Peak Oil Panic

Is the planet running out of gas? If it is, what should the Bush administration do about it?

The Princeton geologist Ken Deffeyes warns that the imminent peak of global oil production will result in "war, famine, pestilence and death." Deffeyes, author of 2001's Hubbert's Peak: The Impending World Oil Shortage and 2005's Beyond Oil: The View from Hubbert's Peak, predicted that the peak of global oil production would occur this past Thanksgiving.

Deffeyes isn't alone. The Houston investment banker Matthew Simmons claims in his 2005 book Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy that the Saudis are lying about the size of their reserves and that they are really running on empty; last September he announced that "we could be looking at $10-a-gallon gas this winter." Colin Campbell, a former petroleum geologist who is now a trustee of the U.K.-based Oil Depletion Analysis Centre, warned way back in 2002 that we were headed for peak oil production, and that this would lead to "war, starvation, economic recession, possibly even the extinction of homo sapiens." In his 2004 book Out of Gas: The End of the Age of Oil, the Caltech physicist David Goodstein wrote that the peak of world production is imminent and that "we can, all too easily, envision a dying civilization, the landscape littered with the rusting hulks of SUVs." Jim Motavalli, editor of the environmentalist magazine E, writes in the January/February 2006 issue, "It is impossible to escape the conclusion that we're steaming full speed ahead into a train wreck of monumental proportions."

And James Schlesinger, the country's first secretary of energy, declared in the Winter 2005–06 issue of the neoconservative foreign policy journal The National Interest that "a growing consensus accepts that the peak is not that far off." He added, "The inability readily to expand the supply of oil, given rising demand, will in the future impose a severe economic shock."

Even some traditionally calm voices are starting to sound panicky. In March 2005, the New York investment bank Goldman Sachs issued a report suggesting that oil prices would experience a "super spike" in 2006, reaching up to $105 per barrel. ChevronTexaco's willyoujoinus.com campaign, featuring a series of full-page newspaper ads that urge Americans to conserve energy, flatly declares, "The era of easy oil is over."

Such forecasts have been bolstered by a steep rise in oil prices over the last three years, going from $18 a barrel in 2002 to $70 last fall. If the price of something goes up, after all, that means it's becoming scarcer.

The good news is that the peak oil doomsters are probably wrong that world oil production is about to decline forever. Most analysts believe that world petroleum supplies will meet projected demand at reasonable prices for at least another generation. The bad news is that much of the world's oil reserves are in the custody of unstable and sometimes hostile regimes. But the oil producing nations would be the ultimate losers if they provoked an "oil crisis," since that would spur industrialized countries to cut back on imports and develop alternative energy technologies.

Apocalypse Yesterday

Predictions of imminent catastrophic depletion are almost as old as the oil industry. An 1855 advertisement for Kier's Rock Oil, a patent medicine whose key ingredient was petroleum bubbling up from salt wells near Pittsburgh, urged customers to buy soon before "this wonderful product is depleted from Nature's laboratory." The ad appeared four years before Pennsylvania's first oil well was drilled. In 1919 David White of the U.S. Geological Survey (USGS) predicted that world oil production would peak in nine years. And in 1943 the Standard Oil geologist Wallace Pratt calculated that the world would ultimately produce 600 billion barrels of oil. (In fact, more than 1 trillion barrels of oil had been pumped by 2006.)

During the 1970s, the Club of Rome report The Limits to Growth projected that, assuming consumption remained flat, all known oil reserves would be entirely consumed in just 31 years. With exponential growth in consumption, it added, all the known oil reserves would be consumed in 20 years. These dour predictions gained credibility when the Arab oil crisis of 1973 quadrupled prices from $3 to $12 per barrel (from $16 to $48 in 2006 dollars) and when the Iranian oil crisis more than doubled oil prices from $14 per barrel in 1978 to $35 per barrel by 1981 (from $45 to $98 in 2006 dollars).

