Friday, September 12, 2014

How to develop a business plan for oil depletion

Chris Skrebowski has a guest post at Business Green on the need for businesses to plan for peak oil - How to develop a business plan for oil depletion.
The world currently finds itself in the position of a man standing in a road who has just noticed two large trucks bearing down on him. These metaphorical trucks are labelled Peak Oil and Global Warming. However, despite increasing evidence and clearer definitions of the risks, collectively we have been remarkably reluctant to move out of the path of the oncoming trucks.

This article will only look at Peak Oil, arguably the most imminent threat to our collective welfare. The general reluctance to act and invest appears to stem from the fact that Peak Oil seems an improbable event, given that oil production and its use has expanded steadily for the last 150 years; and that to do anything about it will be expensive and disruptive to our way of life. A dangerously complacent view that is, unfortunately, widely held.

Peak Oil is often described rather narrowly as running out of oil. This is both misleading and inaccurate. Oil is not running out, but the ability to provide all the oil that we might want at a reasonable price is disappearing. In many countries physical exhaustion of the reserves is already happening. The North Sea is a good example. Oil production in the UK sector of the North Sea will average around 1.3 million barrels/day (b/d) in 2011 or just 45 per cent of its 1999 peak of 2.9 million b/d.

Around 25 large-scale oil producers and up to 40 small ones are already in sustained decline. With roughly half of global production coming from countries where production capacity is falling (depletion) this means the remaining producers need to work ever harder to increase output to offset the losses from those in decline and to meet increasing demand. This is a situation that deteriorates with every additional country that goes into production decline.

Physical exhaustion is only one way that the world can be deprived of the oil production flows it would like. Other threats are:

* Physical constraints – if rebels blow up pipelines or there are wars or revolutions, eg Libya, Nigeria, etc.

* Financial constraints – where the money is either not available or the host government doesnt allow companies with the money to invest, eg Venezuela, Mexico, etc.

* Political constraints – where a political decision not to produce or not to export is made. All Opec quotas are political constraints, while recent statements by both Russia and Saudi Arabia that they may cap capacity at current levels would become major constraints if literally implemented.

Possibly the most important constraint of all is price. Oil came to dominate our societies because it was both plentiful and cheap. It is now expensive and its supply is becoming constrained. In mid-2008, the world found out the hard way that it could not afford high-price oil. Or to be more accurate, the Atlantic basin economies of Europe and North America found they could not afford high-price oil. The rest of the world by a combination of fuel subsidies and dynamic economies were rather less affected.

When the level of oil prices and oil production are compared it can be shown that from 2000 to 2003 prices were steady at around $25/barrel and that production responded by growing – meaning that additional supply was forthcoming without prices rising. From 2004, however, prices started rising steadily, but supply stopped rising from early 2005. This means prices had to rise further to reconcile demand growth with static supply until the price boom-and-bust cycle of 2008 initiated the Great Recession (with a little help from the bankers).

As the economy recovered so did oil prices as the supply response remained minimal. The geopolitical upheaval of the Arab Spring and the Libyan conflict appeared on the point of initiating another boom-and-bust cycle but, for the moment, prices have fallen back and oil output appears adequate.

Looking forward, there is little or no chance of enough reasonably low-cost oil being found and developed to alter the pattern of tightening supply and rising prices, interspersed with periodic busts as high oil prices undermine economic growth. All the indications are that by around 2013 there will be no Opec spare capacity to turn on, insufficient new flows to meet demand and prices will be soaring. In short, Peak Oil will have arrived when the flow of new capacity will be insufficient to offset the loss of capacity to depletion.

Over the last two to three years, the link between oil prices and GDP growth has moved from the economic fringes to the economic mainstream. It is now widely accepted that high oil prices inhibit growth and very high prices will trigger a recession, although the speed of the rise may be as or more important than the absolute level. There is effectively no time for adaptation in the face of a very rapid price rise.

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