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Peaking Of World Oil Production:
Impacts, Mitigation, & Risk Management
Hirsch, Bezdek, and Wendling
IX. Market Signals As Peaking Is Approached
Oil prices have traditionally been volatile. Causes include political events, weather, labor strikes, infrastructure problems, and fears of terrorism.114 In an era where supply was adequate to meet demand and where there was excess production capacity in OPEC, those effects were relatively short-lived. However, as world oil peaking is approached, excess production capacity by definition will disappear, so that even minor supply disruptions will cause increased price volatility as traders, speculators, and other market participants react to supply/demand events. Simultaneously, oil storage inventories are likely to decrease, further eroding security of supply, aggravating price volatility, and further stimulating speculation.115
While it is recognized that high oil prices will have adverse effects, the effects of increased price volatility may not be sufficiently appreciated. Higher oil price volatility can lead to reduction in investment in other parts of the economy, leading in turn to a long-term reduction in supply of various goods, higher prices, and further reduced macroeconomic activity. Increasing volatility has the potential to increase both economic disruption and transaction costs for both consumers and producers, adding to inflation and reducing economic growth rates.116
The most relevant experience was during the 1970s and early 1980s, when oil prices increased roughly six-fold and oil price volatility was aggravated. Those reactions have often been dismissed as a “panic response,” but that experience may nevertheless be a good indicator of the oil price volatility to be expected when demand exceeds supply after oil peaking.117
The factors that cause oil price escalation and volatility could be further exacerbated by terrorism. For example, in the summer of 2004, it was estimated that the threat of terrorism had added a premium of 25 - 33 percent to the price of a barrel of oil.118 As world oil peaking is approached, it is not difficult to imagine that the terrorism premium could increase even more.
In conclusion, oil peaking will not only lead to higher oil prices but also to increased oil price volatility. In the process, oil could become the price setter in the broader energy market, in which case other energy prices could well become increasingly volatile and unpredictable.119
There are a number of factors that could conceivably impact the peaking of world oil production. Here is a list of possible upsides and downsides.
A. Upsides – Things That Might Ease the Problem of World Oil Peaking
B. Downsides - Things That Might Exacerbate the Problem of World Oil Peaking
XI. Summary And Concluding Remarks
Our analysis leads to the following conclusions and final thoughts.
1. World Oil Peaking is Going to Happen
World production of conventional oil will reach a maximum and decline thereafter. That maximum is called the peak. A number of competent forecasters project peaking within a decade; others contend it will occur later. Prediction of the peaking is extremely difficult because of geological complexities, measurement problems, pricing variations, demand elasticity, and political influences. Peaking will happen, but the timing is uncertain.
2. Oil Peaking Could Cost the U.S. Economy Dearly
Over the past century the development of the U.S. economy and lifestyle has been fundamentally shaped by the availability of abundant, low-cost oil. Oil scarcity and several-fold oil price increases due to world oil production peaking could have dramatic impacts. The decade after the onset of world oil peaking may resemble the period after the 1973-74 oil embargo, and the economic loss to the United States could be measured on a trillion-dollar scale. Aggressive, appropriately timed fuel efficiency and substitute fuel production could provide substantial mitigation.
3. Oil Peaking Presents a Unique Challenge
The world has never faced a problem like this. Without massive mitigation more than a decade before the fact, the problem will be pervasive and will not be temporary. Previous energy transitions (wood to coal and coal to oil) were gradual and evolutionary; oil peaking will be abrupt and revolutionary.
4. The Problem is Liquid Fuels
Under business-as-usual conditions, world oil demand will continue to grow, increasing approximately two percent per year for the next few decades. This growth will be driven primarily by the transportation sector. The economic and physical lifetimes of existing transportation equipment are measured on decade time-scales. Since turnover rates are low, rapid changeover in transportation end-use equipment is inherently impossible.
Oil peaking represents a liquid fuels problem, not an “energy crisis” in the sense that term has been used. Motor vehicles, aircraft, trains, and ships simply have no ready alternative to liquid fuels. Non-hydrocarbon-based energy sources, such as solar, wind, photovoltaics, nuclear power, geothermal, fusion, etc. produce electricity, not liquid fuels, so their widespread use in transportation is at best decades away. Accordingly, mitigation of declining world oil production must be narrowly focused.