In response, the federal government imposed price controls on oil and gas in the 1970s and established fuel economy standards to encourage the sale of more efficient automobiles. The sense of doom did not dissolve. In 1979 Energy Secretary Schlesinger proclaimed, "The energy future is bleak and is likely to grow bleaker in the decade ahead." The Global 2000 Report to President Carter, issued in 1980, predicted that the price of oil would rise by 50 percent, reaching $100 per barrel by 2000.

Most of today's petro-doomsters base their forecasts on the work of the geologist M. King Hubbert, who correctly predicted in 1956 that U.S. domestic oil production in the lower 48 states would peak around 1970 and begin to decline. In 1969 Hubbert predicted that world oil production would peak around 2000.

Hubbert argued that oil production grows until half the recoverable resources in a field have been extracted, after which production falls off at the same rate at which it expanded. This theory suggests a bell-shaped curve rising from first discovery to peak and descending to depletion. Hubbert calculated that peak oil production follows peak oil discovery with a time lag. Globally, discoveries of new oil fields peaked in 1962. The time lag between peak global discoveries and peak production was estimated to be around 32 years, but peak oilers claim that the two oil crises of the 1970s reduced consumption and thereby delayed the peak until now. Hubbert's modern disciples argue that humanity has now used up half of the world's ultimately recoverable reserves of oil, which means we are at or over the peak.

The prophets of oily doom are opposed by preachers of energy abundance. Chief among the latter is the energy economist Michael Lynch, president of the Massachusetts-based Global Petroleum Service consultancy. "Colin Campbell has the worst forecasting record on oil supply," says Lynch, "and that's saying a lot." He points out that in a 1989 article for the journal Noroil, Campbell claimed the peak of world oil production had already passed and incorrectly predicted that oil would soon cost $30 to $50 a barrel. As for Matthew Simmons, Lynch dismisses him with a sneer: "Petroleum engineers know a lot more about petroleum engineering than a Harvard MBA."

One petroleum engineer— Michael Economides of the University of Houston—calls peak oil predictions "the figments of the imaginations of born-again pessimist geologists." Like Lynch, Economides, who worked in Russia to boost that country's oil production in the last decade, rejects Simmons' analysis. Saudi Arabia, which currently produces about 10 million barrels of oil a day, "is underproducing every one of their wells," he claims. "I can produce 20 million barrels of oil in Saudi Arabia."

The Tank Is Still More Than Half Full

So who's right? Fortunately, it looks like humanity is at least a generation away from peak oil production. Unfortunately, there could be another "oil crisis" any day now.

The world consumes about 87 million barrels of oil per day, or nearly 30 billion barrels of oil per year. How much oil is left? It's hard to be sure. Proven oil reserves—i.e., oil that is recoverable under current economic and operating conditions—are estimated to be 1.1 trillion barrels by the industry journal World Oil, 1.2 trillion by the oil company BP, and 1.3 trillion by the Oil and Gas Journal. In March 2005 the private U.K.-based energy consultancy IHS Energy estimated that the world's remaining recoverable reserves, excluding unconventional sources such as heavy oil or tar sands, are between 1.3 trillion and 2.4 trillion barrels.

But are proven reserves all that's left? Several analyses put ultimate reserves at much higher levels. For example, the USGS undertook a comprehensive analysis of world oil reserves in 2000. It calculated that the total world endowment of recoverable oil is 3 trillion barrels. (Its figure is higher because it includes estimates for undiscovered resources and projected increases in already producing fields.) In addition, the total world endowment of natural gas is equivalent to 2.6 trillion barrels of oil, plus 330 billion barrels of natural gas liquids such as propane and butane. The USGS figures that the total world endowment of conventional oil resources is equivalent to about 5.9 trillion barrels of oil. Proven reserves of oil, gas, and natural gas liquids are equivalent to 2 trillion barrels of oil. The USGS calculates that humanity has already consumed about 1 trillion barrels of oil equivalent, which means 82 percent of the world's endowment of oil and gas resources remains to be used.

