FSN Energy Roundtable
JIM: Over the last couple of years as oil prices continued to make new highs the public has become increasingly concerned. What's behind the rise in oil? It's obvious something disturbing is happening in the oil markets. Are we running out of oil as some contend or are high oil prices being driven by the greed of speculators?
Joining me in a special roundtable edition this week, my guests are Matt Simmons, he's Chairman of Simmons International and also author of the bestselling book, Twilight in the Desert; also on the program is Dr. Robert Hirsch, he's a senior energy advisor at MISI and a consultant in energy technology and management; and Jeff Rubin, an economist with CIBC World Markets.
The Oil Drum this morning on conventional crude and they talked about the oil [production] has increased yet the production of conventional crude is still down 174,000 barrels from the peak in May of 2005.
MATT SIMMONS: I haven't seen that but that's something I've been focusing acutely on because it's something, frankly, that totally missed my grasp of how complicated it is to now – top up – meet total petroleum demand when crude supply wasn't growing nearly as fast as total petroleum demand. And now that crude supply at least temporarily is off we're digging deep into the well of stock liquidation to kind of bridge supply and demand; and that is really dangerous. [1:52]
ROBERT HIRSCH: I've got a little different point of view on what's been happening. Matt has talked about reaching maximum production a few years ago. And if one looks at the data for total world liquids production, you see that we're on a plateau. In other words, we have reached a level and generally maintained a relatively constant level since middle 2004. The way to look at that, it seems to me, is to recognize that when you're on a plateau you're going to have fluctuations, so 175,000 barrels a day is well within the range of what one might expect. And in fact, if you look at what the plateau in North America you'd see that roughly four percent was roughly the fluctuation level. If you apply that four percent to where we are today, a million or two either direction in fact still keeps you within a band that would be considered a plateau. So we're basically at a constant level of output – at least the way I look at it. [2:51]
MATT: I agree with that. But what's dangerous to me about that is that too much of a percentage of the topping-out is coming from natural gas liquids as opposed to crude.
ROBERT: Well, the thing that the world worries about the most is the liquid supply and yes, Matt, you're absolutely right, details are very important.
MATT: Yeah, it's fragile; a lot of it comes ironically from mature oil fields that have coughed up their gas cap. So while that grows, it's basically a last gasp thing and we hardly have any data about it. [3:22]
ROBERT: Well, the data overall of course, as I think we all recognize, is very poor and nowhere near what one would like to have but that's the character of the problem.
JIM: I want to begin our discussion, Robert, with a report that you made in February 2005, called Peaking of World Oil Production Impacts Mitigation and Risk Management. And you had a wide variety of forecasts within the field as to when oil peaks, but what I believe is really important in your report – if I understood it correctly – is the unique challenges that peak oil is going to present to the world. What are those challenges in your opinion
ROBERT: It goes back to the fundamentals that oil is really a lifeblood of modern economies and if we have shortages and growing shortages over time that's going to have a major impact on GDP worldwide. In other words, we're talking about shortages leading to recessions as they did in 1973 and 1979. We're going to obviously do something about that; and we call that of course mitigation.
Mitigation is going to require everything that is reasonable to not only save on consumption of oil but also to produce substitute oil in order to make up for the growing gap that will occur from the sources that we've been used to. So we're going to have to do a number of things. What we did is look at them on a crash-program basis which is the best that one could do. And the reason for looking at a crash program is it gives you an upper limit on what is likely to be achievable. And when you do that you find out that you really should have started working on the problem well before it hits; and if we keep waiting the economic damage that will be required before we're able to get back on top of the problem is going to be very significant. [5:17]
JIM: You know in that report you listed three scenarios. The best option would be a crash program 20 years before the peak. That would give you enough time to adjust and come up with alternatives. The second best option would be a crash program 10 years before the peak. And the worst option would be a crash program after the peak. It seems to me that having the forecast date right is kind of critical at this point because there's so much in the media today –and I'm going to get to a couple of reports that came out this month that are just astounding – but if you know that the forecast is maybe peak oil is here today (which it looks like to me) or it's five years or ten years, I mean you need to get going otherwise you have a major problem. [6:05]
ROBERT: The reason that we did three scenarios was to kind of bracket the situations that are conceivable. At the time we did it it was less clear when peaking might occur because there was a broad range of opinions on that subject; and we felt that by doing the three scenarios we'd get an idea of what was really the character of the problem. What's happened of course is that we now appear to be on a plateau and it may be the plateau before decline, or it may be that we kick up from here. Nobody really knows that. But looking at the circumstances and the results of that study we are undoubtedly too late now to avoid significant economic problems around the world. [6:47]
JIM: One thing that I've seen on these forecasts regarding peak oil is if you throw the outliers out which is on both ends and you look at just sort of that middle ground where there seems to be a gathering of a consensus, I mean even last week you had the head of Shell Oil say: Demand for oil and gas is going to outstrip within seven years. So if peak oil is not in the living room it certainly looks like it's approaching the front door. Matt, do you want to address that?
MATT: Well, I think it's interesting that up until six months ago the major oil company CEOs were pretty well in lock-step on the same view that peak oil really wasn't an issue that we should take seriously. One prominent company went as far as publishing an advertisement in Fortune and BusinessWeek saying peak oil isn't real; others would refer to it in print as junk science. And it always amazed me because the arguments were all the same: We have this fabulous base of remaining recoverable resources. And they really weren't even focusing on the fact that this group of us that is scared about this are talking about flow rate and decline curves – not running out of oil.
