‘Peak oil? No, but mind the output gap’

Peak oil theorists may have found themselves at home in some unusual company today as the oil and gas industry gathered for its biggest annual conference, which is being held in Asia.

Those who believe the world has reached the point of maximum oil production, or will soon, would have found themselves nodding in agreement with Shamsul Azhar Abbas, the chief executive of Petroliam Nasional Bhd., Malaysia’s state oil and gas company.

And what the normally reserved Shamsul had to say sounded very worrying indeed, especially in the context of the energy-hungry economic growth many countries in Asia are banking on to lift large numbers out of poverty.

Making the reasonable assumption that crude demand will rise to 107 million barrels per day (bpd) by 2030, an increase of about 20 million from current levels, Shamsul calculated that there will be an output gap of 32 million bpd by then on the basis capacity should rise to 112 million bpd.

And breaking down his analysis is pretty disturbing. Production from today’s fields will have halved to 36 million bpd by 2030 because of natural decline.

This will be partially made up from output of 18 million bpd from already proved reserves and the supply of 26 million bpd of natural gas liquids from unconventional sources.

This leaves Shamsul’s gap of 32 million bpd, roughly what the Organization of Petroleum Exporting Countries produces today.

The solution presented was more exploration, but Shamsul also acknowledged that $2.4 trillion spent by oil companies around the globe between 2005 and 2010 served only to keep production steady. Between 1995 and 2004, the same amount of capex yielded an increase of 12.3 million bpd.

Enhanced oil recovery techniques to boost the life of old fields and improve production rates will also play a part, but this serves only to confirm that getting new oil out of the ground will be far more expensive than it has been in the past.

This analysis paints a rather grim picture for the future of crude supply, especially when it relies very heavily on unconventional natural gas liquids and presumably huge amounts of exploration spending in ever more challenging environments.

It is hard to see how this output gap can be closed without a dramatic increase in the real price of oil in order to fund the needed capex.

It’s equally hard to see how alternatives can close the gap significantly. Yes, you can get more biofuels but only at the risk of not producing enough food for a world population that may be heading for nine billion by 2030.

It is also possible that natural gas can carry more of the load as a transport fuel, either through vehicles adapted to run on compressed natural gas or even liquefied natural gas. But it is more likely that increasing natural gas output will be used to replace coal-fired and nuclear power generation on the basis that it’s the cleanest alternative around.

Perhaps the biggest potential to close the output gap lie not with increasing supply but with cutting demand.

The electric car may be a game-changer by 2030 or perhaps even sooner. Increased output of the batteries is reducing their cost, making electric vehicles more cost-competitive than cars powered using fuels derived from crude.

Hard as it is to envision Americans trading in gasoline-guzzling sport utility vehicles for small electric cars, it is within the realm of possibility given the right incentives, especially for residents in crowded and often-congested cities.

Even without a switch to electric cars, Americans already seem to be buying more economical, smaller cars in line with what happened in Europe over the past four decades.

The other possible source of lower demand comes from Asia, which sounds counter-intuitive given this is the region with China and India, the two main drivers of consumption.

Many Asian countries, including those two, still subsidise or control the price of fuels, primarily to give cheap energy to support economic growth, but also to contain inflation and support lower income groups.

However, there seems to be a growing realisation that subsidies and price controls are unsustainable from a fiscal perspective and that there are better ways to control inflation and help the poor.

It may well take several years, but subsidies and controls are likely to be withdrawn, resulting in higher prices in Asia.

It is higher prices, both in Asia and the U.S. that may be most effective in closing the output gap.

Financial Express