5. Mitigation Efforts Will Require Substantial Time
Mitigation will require an intense effort over decades. This inescapable conclusion is based on the time required to replace vast numbers of liquid fuel consuming vehicles and the time required to build a substantial number of substitute fuel production facilities. Our scenarios analysis shows:
The obvious conclusion from this analysis is that with adequate, timely mitigation, the economic costs to the world can be minimized. If mitigation were to be too little, too late, world supply/demand balance will be achieved through massive demand destruction (shortages), which would translate to significant economic hardship.
There will be no quick fixes. Even crash programs will require more than a decade to yield substantial relief.
6. Both Supply and Demand Will Require Attention
Sustained high oil prices will stimulate some level of forced demand reduction. Stricter end-use efficiency requirements can further reduce embedded demand, but substantial, world-scale change will require a decade or more. Production of large amounts of substitute liquid fuels can and must be provided. A number of commercial or near-commercial substitute fuel production technologies are currently available, so the production of large amounts of substitute liquid fuels is technically and economically feasible, albeit time-consuming and expensive.
7. It Is a Matter of Risk Management
The peaking of world conventional oil production presents a classic risk management problem:
Mitigation efforts initiated earlier than required may turn out to be premature, if peaking is long delayed.
On the other hand, if peaking is imminent, failure to initiate timely mitigation could be extremely damaging. Prudent risk management requires the planning and implementation of mitigation well before peaking. Early mitigation will almost certainly be less expensive and less damaging to the world’s economies than delayed mitigation.
8. Government Intervention Will be Required
Intervention by governments will be required, because the economic and social implications of oil peaking would otherwise be chaotic. The experiences of the 1970s and 1980s offer important lessons and guidance as to government actions that might be more or less desirable. But the process will not be easy. Expediency may require major changes to existing administrative and regulatory procedures such as lengthy environmental reviews and lengthy public involvement.
9. Economic Upheaval is Not Inevitable
Without mitigation, the peaking of world oil production will almost certainly cause major economic upheaval. However, given enough lead-time, the problems are soluble with existing technologies. New technologies are certain to help but on a longer time scale. Appropriately executed risk management could dramatically minimize the damages that might otherwise occur.
10. More Information is Needed
The most effective action to combat the peaking of world oil production requires better understanding of a number of issues. Is it possible to have relatively clear signals as to when peaking might occur? It would be desirable to have potential mitigation actions better defined with respect to cost, potential capacity, timing, etc. Various risks and possible benefits of possible mitigation actions need to be examined. (See Appendix V for a list of possible follow-on studies).
The purpose of this analysis was to identify the critical issues surrounding the occurrence and mitigation of world oil production peaking. We simplified many of the complexities in an effort to provide a transparent analysis. Nevertheless, our study is neither simple nor brief. We recognize that when oil prices escalate dramatically, there will be demand and economic impacts that will alter our simplified analysis. Consideration of those feedbacks will be a daunting task but one that should be undertaken.
Our study required that we make a number of assumptions and estimates. We well recognize that in-depth analyses may yield different numbers. Nevertheless, this analysis clearly demonstrates that the key to mitigation of world oil production peaking will be the construction a large number of substitute fuel production facilities, coupled to significant increases in transportation fuel efficiency. The time required to mitigate world oil production peaking is measured on a decade time-scale, and related production facility size is large and capital intensive. How and when governments decide to address these challenges is yet to be determined.
Our focus on existing commercial and near-commercial mitigation technologies illustrates that a number of technologies are currently ready for immediate and extensive implementation. Our analysis was not meant to be limiting. We believe that future research will provide additional mitigation options, some possibly superior to those we considered. Indeed, it would be appropriate to greatly accelerate public and private oil peaking mitigation research. However, the reader must recognize that doing the research required to bring new technologies to commercial readiness takes time under the best of circumstances. Thereafter, more than a decade of intense implementation will be required for world scale impact, because of the inherently large scale of world oil consumption.
This work was sponsored by the National Energy Technology Laboratory of the Department of Energy, under Contracts No. DE-AM26-99FT40575, Task 21006W and Subcontract Agreement number 7010001197 with Energy and Environmental Solutions, LLC. The authors are indebted to NETL management for their encouragement and support.
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