But out of the blue at the Oil and Money Conference in London which was in late October, de Margerie who is the new CEO of Total in his sort of major talk said: I just can't see how oil demand can get past about somewhere in the low 90s in the next few years because I just can't add up the whole industry –everything I know – and see how we'll ever supply that. Then about several weeks later at some conference I think here in the States, Jim Mulva the CEO of ConocoPhillips said: Add the numbers up and I can't see how we get beyond about 90 or 92.
One of the most respected voices if not the most-respected voice on the whole supply situation in the Middle East is Dr. Sadad al-Husseini who was until three years ago the executive vice-president and board member of Saudi Aramco in charge of all their exploration and production programs; and Dr. al-Husseini has his PhD in geology from Brown and he's a very smart guy. He just yesterday sent a couple of us...we saw the detailed assessment of oil capacity through 2030 and he's looking at not only what he knows best – the Middle East – he's looking at all the data you can get on the rest of the world and he's just best case: we're at an undulating plateau right now. Not only do they have a global reach of things but like Dr. al-Husseini's case there's nobody that knows the oil fields of the Middle East and particularly Saudi Arabia better than Sadad. [9:14]
JIM: You know if we talk about the things that we know right now, for example, oil discoveries matching consumption, I think we haven't seen that in over two decades; oil discoveries peaked in the late 60s. We're not finding giant oil fields. OPEC's spare capacity has dwindled down to one to two million barrels; that's questionable.
MATT: Or zero.
JIM: OPEC has demonstrated an inability to really grow its production. Demand is higher within OPEC and Asia. The whole energy infrastructure is aging. I mean is there anything I'm missing here?
MATT: How little we know about our usable oil stocks and how low they are and the danger when you breach minimum operating levels because it not only creates shortages it creates a run on the bank. And literally we could see a situation [where you] get two or three random events happening and it basically creates panic – a great reminder of this is when Houston had to evacuate because of hurricane Rita. It took four hours before the gas stations of greater Houston were dry. And once you've had a run on the bank, I can't figure out, without a moratorium for several weeks, how we'd ever fill the system back up. [10:17]
JIM: I want to move on to the subject of OPEC because all the studies – whether you're looking at the EIA or the IEA – on demand and supply assume, number one, that they're going to be there to provide it. And there's a couple of problems that I see: Demand is growing fastest within OPEC; OPEC figures, the reserves, for example, never change and they're unaudited. They've been unable to increase that production and $90 oil hasn't brought on as much supply as people would have thought, because that's one of the main arguments that the economists will make: Well, given higher prices in the market place, that means that more oil will come to the surface. We're not seeing that. I mean this all seems like it's based on hope. [11:03]
MATT: Yeah. Faith.
JEFF RUBIN: Well, one of the reasons of course that we're also not seeing more export capacity out of OPEC and countries like Russia and Mexico is not just the problematic supply outlook, but also what's happening to internal demand because internal demand is growing the most rapidly in the very places that are among the world's largest producers. And that's not an accident.
And what perversely is happening is that higher oil prices are in fact boosting demand in those countries because gasoline is, you know, not $100 a barrel, gasoline is 25 to 50 cents a gallon in places like Caracas and Saudi Arabia. And now what's happening is that soaring demand growth in the neighborhood of 5 to 10% per annum unrationed by rising world prices is now starting to cannibalize export capacity. And I guess the most notable example of this is going to happen in Mexico in the next four to five years – a country that next to Canada is the US's largest supplier at about 1 ½ million barrels a day; and between soaring rates of internal demand growth, particularly for gasoline because of exploding rates of car ownership, coupled with rapid depletion of Cantarell, Mexico's exports are probably going to collapse in the next four to five years.
And looking at OPEC, we're probably going to see from OPEC, Mexico and Russia the combination of depletion and soaring internal demand resulting in a three to three-and-a-half million barrel a day decline in exports over the next four to five years. And it's sure not obvious who's going to make up the gap. I mean, if the gap is going to be made up of unconventional oil from, say, the Canadian oil sands or the Orinoco oil sands, I mean that's a world of triple digit oil prices to make those extraction economics work and you can just see today's talk about the overrun on the Suncor project as a heads up on where costs of production is going in those sources of supply. [13:19]
ROBERT: This is Bob Hirsch. The situation in peak oil is that if you think about it and you're an exporter – you're an OPEC country or Russia, for instance – and you think about what peak oil means and is likely to mean to the world, one of the things that a good ruler or a good government would do would be to husband the resources that they have. In other words, you've got a world that wants more and more and you could conceivably produce more. But why should you because you're earning extremely good money with the oil that you're producing now, and if you hold back on future production then your country is going to be in better circumstances than other countries in the world. So it makes good sense to hold back, in fact. [14:02]
MATT: Bob, there's another really important aspect of that: Over the last few years, with oil prices so low every producer was forced to basically maximize the highest production to make their economics work. You talk to any of the old timers of reservoir management and the lower rate at which you produce a field the safer it will produce and probably end up recovering a little bit more oil while you still have reservoir pressure. So part of this is not just out of greed to make more money, part of it is in Russia's case, for instance, until they find massive new Russian oil fields they would be stupid to ramp up their production of these old fields by another million barrels a day just to keep the market supplied. In fact, in a sense, you could argue they should probably back off to maybe seven million barrels a day and say we could probably at that level do that for 15 years. If Saudi Arabia really took seriously how fragile their old fields are, I think they could argue maybe we should go down to maybe six million barrels a day and it will last 25 years because we have nothing after oil. [15:02]
JIM: Something that does not get enough play in my opinion is depletion. I mean we saw the CERA report that came out a couple of weeks ago that said that world oil depletion was 4 ½% a year or about 4 million barrels that we need to find just to stay in place. And yet we know the large oil fields – Cantarell, North Sea, North Slope – the depletion rates there are much higher. Matt, you looked at the world's oil fields and came up with some different conclusions than the optimistic CERA report. Were you guys looking at different data because...
