294. WILL A SUPERSPIKE MODERATE DEMAND?

In the peak oil community as a whole it is becoming ever clearer that an enormous amount of technological & sociological options are there to provide us with a sustainable world. The discussion of what level of welfare can be achieved with these options is still ongoing. Everyone that has studied the peak oil issue knows that a large change has to happen to make this a sustainable world, no matter what level of welfare we are talking about.

I think oil prices can be a great help in forcing this change. Only in times of need can the radical changes and re-doing that is necessary take place. The question we need to ask to understand this process is how the oil market will develop. Until now the peak oil crowd has mostly looked at production scenarios from the supply side. Next week on the 27th of April I will discuss future oil price predictions at a conference of the Dutch University of Tilburg. In my presentation I have included the following chart:


What we see in the chart above is the Regular scenario that I made in the Peak Oil Netherlands World Oil Production & Peaking Outlook of 2005 (peak in 2012). This was based on a bottom-up oil projects analysis which has now proven to be slightly on the optimistic side. The actual production at the end of 2005 has been roughly 600.000 barrels per day lower than what I expected. The preliminary conclusion that we can draw from this is that the decline in the world as a whole is somewhat larger, more in the vein of ExxonMobil’s 4% to 6% than Shell’s 2% - 3%. Another option is that geopolitical forces and project slippage are quite big (even the disruptive scenario which tried to account for these factors was a little bit too optimistic).

In any case, should we be worried about this outcome for 2005? That depends on your viewpoint. The second scenario in the chart above, demand influenced, is trying to integrate demand side responses. At the moment I am not that sure how this will all play out. I strongly believe that we are in what Goldman Sachs calls the “superspike” period. Oil prices will go through the roof (100+ dollars) in the coming years due to supply constraints on the geological side but also the investment and refining side. According to the oil project analysis there is enough oil out there to postpone a peak until at least 2010. I realize that this is still under debate, but for the scope of this article I consider a peak before 2010 quite unlikely.

In the media the current price rise is attributed mainly to demand and geopolitical factors. While this is true, the underlying cause is simply that many more oil countries have peaked as of late. In the past five years, nine countries have peaked so far. In the 10 years before that only eight countries peaked. It is safe to say that the decline rate in the world as a whole is increasing. This is what has truly caused a decline in the spare capacity of the world; the increased demand only increased the problem. The chart below shows the years at which either peak or a decline after the plateau period happened for the stated country.

If we assume that superspike will happen in the coming years how will it influence demand? In the most optimistic case everything goes very smoothly. At a certain supply level demand lowers itself to fit into the constraints of supply. That will cause the oil price to equilibrium out at the level of supply at that time. The price will cause additional investments to take place that could provide more oil to the market. This is the basic outline for the “regular” scenario. On the other hand, will the world be such a smooth place in the zero-spare capacity game we are in at the moment? All eyes are focused at Iran at the moment. What will happen to oil production given the nuclear debate and possible intervention? I consider it quite likely that another oil shock takes place, or multiple smaller ones, triggering “superspike”. In this case the demand influence comes into play. The production level I have presented in my scenario is only instrumental to demonstrate this point; it could very well be that production drops firmly for a while due to such a shock.

If such a shock happens, economies will take a blow like in the 70’s, demand drops to come into equilibrium with the new supply situation. However, there is no fall back cushion from the supply side, only a strategic reserve cushion that could help somewhat. You can imagine that the effects could last for quite some time; oil production is not restored that easily and stays on a plateau level. In the beginning, oil prices of near 200 dollars per barrel are a reality, probably moderating after a few months to a year to around 100 dollars a barrel.

This superspike period will be the time when we all the technological & sociological options will be put to the test. If the will to invest and change doesn’t take place in a longer period with very high oil prices, when will it work? In the most optimistic scenario, oil production just keeps on a plateau until it drops off because demand starts to decrease due to the technological and sociological change. The peak presented in the demand influenced scenario can be scrapped from the chart. And peak oil isn’t all that interesting anymore.

In the more realistic scenario, we still keep on demanding gigantic quantities of oil. Since everyone wants to have more of the stuff huge investments take place in oil production capacity to sell at high prices. After a few years, this investment is translated into higher oil production which may moderate oil prices of around 100 dollars a barrel to a lower level, such as 60 dollars a barrel. Than the last spurt takes place to a peak around the end of the next decade, pumping at full tilt until production starts dropping off sharply. The downside curve in the chart may be too optimistic in this case. In any case the continued high prices will be a breaking point to cause change.

Note:

The demand influenced scenario has not been based on any calculations but on a mental framework. The scenario only serves an instrumental purpose. So do the oil prices mentioned in this article, they are wild guesstimates. The website of the discussion at the University of Tilburg is http://www.internationalconference.nl

-- by Rembrandt Koppelaar (Peak Oil Netherlands Foundation)