In its 2005 Energy Outlook, ExxonMobil estimates "global conventional oil resources total 3.2 trillion barrels…with non-conventional 'frontier' resources such as heavy oil bringing that total to over 4 trillion barrels." In November 2005, the International Energy Agency, an organization created in 1974 by 26 industrialized countries to assess global energy issues, released its annual World Energy Outlook report, which accepted the USGS numbers and concluded that "the world's energy resources are adequate to meet projected growth in energy demand" until at least 2030. The report predicted that oil production would grow from the 2004 level of 82 million barrels a day to 115 million barrels a day and that any "peak" would occur after 2030. It suggested that world oil prices will decline to around $35 per barrel (in 2004 dollars) by 2010 and eventually rise to $39 per barrel by 2030. At the Montreal Climate Change Conference in December, Claude Mandil, head of the International Energy Agency, declared: "We don't share the tenets of the peak oil theory. We feel that they underestimate technological developments. For many decades to come there is no geological problem."

Probably the most respected private oil consultancy in the world is Cambridge Energy Research Associates (CERA) in Boston. On December 7, 2005, CERA senior consultant Robert W. Esser testified at a House Energy and Air Quality Subcommittee hearing on the peak oil theory. "CERA's belief is that the world is not running out of oil imminently or in the near to medium term," Esser said. "Indeed, CERA projects that world oil production capacity has the potential to rise from 87 million barrels per day [mbd] in 2005 to as much as 108 mbd by 2015.…We see no evidence to suggest a peak before 2020, nor do we see a transparent and technically sound analysis from another source that justifies belief in an imminent peak." Instead of a sharp peak followed by a production decline, CERA's analysts foresee an "undulating plateau" in which global oil production remains more or less steady. "It will be a number of decades into this century before we get to an inflection point that will herald the arrival of the undulating plateau," said Esser.

Peak oilers discount these rosy scenarios, insisting the relevant fact is that new oil discoveries have been falling during the last couple of decades. But the petroleum optimists, such as the analysts at the USGS, say there is more to it than that. They point out that reserve growth and new discoveries have been outpacing oil consumption. (Reserve growth is the increase in production in already discovered and developed fields.) From 1995 and 2003 the world consumed 236 billion barrels of oil. It also saw reserve growth of 175 billion barrels, combined with 138 billion barrels from new discoveries, added a total of 313 billion barrels to the world's proven oil reserves. In the U.S., oil field reserves typically turn out to be four to nine times as high as the original estimates. The increase in production is a result of improved recovery technologies, further discoveries in the field, and improved field management.

Consider the Kern River field in California, which was discovered in 1899. In 1942 it was estimated that only 54 million barrels remained to be produced there. During the next 44 years the field produced 736 million barrels and had another 970 million barrels remaining. For geological reasons, petroleum engineers cannot pump every drop of oil out of a reservoir. But by 2004 technological advances enabled them to recover 35 percent of a conventional reservoir's oil, up from an average of 22 percent in 1980. If this recovery factor can be increased by another five percentage points, that would boost worldwide recoverable reserves by more than all of Saudi Arabia's current proven reserves. Economides points out that in 1976 the U.S. was estimated to have 23 billion barrels of reserves remaining. In 2005 it still had 23 billion barrels of oil reserves, even though American oil fields produced almost 40 billion barrels of oil between 1976 and 2005.

Matthew Simmons claims to have found that the Saudis are greatly exaggerating the size of their reserves. If true, this is bad news, because the Saudis have more than 30 percent of the world's reserves and have served as the world's supplier of last resort for a couple of decades. Simmons argues that the Saudis and others are exaggerating what they have because the supply quotas set by the Organization of Petroleum Exporting Countries (OPEC) were tied to the size of a country's reserves—the bigger its reserves, the more oil it was permitted to sell. But the desire to boost quotas cannot account for the fact that non-OPEC reserves grew nearly three times faster than OPEC reserves between 1981 and 1996. And whatever incentive OPEC members had to lie about their reserves should have dissipated as the price of oil rose during the last couple of years. Economides notes that the Saudis are investing $100 billion in new production projects, which undercuts the notion that they know they are running out of oil.