MATT: I don't have any idea. I'm very puzzled with that report. They lay out, without any names, some very specific numbers and in the number of fields they say they're looking at and how much those fields collectively add up to. And what puzzles me is that they say they have 811 fields in their database – in their proprietary database – and that 400 of the 811 are all giant oil fields accounting for about almost 50% of world production, which means that they would have to average 90,000 barrels a day per field.
Well, when I went through last – in the fall of 2001, one of the more enjoyable treasure hunts I've done because I got more and more intrigued by no one seems to have a list of the top 20 or 30 or 40 oil fields. So I decided to put a cut-off of 100,000 barrels a day as my definition of anything over that is a giant oil field. And I searched far and wide and in fact at one point we spent a fair amount of money buying 34 fields from the IHS database because even the CIA didn't have any field production out of Russia. They didn't even know the names anymore. So at any rate, I finally got this, added it all up, put in a pretty extensive white paper and then circulated that to hundreds and hundreds of people that might know, and saying that “I'm going to republish when I get some better data or if you think x field is producing less or more, please let me know.” That got unbelievably widely praised as the first study that anyone had done maybe ever on oil fields – not by their reserves but by their production. And I came up with 110 that accounted for 90% of our current production, so how you could find 400 that were 49%. Something had to be totally wrong with the study I did. I mean vastly wrong. [17:21]
JIM: What about the situation too where a lot of these oil fields, particularly in the Middle East, we don't have good data on those fields so how do we really know –
MATT: They'd have to know that for them to be accurate in their data and if that's the case then they slipped inside the vault or they've been taken into confidence by Saudi Aramco, which no one has ever been able to do. And maybe that's the case, but I think they're so strident in saying that this report proves we have no problems. But what's also interesting the Wall Street Journal who did the first analysis on this casually pointed out that even if they're right we only have a 4 ½% decline of the existing base, given where they say demand is going to be in 2017 which is only 10 years from now, you'd only have to add 59 million barrels a day which is just six new Saudi Arabia's in the next decade. [18:10]
JIM: It's unbelievable.
MATT: You know, it's impossible.
JIM: Given this situation that we're in give, I want to come back, Bob, to your report about mitigation scenarios. Whether people believe in peak oil, is now, five years or ten years from now, the important point you stressed in there in your crash scenario we need to be doing something about it now. But you hear stories in the media for example that we're okay till the year 2037. We heard about the Jack discovery and everybody got excited about that. And it's real easy when you hear these kind of feel good stories – “hey, we're still finding this stuff” – to become complacent and not do anything about it right now. If you take a look at what's prominent in the press right now it's global warming – something that may or may not happen 40 years from now; that's the big worry. Any comments.
ROBERT: Yeah, where to start. First of all, the whole peak oil story is a frightening story. It's terribly, terribly frightening. You only have to think about it a little while, look around you to see how much of our everyday lives depend on oil from not only getting around but getting our food and getting to work and what happens in our work and so forth, to recognize that much, much higher oil prices and oil shortages that would go with that when peak oil occurs; it's a terrible, terrible thing to think about. And a lot of people like to shut it out. Other people like to think that, gee, whiz, we changed computers and upgraded them very rapidly, we'll do the same thing in oil; industry will take care of it and so forth.
But if you look in detail at what's involved, it's easy to change things that are very small like computer parts quickly, but the massive scale of oil is almost unbelievable in terms of volumes and in terms of infrastructure and everything else. And so people I think would like to think this problem will go away but part of the problem with the work of the three of us (and a number of other very good people and as was said earlier, a number of oil companies who are now beginning to ‘fess up on this thing) is that we're headed for very serious trouble very quickly. And, yes, we will do something about it and that was part of the point of our mitigation study, but the mitigation study also says the magnitude of this thing is just so huge that to effectively do something is going to take a long time (and forget the expense and forget the lack of industrial capability to do a whole lot of other things and the people that are needed to do what it is we're going to have to do) – so this is going to be a very, very bad bumpy road. [20:57]
JEFF: Well, the mitigation aspects on the economy, you know, is certainly going to be expedited by the price signals. And whether people acknowledge that we're in a period of peak oil supply, what they are facing is close to $100 a barrel oil, and more specifically they're looking at gasoline prices that they haven't been accustomed to. And you know, when people are looking at the reality of maybe in the next three to four years, four-and-a-half dollars a gallon gasoline, that's going to temper demand; and that's going to be a key part of the economic adjustment to effectively decarbonizing our economy or certainly minimizing our carbon usage per GDP.
