to be strikingly primitive. 

Why $40 per barrel is no cause for complacency

This article, co-authored with David Strahan, first appeared on the website of think tank and strategy consultancy SustainAbility

These days it is comforting to have one thing not to worry about.  As the world teeters on the edge of a full-blown depression, and business is crushed between slumping sales and seized-up credit markets, at least the oil price is in retreat.  From an historic high of $147 per barrel last July to around $40 today, the price of crude has collapsed so quickly it is tempting to believe it means the end of the energy crisis; that the spike was just some speculative aberration; and that all talk of ‘peak oil’ is so 2008.  

It is true that the horizon has been utterly transformed.  Last year the big issue keeping many company bosses awake in the small hours was rising energy bills – this year all manner of competing spectres haunt their sleepless nights.  But to relegate oil simply because the price has slumped is to misunderstand the causes of the recent spike and collapse, and therefore the future outlook for energy prices and what it means for business and the climate.  

It is commonplace to blame $147 oil on booming demand in China and India, but that is only one half of the equation.  The other is that global oil production between early 2005 and mid 2008 was stagnant, at around 86 million barrels per day.  So for three years the oil supply was a zero sum game: the East consumed more, and with production static, the price of crude had to rise to force the West to consume less.  Under the circumstances the oil price was a one way bet.  But in the past, rising demand has always been met by increased output, so the key question is: why did global oil production fail to grow?

Analysts divide the oil producing world into two halves: OPEC and the rest.  Non-OPEC output has underperformed against forecasts every year this century.  Because it depends on production from regions that are increasingly mature, non-OPEC output is widely expected to peak by around the end of this decade.  But OPEC also failed to raise its game, and this is unlikely to have been the result of deliberate market manipulation.  At $147 per barrel, the incentive to pump more oil rather than risk destroying demand would have been irresistible, if it were possible.  In fact, there are good reasons to suspect that the cartel’s members have been exaggerating the size of their reserves for decades (most observers attribute the sharp jump in proved reserves of several Middle Eastern members during the 1980s to a dispute over production quotas, which created an incentive to overstate reserves).  So OPEC’s collective inability to respond to record prices by raising production may suggest its output is approaching its geological limits.  If we have not yet arrived at the oil peak, we seem at least to be in the foothills.

The subsequent oil price collapse is just as misunderstood as the spike that preceded it.  Of course, the price is falling because demand is shrinking, and that’s due to the recession.  But what caused the recession?  The obvious culprit is the banking crisis, which has clearly been extraordinarily damaging.  But so too are oil price spikes; every major recession since World War II has been preceded by one.

It’s not hard to see why: the global transportation system – moving goods, workers and consumers around, thereby enabling an increased level of economic activity to take place – is almost entirely fuelled by crude oil.  When the price of oil soars, almost all aspects of modern daily life become more expensive.  And as the oil exporters accumulate more of the world’s money, so everyone else has to make do with less.

The 2008 spike not only set a new record high oil price, in both absolute and inflation-adjusted terms, but it was also very sudden, with the price almost trebling in around eighteen months.  So it seems highly likely that even without the credit crunch, the oil market fundamentals would have been sufficient to push us into a global recession.

Far from being a source of relief, today’s relatively low oil price is as damaging in its own way as the spike.  Oil companies around the world are cancelling or delaying investment in planned production projects, because they are uneconomic at current levels; $60 billion of investment in the Canadian oil sands was shelved in the three months to January alone.  At the same time, existing global production capacity is constantly shrinking, as oil fields age and reservoir pressures decline.  The International Energy Agency (IEA) estimates that capacity is currently shrinking by around two million daily barrels per year, and that this decline rate will accelerate in future (World Energy Outlook 2008).  Oil production projects have long lead times, so the combination of declining reserves and limited investments means there is a very real danger that when economic growth returns, oil supplies will be inadequate to meet demand, and the price will spike once more.  And the cycle starts all over again.