At a November meeting of the Council on Foreign Relations, chief International Energy Agency economist Fatih Birol responded to the assertion that Saudi Arabia can't raise its oil production by outlining a scenario in which he assumed that Saudi oil reserves were 35 percent lower than claimed. Birol noted that experts believe forcing water into reserves to maintain pressure would raise the cost of producing oil by 70 percent at most. In his analysis, Birol assumed it would raise the cost by 300 percent. Considering that it costs about $1.50 to produce a barrel of Saudi crude oil, that means the cost would rise to $6 per barrel. Even with these two assumptions, Birol argues the Saudis could easily produce 18 million barrels of oil per day by 2020, up from the current level of around 10 million.

So if the world has adequate oil supplies for the next generation, can we all go back to driving Hummers? Not so fast.

The Real Oil Crisis

Simmons has been wrong so far: Gasoline does not cost $10 a gallon. Oil prices hovered between $55 and $65 per barrel in late 2005 and early 2006, down from $70 in September 2005. The U.S. Energy Information Administration believes gasoline prices will remain below $3 per gallon in 2006.

What about the future? The International Energy Agency calculates that $3 trillion must be invested in oil production and refining facilities during the next 25 years to meet world demand in 2030. In principle that target could easily be met, since producing 1 trillion barrels at $30 per barrel yields $30 trillion in income over 25 years.

The problem is that the vast majority of the world's remaining oil reserves are not possessed by private enterprises. Seventy-seven percent of known reserves belong to government-owned companies. That means oil will be produced with all the efficiency associated with central planning. Michael Economides estimates, for example, that it will take $4 billion in investment to keep Venezuela's oil production at current levels. Yet that country's Castro-wannabe president, Hugo Chavez, is investing just half that.

If ChevronTexaco, ExxonMobil, or other private companies actually owned the reserves, the world would be in a much more secure position with regard to oil production. Instead, we are subject to the whims of figures like Chavez, Russia's Vladimir Putin, and Iran's Mahmoud Ahmadinejad, and must worry about the doubtful stability of their personalities and regimes. (To be sure, even a private reserve under such a regime would face the constant threat of nationalization or other interference.) In the mid-1990s, the world had more than 10 million barrels per day of spare production capacity. That figure has fallen to between 1 and 2 million barrels, which means that any significant disruption in supplies can cause prices to soar.

Economides worries that the conventional wisdom that oil-producing countries do not want to cause a global economic recession is wrong. "The danger posed by the axis of energy militants—Venezuela, Iran, and, increasingly, Russia under President Vladimir Putin—is that they could not care less," he says. "These militants hardly have functioning real economies whose workings would be adversely affected by a recession." Economides' views looked prophetic when oil prices jumped to a three-and-half-month high after Iran's threat in January to retaliate against any United Nations sanctions imposed to curb its nuclear ambitions by cutting its oil exports.

Despite the recent jump in oil prices, the world's economy has not slowed down. Why not? Goldman Sachs notes that oil is less important than it was a generation ago. At the height of the Iranian oil crisis in 1980–81, paying for gasoline took up 4.5 percent of U.S. GDP and 7.2 percent of U.S. consumer expenditures. In 2005, even though U.S. gas prices peaked at $3.07 per gallon after Hurricane Katrina, only 2.6 percent of GDP went to pay for gas and consumers spent only 3.7 percent of their incomes to fuel their cars and SUVs. Goldman Sachs believes gasoline prices would need to exceed $4 per gallon before consumers really started to cut back.