I mean the problem in the developing world is really the absence of a price mechanism either through massive subsidization or just a lot more income sensitivity of demand because you're looking at first time car owners. And you know, probably within the next three to four years the developing world is going to exceed the developed world in oil consumption but the reason is because in the developed world and particularly in North America we are seeing prices. And I'm hopeful that that's a good thing and not a bad thing because it's through the price mechanism that we're going to wean ourselves off oil consumption – whether we recognize it in terms of peak oil or not. [22:26]
MATT: I'm not as sanguine. I used to feel a lot more like that, but I'm getting a little more concerned that we maybe are kidding ourselves about how the consumer will start to once he gets over sticker price...
It was interesting at the end of October when I was in London I was going out to Gatwick and the traffic was just unbelievable and I asked the driver: Has there been any kind of slowdown in traffic –once you get outside of London where they do this tolling now that has made a big difference. He said, “oh, no. this is just as bad as it ever was.” And I said, “what are you paying for your petrol?” And he told me in pounds and liters and the two of us together took about five minutes to make the simple conversion from liters into gallons and pounds into dollars, and he said, “well, I guess then I just paid $9 a gallon; didn't I? That's a little bit more than you do in the United States; isn't it?”
ROBERT: The other thing though that we're talking about is we're talking about shortages; we're talking about prices are going to go up and, yes, that will impact people, as Jeff says. But we're talking about shortages and we're also talking about governments sometimes overzealous that get in and try to control things and ease things. Even if they don't, we're talking about shortages and so folks who are living far out in the suburbs and commuting into to town are not going to be able to get the fuel that they need to get from point A to point B. That means people are in a whole lot of trouble. Of course, when that kind of thing happens, industry is certain to pull in its horns in terms of investment and new employment let alone keeping the employment that it has; and so it's easy and very painful to think about how that all spirals and it spirals negatively. If you look at what happened in 1973 and 1979, we have two cases where prices went way up but there were also shortages and people couldn't get what it is they needed. Those were both very brief events and peak oil will not be brief.
JEFF: One of the things that 73 and 79 did was make transport costs important again and make the world a lot flatter. There was a huge diversion in US trade in the space of those four to five years; the share of imports from transoceanic trade fell four percentage points and from the rest of the hemisphere increased four percentage points. No doubt a huge challenge, but what it might do is give people like Mexico and cheaper labor markets in Latin America a second wind because all of a sudden the cost of transporting stuff from China across the Pacific, as I say, the higher oil prices go the more distance costs. So you might see some fairly significant trade diversion as a result. [25:08]
MATT: It gives our farm belt a second wind too.
JEFF: It sure does. It's the end of the 3,000 mile salad where you're flying in the avocadoes from Mexico when all of a sudden transport costs have tripled or quadrupled. All of a sudden you're eating more local products.
JIM: But you know, instead of dealing with this, I have in front of me the January issue of Condé Nast. And this is going to be shocking to most of us here: On the front cover is an article called “oil shock: why prices will plunge.” And you turn to the article and it's called The Coming Oil Crash. And they make the case because of economics, the economy. Let me just see here: New technology, global downturn, slowing consumption, increase in oil exploration, ethanol subsidies and gas alternatives. And they're talking about 20 to 30 dollar oil. I mean this is...
MATT: Who wrote it?
JIM: This is a guy by the name of John Cassidy who's their economics editor.
MATT: Oh yeah, he's...I've read his stuff before.
ROBERT: Economists tend to think in terms of how the widget market works rather than a finite resource. And if everything was changing very slowly then of course economies would be able to accommodate reasonably. The problem is that the magnitude of our use is so high and the decline rates and depletion rates that we have seen are so significant that we've got a shock situation and that's what economists oftentimes have a very difficult time understanding.
JEFF: I think the problem for economists – because I am a macroeconomist, and was pretty alone getting on sort of the ASPO depletion bandwagon – is that why it's so difficult for economists to come to terms with sort of the Hubbert curve theorem of supply is the notion that the supply curve is upwardly sloping. I mean that's one of the most axiomatic principles of economics. It's like the demand curve is downward sloping. And when the supply curve is upward sloping that means higher prices lift new supply and so the argument was as we get to $100 oil prices we're going to lift a lot of new supply out of the ground. Of course, it presupposes that the supply physically exists, which is an assumption that most economists wouldn't bother to get involved in.
I think economists are right in the sense that it has lifted new supply. We wouldn't be talking about three million barrels coming out of the Canadian oil sands at $60 a barrel. But what it hasn't done is lift new conventional supply even though oil prices have doubled. And surely that says something about the physical existence of supply. But I think the reason that economists just reflexively get head faked on this issue is because they're still thinking about the upward sloping shape of the supply curve. [28:01]
MATT: They also don't, in my dealings with a lot of the optimists, they don't have the vaguest understanding of how complicated it is to actually drill a well. And the fact that you actually have to have something called a drilling rig and the numerous amount of complicated support crews that are coming out to do things and casing programs and drilling-mud programs. We're out of all of that – we have a people shortage that is unbelievable. All of the oil field assets are basically so old they are rusting away and it's going to take a decade in my opinion to kind of go on a crash, Victory ship building program and address the rust issue of the industry because we are really rusting away. Our pipelines are too old. I'm looking down outside my window down at the ship channel and I can see the Texas City refinery. It should have been bulldozed over 20 years ago and rebuilt; it's too old. [28:49]
ROBERT: Well, we can do wonderful things when we set our mind to it and we did that in the Second World War; we also did it in going to the moon. So I mean once we set our mind to doing things I think we're going to achieve a great deal. We haven't made up our mind yet. Time is slipping away and you know that, each of us knows that, very well and that's the problem: The later the start, the deeper the hole that you're in. [29:13]
MATT: If you use World War II and the United States as a classic example, then unfortunately you can also know that we wouldn't ever have woken up had Pearl Harbor not happened. Go back and look at the newspapers the weekend before Pearl Harbor. We basically barely recognized that World War II was 40% over. So you say, we are so ingenious, but we need a Pearl Harbor.