Extreme volatility in the oil price will of course mean the same for gas and electricity.  Natural gas purchasing agreements are tied to the price of crude, meaning that extreme volatility in the oil price means the same for gas and electricity – as has been demonstrated in the past two years.

This is likely to wreak havoc with company budgets, and share valuations – at least for those companies that do not take steps to reduce their exposure.  A recent analysis of the correlation between energy costs and the share valuations of logistics companies showed that financial markets can reward fuel thrift and punish profligacy.  A 10% rise in energy costs was credited with precipitating a 10 cent fall in FedEx’s share price, but a rise of 3 cents for UPS.  It turns out that fuel-per-package-delivered is a key performance indicator for UPS, for which managers are held accountable.  So in addition to carbon reduction, cost cutting, and resilience to short term supply disruption such as the UK fuel duty protests of 2000 (which are likely to become more frequent as the oil supply tightens) there is now yet another reason for companies to eliminate their dependence on oil.

When the next spike occurs depends crucially on the depth of the recession – or depression – although analysts such as Barclays Capital forecasts that in the fourth quarter of this year the oil price will average $87 per barrel, rising to $96 twelve months later.  But for as long as the oil price stays low, it’s not just bad for the future oil supply, but also for investment in renewable electricity generation, where the economics are judged against the cost of electricity from gas fired power stations.  The impact is worsened by the low price of allowances in the EU Emissions Trading Scheme (ETS), now languishing at around 10 EUR per tonne of CO2, where most energy analysts believe it is impotent as a stimulus for green energy investments.  (The economic slowdown has thus highlighted one of the inherent flaws in the existing EU ETS: emissions allowances are allocated in advance, on the assumption that economies will grow.)  Major projects such as the London Array offshore wind farm are in the balance, while plans by the legendary oilman T Boone Pickens to build the world’s largest wind farms in Texas have already been put on hold.  Paradoxically, one of the indirect impacts of falling oil consumption is that investments in green energy technologies are less economically viable.

If we are still in the foothills of peak oil, there is good evidence to suggest we will reach the summit well within most companies’ planning horizons.  We are clearly already in deeply unsustainable territory: discovery of oil has been falling for over forty years, while consumption has risen inexorably, save for a couple of brief recessionary interludes.  Today, for every barrel of oil we discover, we consume three; annual production is already falling in over sixty of the world’s 98 oil producing nations.  Many oil companies and forecasters expect trouble at least by the middle of the next decade – whether or not they strictly accept the term ‘peak oil’.  Shell expects global production to plateau, Total’s chief executive, Christophe de Margerie, says the world will never produce more than 89 million barrels per day, and the IEA says we face a “supply crunch”.

Given the prominence of the peak oil debate, no CEO can claim they were not put on notice about this fundamental threat to their business, irrespective of their role within the economy.  It is hard to imagine any sector prospering today in the absence of a functioning transportation system.

The good news however is there is absolutely no shortage of energy.  The sunlight that hits the earth in an hour contains enough energy to run the global economy for a year.  But while solar, wind, wave, tidal and geothermal energy can all be harnessed to generate clean electricity, they cannot hope to solve the oil crunch – and with it many of the environmental consequences of our crude oil addiction, not least climate change – as long as the global economy runs on liquid hydrocarbon fuels.

There is scant evidence that governments have awoken to the scale of the peak oil crisis, the impacts of which will surely be felt well before the worst effects of climate change start to kick in.  Oil market psychology lurches between two extremes: complacency and panic.  What we need is to find the middle ground: a sense of urgency and an appetite for action commensurate with the challenge, and to sustain it even when oil prices are low.  The trick for corporate leaders will be to figure out what the post-petroleum economy is going to look like, what technologies and policy frameworks will be required to expedite the transition, and what risks and opportunities will emerge within the changing regulatory environment.  In short, they will need to plan how to survive – or better still, profit from – the inevitable transformation.