As the oil crisis of the 1970s demonstrated, while the demand for oil is inelastic in the short run, consumers do eventually adjust to higher prices. U.S. oil consumption declined by 13 percent between 1973 and 1983. According to Frederick Cedoz, vice president of the D.C.-based energy and political risk consulting group Global Water and Energy Strategy Team, "We get three times more GDP out of a barrel of oil than we did in the 1970s."

The higher prices of the 1970s led eventually to an oil glut and prices below $10 a barrel by 1986. Should one or more of the "energy militants" choose to deploy the "oil weapon" again, they will cause considerable economic pain to the developed countries. But detonating the oil weapon would end up disarming the energy militants for a generation, after consumer cutbacks produce a new glut.

Oil War Hawks

Unfortunately, you don't have to go to Iran, Russia, or Venezuela to find energy militants. We have some homegrown ones right here in America, and they think the world is already in the opening stages of a global energy war. Last July, the conservative Heritage Foundation in Washington, D.C., assembled some of the scariest American oil war hawks for a program called "The Coming Energy Wars: A 21st Century Time Bomb?"

All the participants apparently accept the idea that world oil supplies are about to decline, and they all share a zero-sum view of natural resources. According to the Heritage panelists, the chief villain in the coming energy wars is China. Referring to China as the "Thirsty Dragon," Cedoz warned, "China wants to lock up supplies at the wellhead with long-term purchase contracts." He darkly pointed to Chinese negotiations over oil supplies in Sudan, Ecuador, and Colombia. (Actually, if the Chinese sign up for long-term contracts, that would encourage producers to invest more in production. That would benefit all consumers, not just the Chinese.)

Refurbished cold warrior Frank Gaffney, president of the Center for Security Policy, opposed the $18.5 billion bid by the China National Offshore Oil Corporation for the California-based oil company Unocal last year. "It's a very ill-advised transaction," said Gaffney. "It's not in our interests to turn over more of our finite resources to others. They should be taken off the market." Our finite resources? Seventy percent of Unocal's reserves and production are located in East Asia and the Caspian Sea region.

The Chinese company withdrew its bid after a number of congressmen promised to outlaw the sale. But Gaffney isn't breathing easier. China's oil grab, he announced, "is only part of a larger plan to deny us strategic minerals, strategic choke points, and strategic regions. Their purpose is to deny the U.S. a dominant role in the world and if necessary to defeat us."

Ilan Berman, vice president for policy at the American Foreign Policy Council, regretted that "energy is not viewed through a national security prism. We should be competing to lock up supplies and diversifying and exploring new technologies." Berman argued that as resources become scarcer there is no way to avoid a zero-sum game. "We have to approach this through the lens of the haves and have-nots," he declared.

One dissenting voice at the Heritage Foundation session was Harvey Feldman, a former ambassador to Papua New Guinea and an East Asian specialist. "Berman is suggesting that we change from a paradigm of relying on the market," said Feldman. "OK, we're going to be in competition with the British, Japanese, French, Germans, Indians, and everybody else. Is this really in the interest of the United States?" Given that most of the experts in the oil business don't think the world is about to run out of oil, this is one time to hope that President Bush is listening to his buddies in the oil industry.

Instead of preparing for an energy war, the best policy is to let markets have free rein. Even if, say, the Iranians make the political decision to disrupt the flow of oil to world markets, those markets left to themselves will eventually discipline them. The temporarily higher prices will encourage more exploration and technological advances, which will bring energy prices back down. On the day of his inauguration in 1981, President Ronald Reagan lifted oil price controls. Five years later oil prices fell below $10 a barrel.

One day, the oil age will end. As with all resources, there is ultimately a finite supply of oil. So it is not yet clear how the world will power itself for the bulk of the coming century. But we have at least another three decades to find alternatives to petroleum. "Trusting markets is the only way we can assure energy abundance in the future," notes the University of Houston's Economides. "It's also the only way that we will ever transition to something other than oil and gas."