JIM: Unfortunately, and I think all three of us recognize this, there needs to be some kind of a signal that gets people's attention. There is a lot in the media as we've talked about here. There are more and more people that are getting involved. There is better and better analysis that is coming along and we still, though, don't have the attention of people at a high level.
And by the way, when this really hits public consciousness there's going to be a whole lot of chaos. I think it's going to be kind of like 1973 because people and companies and governments are going to be frightened. And when people are frightened they don't always do rational things and they look for instant solutions and there are not going to be instant solutions. So we're talking about problems in the stock market. We're talking about problems in investment; we're talking about problems with individual folks and their livelihood and the need to change state of mind and not worry so much about global climate change. Which of course is something indeed we have to pay attention to, but you have to worry about keeping a job and keeping your house and keeping your car and keeping your kids at school and so forth. That gets pretty frightening. [30:42]
JIM: Matt, I know you talk to a lot of people in Washington and Robert you do as well, and Jeff I'm sure you're talking to people in government: Has it surprised you and you know, if you look at this year's presidential campaign, maybe on the backburner you'll hear some of the candidates occasionally talk about it?
MATT: It's been an enormous surprise to me. I've watched probably more of the debates than I sort of wish now that I had of, and the only time that I can remember when a solid reference, sometimes it's sort of you notice an oblique reference in a question. Remember, these moderators are trying to dig in, they are trying to ask the toughest issues possible to get a good lively debate going. And in the New Hampshire marathon when ABC had back-to-back the Republicans first and then the Democrats; it was about four hours. And it was interesting that there was only one question that was asked in each time about energy. And it was also interesting to see that virtually all of the candidates said essentially the same thing: we need to basically become energy independent within a decade. Which we can't do. We can't do. [31:43]
ROBERT: There's something else too. Again, it gets back to this being a very unpleasant story and also the public wants to think that renewables are going to solve everything and all we have to do is knock down some of the things that we're doing and just go to renewables and everything will be just fine. And so particularly in a presidential campaign unless somebody forces you to talk about the really tough issues people tend to stay away from it. I came across something here that indicated that Bill Clinton, who has a relative in the race, back at the London Business School in March of 2006 talked about peak oil, and said we may be at the point of peak oil production, back then. [32:25]
JIM: I was sitting in the big auditorium at Rice University this spring because my daughter...Clinton was coming to speak. I'd never heard President Clinton speak before; I'd never seen him before. And he was going through his talk about the world's poor people and about half way through his talk he said: “We also need to be worried about natural resource scarcity. There's a prominent oil man, Matthew Simmons – and I about fell off my chair – who says we only have 35 years of oil left. ExxonMobil think he's crazy, we have hundreds of years.” I thought that was so unbelievably surprising that he actually was on to that issue. [33:00]
ROBERT: A couple of us having been briefing staffs of some of the presidential candidates and in some cases it's been heartwarming the people that we've talked to and their interest and so forth; and in other cases it is not so heartwarming and I'm not going to talk about individuals. But at some point this thing may break into the presidential race, and if so some of what some of these people know will become public and we'll all know to what extent they've been avoiding the issue. [33:31]
JEFF: You know, I think people have to appreciate the intersection of this issue with another huge issue. It certainly came up at the ASPO conference in Cork, Ireland this fall and that is how peak oil fits into a world where people are very concerned about global warming and man-made climate change. And you've got to understand that from their perspective peak oil is a good story because peak oil basically takes the task of decarbonizing our economy out of our hands. I mean it's going to be forced upon us. So just realize – and this isn't just true of the US primaries right now, this is a recurrent theme all throughout the OECD; and just look at the election results in Australia as an example of that – that carbon is becoming a huge political issue. I mean the vast majority of states in the US now have passed effectively cap-and-trade systems for CO2. And at the intersection of these two issues creates a very interesting dynamic because while undoubtedly it poses huge challenges to our economy, there are a whole lot of people and a growing number of people who might regard this as a positive thing. [34:45]
JIM: But here we have a presidential election where the number one topic right now is the economy; and if there is a shortage, if there is some kind of an event in the Middle East or you have a couple of refineries go out or heaven forbid we have another hurricane season like we had in 2005...
MATT: Or the winter weather in China.
JIM: Yeah. I mean think of what this does to the economy. Jeff, I want to get to something that you've written lately and you were describing: What goes on here in the US may be becoming less relevant to what happens in the oil markets. In other words, oil consumption has been falling in the OECD countries.
JEFF: That's right.
JIM: Given depletion rates of four million barrels a day, delays in projects of about 5 million barrels, oil is going to need to be rationed. So if you take a look at growing demand in Asia and growing demand within OPEC itself this rationing through the price mechanism is going to take place in the West.
JEFF: That's right. And in fact we don't see global production and hence global demand getting much above 88 million barrels a day in the next four to five years. And that means if you're going to have oil consumption in OPEC and Mexico and Russia go up from maybe 13 to 16 million barrels a day and see oil consumption continue to grow at 1 ½ to 2 percent in the rest of the developing world, it means that oil consumption is actually going to decline in the OECD. And indeed, it in effect has. I mean we talk about peak supply but in the OECD we've probably seen peak demand. Consumption has now fallen for two years in a row; and we expect over the next five years as oil goes from 100 to 150 dollars a barrel, consumption in the OECD is going to fall by about four million barrels a day. Probably half of that is going to come out of the US which is right now around 21 million barrels a day.
