Quenching the world’s growing thirst for oil

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: Some 70 years ago on the eve of World War II, Winston Churchill made an historic decision: to use oil in place of coal to power British navy ships to make his fleets faster than those of the Germans. This heralded a tectonic shift—an energy transformation equivalent to the shift from wood to coal in the 17th century.

Unarguably, oil has shaped the 21st century, invading every facet of the economy, from agriculture to aviation. However, though it took millions of years for oil to form, we have managed to consume roughly half the globe’s oil reserves in barely 150 years, and a bulk of them in the last 70 years.

The world today consumes 85 million barrels of oil a day and demand is growing exponentially, apparently unaffected by the onslaught of rampaging oil prices that have touched $120/bbl. The unfolding scenario is a far cry from that of barely a decade ago when oil was sold at $10/bbl.

The Association of Peak Oil is crying itself hoarse predicting that we have either reached, or are on the verge of, peak oil. From here onwards, the slide is imminent and production is bound to decline. On the other hand, Cambridge Energy Research Associates (Cera), contesting the peak oil theory, sees no evidence of a peak in oil production before 2030, with global production eventually following an undulating plateau for one or more decades before declining slowly.

However, there is no contesting the evidence that supply is becoming severely constrained with each passing day. Demand growth, fuelled by the booming economies of China and other developing nations, is one of the factors.

But the predominant factor is that supply has failed to keep pace with demand. The moot question now is: does the world have enough oil to feed the ever-growing demand of developed and developing countries—and for how long?

Jeremy Leggett in his article, Peak Oil: The Twilight Zone, in The Independent in April 2005, pointed out that no major oil province has been discovered since the 1970s, and that the 100 largest oil fields, which account for around half the global oil production, are more than 25 years old. We are consuming more than what we are discovering. Given the level of sophistication and the understanding reached by geosc-ientists of this age, it is very unlikely that a large major field has eluded their attention.

The oil industry is also coming to terms with the fact that ‘easy oil’ has been found and that future discoveries are likely to be in harsh and inhospitable environments. Today, the oil industry is spending substantial sums of money and using state-of-the-art technology to find new oil in areas like the Arctic and ultra-deep waters. This quest is further hampered by the lack of resources, particularly in oil field services, deepwater drilling rigs and even skilled manpower.

The decline in production, though, is not evident from global oil production figures, which went up by 9% in the last five years (up to year 2006) at a compounded annual growth rate (CAGR) of 1.7%. But this increase is largely attributable to former Soviet Union countries, which had a robust 41% growth with a CAGR of more than 7%. Compare this with the production decline of 9% in OECD countries and more alarming 27% decline of EU-25 countries over the same period. Some major producers like the US, Norway, Venezuela and UK all registered declines ranging from 10% to 34% during the same period.

For how long can the former Soviet Union countries and Opec bail the globe out? Not for long. Major oil fields worldwide are registering a declining trend. In a recent study of more than 800 oil fields, Cera concluded that the “aggregate global decline rate of the oil fields is 4.5%, rather than the 8% cited in many studies”.

Even this lower decline rate is hardly comforting. These ominous signs have neither dampened the demand for oil nor impacted its prices that continue to chart a three-figure trajectory with each passing day. In fact, oil prices have risen a whopping 1,000% since December 1998 and by 300% from December 2003, the last time when it ruled below $30/ barrel (WTI spot prices).

The unfolding oil story suggests that prices are increasingly becoming divorced from market fundame-ntals. Though the traditional fundamentals of demand and supply continue to hold good, a few new factors appear to be driving current record highs.

Today, the weak dollar is just as important as the slim supply cushion and rising demand for oil in determining oil prices. The dollar fell 20% against the euro from March 21, 2007 (the last time oil reigned in $50s) to April 22, 2008. Showing a marked negative correlation, crude prices rose by 109% during the same period.

Oil field services costs, which have doubled over the last three years, coupled with the pressure of heavy fiscal terms on oil investments in the form of higher taxes are also cited as factors leading to higher oil prices.

Further, high prices are needed to support the development of new oil supplies through greenfield projects. The huge upswing in the overall commodities market and entry of speculators are other non-fundamental factors attributed to driving up oil prices.

(To be concluded)