I mean people forget...you know, people ask me, “well, have you factored in a US recession from the subprime mortgage crisis in your estimates of demand?” But people don't understand that while the US is the energy hog of the world, the US has not contributed anything to world crude demand over the last two years. It's in fact fallen. And that's a story you see in nickel and copper and aluminum and in a lot of base metals as well. But in fact, what you're going to see is that the more that oil is subsidized in OPEC and the more that they cannibalize their own export capacity through soaring rates of domestic consumption, the higher prices are going to be in the rest of the world where the price mechanism is allowed to work and the more demand rationing there is going to be. And as I say, I think the US is probably going to consume two million barrels a day less by 2012 and OPEC itself will be down four million barrels a day. The non-OECD world will be the primary consumer of oil and that's certainly not without its implications when it comes to carbon emission management because of course, you know, how do you create emissions? You consume hydrocarbons. So if the developing world is going to be the major source of oil consumption in five years, it's also going to be the major source of greenhouse gas emissions in the next five years. [38:10]
JIM: If we look at being close to peak oil, I want to get back, Bob, to some of your mitigation scenarios going back to those three. What do we need to be doing now; and place a priority on what should be done?
ROBERT: Well, first of all we've got to get people's attention and that hasn't occurred yet because action comes after people take a problem seriously and we're not there yet. And hopefully that will be soon.
In terms of the things that we looked at, we looked at physical mitigation; in other words, what can you do in the way of conservation and what can you do in the way of substitute fuel production; what are your options worldwide. And the reason that we did it that way is that we recognize the enormous capital investment of oil consuming equipment around the world. We're not just talking about automobiles, we're talking about trucks and heavy trucks and airplanes and ships and so forth. And for a number of those things, eventually, 30, 50 years from now we'll be able to get off liquid fuels and on to something else to power those things. But you can't replace that much capital equipment in a short period of time so you've got to fuel it. So you do the best that you can on conservation which is going to be important in the near term and also the long term. The biggest target there was automobiles and improved automobile mileage standards (the Congress has passed something recently and that is in the right direction but is not enough in my opinion to have a big impact on the kind of problem we're talking about) but then you look at Jeff's backyard and oil sands in Canada and Venezuela; you look at enhanced oil recovery around the world; you look at coal and making clean liquids out of coal; there's stranded gas that you can use to make liquid fuels. If you take a look at all of those things, just think about the fastest that you can possibly do, that gives you a rate and a timing of what can possibly be done. And unfortunately, the figures that most of us come up with – recognizing uncertainties – are such that declining world conventional oil production is going to run away from what we can do quickly. [40:27]
JIM: One problem, as our politicians are talking about stimulus and let's put aside the rebate for a minute but it seems to me that there is a tremendous opportunity here, and Matt you've talked about this, which is our whole energy infrastructure whether you're looking at the aging offshore drilling fleet, the number of drilling rigs, tankers, LNG terminals, the condition of our refiners, the dearth of geologists out there, well-casings. I mean everywhere you look within the energy infrastructure which powers this economy it's falling apart.
MATT: Yes, and this is one of the really discouraging things is that there is such a lack of interest in thinking through the maintenance and also, I hear this all the time by people: “You know, that's really not the problem you think it is because we're getting so good now at being able to go ahead and when we're doing a refinery turnaround we replace everything.” Well, it's like someone that owns an 85-year old building saying, oh gosh, we've got new wiring. And it's still an 85-year old building. A 25-year offshore rig is still a 25-year old offshore rig. And we're blindsiding ourselves. I suspect if we could levitate our pipelines out of the ground so we could walk the line, we'd probably pass out. The only way we generally find a pipeline leak is when you have a cave-in of the earth and by then, it's been leaking so long. We wouldn't know about Prudhoe Bay if it hadn't had stains in the snow. [41:51]
JIM: This is absolutely amazing. Given the price of where we are today at close to $90 in oil, the top performing sector over the last three years has been the energy sector in the marketplace. But if you take a look at what has happened to many of these companies, whether it's oil service, oil producing companies, in this kind of market I don't think people get really what is going on in the energy sector. John S. Herold Inc. recently did an analysis of oil companies and many of these companies were selling at prices assuming that oil was back to 40 and 50 dollars a barrel. Jeff, do you want to address what you think is going on here.
JEFF: Yep, well part of it is really the psychology of what are still very Amerocentric financial markets. And when you look at market sell-offs that are being triggered basically by concerns of financial institutions and their exposure to subprime mortgage assets, but the casualties have been what have been called the cyclicals (base metals and energy companies) because the view is that if we have a recession in the US that the US being the center of the global economic universe that all of a sudden we're going to see a huge reduction in global demand for base metals and energy. And I think that view of the world totally ignores the fact that the US has made a negative contribution to global demand growth for oil or for that matter copper, nickel and zinc over the last three to four years; and that the US is not driving the global economy like it was in the 1990s where it accounted for about 30% of world GDP growth but is now accounting for about 10% of world GDP growth; and that the growth in countries like Russia and China is not really about servicing Walmart at all but really about servicing their exploding, domestic economies. So the perception here is that, you know, $100 oil or $90 oil is based on strong global GDP growth. The reality is that $90 oil and $3.25 a pound copper is really based on strong overseas economies that are not nearly levered to the US as American financial markets believe them to be. [44:13]
JIM: Let's talk about some of the alternatives as we come to some conclusions here. You hear this on the presidential campaign trail, you hear it in the press all the time: We've got alternatives; we've got technology-wise, we're seeing hybrid cars, there's electric cars and I was glad to see that Mercedes is now working on a diesel hybrid. You've got wind, solar, nuclear. Matt, you've been looking into ocean energy. We have biofuels. So everybody seems to think that we've got all this stuff out there, all we need to do is just ramp it up and we're going to solve this problem. But I don't care if you're looking at a nuclear power plant, you know, that takes seven to ten years to build; if you're talking about wind or solar it's a great idea and we are starting to use that but you know it's not become ubiquitous.
ROBERT: The problem is that you've got to recognize that is not just simply an energy problem. For quite some time this is a liquid fuels problem. And so wind and nuclear and solar, photovoltaics and so forth will do essentially nothing for you in terms of powering your automobiles or those airplanes and so forth. So the issue for quite some time is going to be a supply of liquid fuels to keep enough of those cars and planes and trucks and everything else going that we can maintain some kind of reasonable economy as we work through to what will 30 to 50 years from now be a better, cleaner different-based world than we've got today. [45:43]
MATT: Yeah. Bob's so right on that. And I think nuclear for instance is going to have to have a big comeback but it's electricity. It will address a twin problem that we haven't discussed that's just as bad as oil, that's the terrible state of our natural gas – both in North America and I'm afraid probably worldwide. And we have to stop using natural gas to create electricity. It's a very inefficient use. So we need all these other things to solve a different problem but they don't have any impact on the oil front. [46:14]
JEFF: Well, I guess when we're talking about liquids, I mean in the US the big initiative has been on ethanol and we're now producing, what, seven billion gallons and the target is 17 billion.
MATT: Yup, we've really upset the food chain.
JEFF: Yeah, I think what we're going to find is that the inflationary consequences of ethanol are far greater than the inflationary consequences of $100 oil because food has got over double the weight in the CPI as oil; US food price inflation is already 5% and we're only not even half way to meeting President Bush's target. And of course, it's not just raising the price of corn, it's raising the price of everything else as it induces widespread crop substitution to corn. So you know, I mean one question is the sustainability of this program when we start to see US food inflation on a one-way street. And when it starts getting above 5, 6 or 7 percent, I mean the Fed is cutting interest rates right now because of what's happening in the subprime mortgage market but under any other circumstance the Fed would be focusing very closely on what's happening to food and energy inflation. And if we continue with this policy US food inflation can only go in one direction and that's higher. [47:32]
MATT: And corn ethanol at the end of the day is outrageously energy intensive to produce and you produce a low quality BTU, highly corrosive product. So it's just a bad solution.
JEFF: But there's a whole lot of natural gas being burnt to produce a liter of ethanol.
MATT: Yup, and water.
JEFF: And water, yep.
ROBERT: And coal.
JIM: If peak oil is here or on our doorstep, economic growth we know is going to be impacted by that and I can't help but think of the implications of a debt-ridden economy like the US. I don't even want to think about that for the moment. But here's something that worries me because I can remember the gas lines in 73 and 74, you had people starting to hoard; energy becomes scarce. But even more important, if each one of you would address this and Matt, I want to start with you: How do you stop the wars? I've been watching a documentary this week on both World War I and World War II where energy or access to energy or lack of it played a very important role in both wars. How do you ration energy peacefully?
MATT: Well, I think what you have to do is not going to be easy. But if we had energy data reform and forced a mandatory field-by-field production reporting of all the key fields a tribunal within about a month could actually take this debate away and say: “Okay, now you can accurately track the decline curve and either we don't have a problem for three more years or seven years, or the problem is actually right at the door today.” And it would be so scary and real that we could then conduct a global energy summit the likes of which when we did the United Nations in San Francisco and tell all the world leaders: “It's nobody's fault but we basically have the most awful transitional event on our doorstep and it's already too late and so we can join arms and actually figure out a way out of here like we did in the Marshall Plan or we can just go back and get our uniforms on. And we have about a week to decide.”
And I think put the right way we would actually not go home and put our uniforms on. [49:30]
ROBERT: Part of the issue is will other people put their uniforms on because we're talking about people going into serious poverty; we're talking about nations being threatened in ways that we can only dimly perceive. And folks tend to go to war in situations like that. It may be local wars or it could grow to be larger wars. And we haven't talked about that kind of thing and on the other hand it's something that's entirely possible. I think what Matt says is right: We're going to have to sit down with other people and talk seriously. I don't think that will go quickly at all because I think people are in a mode of thinking about how good it's been for so long and worrying about how the public will react to different things and so forth. So I think it's going to be a very rocky problem of adjusting to facing up to the problem. [50:19]
JEFF: Well, I don't know if we're going to put on uniforms or not, but long before we put on uniforms I think what we're already seeing is huge changes in the nature of oil ownership. That the oil industry is rapidly becoming an industry dominated by national oil companies and that's as motivated by interests of long run energy security as it is about capturing the enormous economic rents of $100 oil. And I think every year what we find is another oil patch is closed to private investment. I mean in most places in the world now, it has become motherhood that hydrocarbon assets should be owned and developed by the state. And we're not just talking countries like Libya and Venezuela, we're talking the Mexicos of the world, we're talking now of the Russias of the world. So I think that one of the things that we're seeing is that this is becoming effectively an industry run by state monopolies that shut you out of their own oil patches and compete with you aggressively in other people's oil patches and that I think this is at least in part motivated by growing concerns over long run energy security. [51:37]
JIM: Gentlemen, a final question as we close. This is a presidential election here. Let's assume that each one of you were a candidate for the presidency and you won. What would be the first thing that you would do in energy policy? Matt, starting with you.
MATT: Probably cry. It's too far-fetched. I wouldn't do that but – I guess I would basically hold my fireside chat after having the conversation all day with the 20 most important world leaders and saying we need tomorrow morning to slap a $20 a barrel transportation fine on any producer of oil that will not release their basically field-by-field production statistics because we have a week to figure out how bad this problem is. And then a week later I would come back and hold my second global chat and I would have on my panel with me, the president of China and the president of India and the head of the G-7, and I'd say: We're not going to let this take us down. We're going to figure out over the next month or two the most comprehensive plan anyone has ever done to basically wean ourselves from this addiction to oil. [52:47]
ROBERT: Well, I'm not sure about the crying part but this is really tough. This is way outside of the box than most people are used to thinking outside of the box. What I would do if it was up to me is I'd would call a number of the major players from corporations in the country, bring in some folks from the public (the non-governmental organizations also) and basically lock everybody up for a number of days to number one, get clear that we've got a very serious problem and to lay out what it is we can do because when a president stands up to say that we've got a very serious problem he also has to stand up and say, “here's the plan that we're going to follow to do something about it.” And then, as Matt indicates, once one does that or maybe simultaneously one also meets with other leaders throughout the world in order to coordinate and begin coordination projects – a process that's going to be very, very difficult. [53:56]
JEFF: Well, I believe in the price mechanism and I believe that where policy can be helpful is not so much in finding new sources of supply growth but in reducing demand. I mean the first thing I would do would be to raise minimum fuel requirements standards in the United States. I would impose the California standards nationally. The second thing I would do is develop a cap-and-trade system for carbon emissions that is already endorsed by the vast majority of US states. I think we're looking at $30 to $40 a tonne. I think that would go a long way to reducing energy demand. And I guess the last thing I would do is on the ethanol front: I would drop the 50 to 53 percent tariff on actually economically efficiently-produced Brazilian ethanol and cut subsidies to inefficient US-produced ethanol. [54:41]
JIM: That'd make you popular!
JEFF: I've already won the elections so I don't care!
ROBERT: Whoever takes the reins is going to have to face up to some extremely unpleasant things and is not going to be popular and in a world where we criticize everybody for everything, criticisms are going to fly all over the place. As people get serious about this thing I think they're going to realize that this is a different kind of a world. It's more like a World War II kind of mentality. It's necessary to work our way through this.
JIM: I can just see the president, whoever that may be, as they raise their hand on the Bible, I think they just ought to give the president a fireman's hat because I can just see one crisis after another as this whole thing unfolds.
Gentlemen, in terms of educating the public –and I appreciate the effort of all of you going out speaking on this topic and talking – any recommendations in terms of listeners to this program what they can do to become better informed on this issue?
ROBERT: I think that a lot of people don't really understand what goes on in energy because it's been so easy and we've been so fortunate for so long and I think that good voters and good citizens understand to at least to some degree what the issues are. People need to dig in and understand some of the basics of energy and understand some of the conflicts between our total desire – and when I saw total I mean all of us – our desire to have a cleaner environment and a non-warming world and so forth, with the realities of the economic problems that could be. People need to do that and then they need to raise all kinds of hell with their politicians. [56:19]
MATT: There's a growing number of documentaries that are circling around. A Crude Awakening which I haven't seen yet – I've heard 20, 30 different people say it's just fabulous in its education. And there are three or four others that I've just recently been shot where they're coming out in the three or four months. These are really serious documentary people trying to tell a story.
JIM: In fact, Basil Gelpke the Director of that, we interviewed him last year and that interview is on our site.
Jeff, anything you'd recommend?
JEFF: Well, you know, I think most of the education actually is going to happen at the pump because people are going to see that this isn't a spike, this isn't an aberration, this isn't because of some refinery shutdown. They're going to see that this is a new age and an age very different from what they've been told by oil companies, economists and politicians. But it's all about expectations. Certainly economic behavior is about expectations and I think an important change in expectations is the notion that triple digit oil prices are here to stay, they're not a passing fad; and that the sooner we recognize that, the sooner we're going to change our economic behavior. [57:29]
JIM: Well gentlemen, I know some of you have to get off to meetings but I'd like to thank all of you for being so gracious with your time coming on the program. If you'd like to follow Matt Simmons's work you could go to his website, it's at www.simmonsco-intl.com. Matt is also the author of the best-selling book Twilight in the Desert. If you want to read about Robert Hirsch's report you can just google Robert Hirsch. And Jeff Rubin's work can be found on the CIBC website.
Gentlemen, thank you so much, all of you, for the work that you're doing to keep people informed.
© 2008 Copyright. All Rights Reserved.
Financial Sense® is a Registered Trademark
NOTICE: This transcription may NOT be reproduced without the expressed, written permission of Financial Sense®. Selective quotations are permissible as long as this web site is acknowledged through hyperlink to: www.financialsense.com.