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Need For A Balancing Act: Reducing Oil Dependence
Without Triggering A Global Crisis

Oil adiction

By Gavin Longmuir and AF Alhajji

Three facts underscore the importance of the debate about the future of oil: oil is a finite resource; oil is one of the major anthropogenic sources of carbon dioxide; and the world economy is heavily dependent on oil, especially in the transportation sector. The most important questions are: How do we balance depletion, the environment, and economic growth – remembering that “we” includes human beings in oil-exporting countries as well as those in oil-consuming countries? Will the transition to new energy sources be seamless and easy, for oil-exporters as well as for oil-importers? How will oil-producing countries react to the non-market based efforts of oil-consuming countries to reduce their dependence on oil? Should oil-producing and oil-consuming countries cooperate to make the transition to new energy sources as painless as possible for all parties? Will these efforts at cooperation succeed in the long run if they are not market-based efforts?

We suggest that politicians, environmentalists, and the public in oil-consuming countries do not ignore the valid interests of the oil-exporters on whom they depend. They should not ignore the fact that the market has chosen a fuel – oil – that differs from some governments’ current fuel preferences. In a recent editorial, the Oil and Gas Journal summed it up nicely by stating “The new energy vision clashes with fuel choice by the market.”2

Oil Independence And Sustainability Of Energy Supplies

The main threat to sustainability of energy supplies is not a terrorist attack on energy facilities or the imposition of an oil embargo by an oil producing country. These are short-term events that can be dealt with quickly and effectively through various measures that include the use of the Strategic Petroleum Reserve, increase in production, and diversion of oil shipments.

The main threat to sustainability of energy supplies in the medium term is the mismatch between investment in additional capacity and energy infrastructure on one hand and the growth in demand for energy on the other. One of the most plausible scenarios is a relative decline in investment in additional production capacity in the oil-producing countries in response to calls by governments and politicians around the world to reduce or even eliminate dependence on oil. An energy crisis in this case is unavoidable if those who call for eliminating dependence on oil fail to provide a replacement in a timely manner. Most of the efforts to replace oil are not market driven and heavily subsidized. Most likely such efforts will fail to replace oil within a reasonable time. They cannot sustain the pressure of markets in the long run.

Finland recently announced its intention to eliminate oil as an energy source by 2030. Earlier Sweden announced plans to become a carbon-free zone.3 There is a rising tide of announcements from European countries on their aims to boost the use of non-fossil sources of power. India is talking about increasing gas and LNG imports and is pursuing a nuclear power cycle based on indigenous thorium supplies. China has said it plans to build more nuclear plants.

The US has joined the chorus of countries that want to reduce or eliminate dependence on oil. President George W Bush has spoken about elimination of dependence on oil,4 while encouraging clean-coal technology, hydrogen, and biofuels. Some members of his administration have echoed his call for lowering dependence on foreign oil. Others have called for a complete elimination of dependence on oil as a source of energy. In a strange twist of history, environmentalists and neoconservatives, socialists and capitalists, Westerners and Easterners have a unified goal: eliminate or sharply reduce dependence on oil. It is time to give some thought to the possible impact of these proposals on major oil-exporting countries.

Oil is still abundant. A recent report by CERA estimates, perhaps optimistically, remaining global oil resources at 3.74 trillion barrels.5 Even the more pessimistic proponents of Peak Oil assert that about half the planet’s endowment of recoverable conventional oil is still in the ground, waiting to be recovered – approximately 1 trillion barrels, with a gross value about twice the entire world’s current annual GDP. Much of the remaining conventional oil is in the hands of a very small number of governments, primarily in the Middle East. Will all the talk about reducing dependence on oil have an impact on their behavior?

“Security of Demand” is becoming a more common expression in comments by major oil exporters such as OPEC and Russia. Developing major oil fields involves huge long-term commitments, which producers undertake because they expect long-term demand for their oil. Major oil exporters have tended to view their remaining oil in the ground as an appreciating asset, to be exploited at a measured pace so that some is left for future generations. Even in straightforward political terms, the call for “Security of Demand” becomes very attractive when the other side is exerting pressure on the producing countries to insure “Security of Supply.” Such pressure was on display in 2005 when King ?Abd Allah, then Crown Prince, brought a team of experts to President Bush’s ranch in Crawford, Texas, to explain the Saudi plans to increase oil production capacity.6 On 21 April, Saudi Oil Minister Ali Naimi presented the plan to the 6th International Oil Summit in Paris.7 Under pressure for “Security of Supply” from consumers, “Security of Demand” became a valuable political tool for oil producers.

Talk about moving away from oil through non-market-based coercive policies thus provides a serious challenge to the sustainability of oil producers’ societies. To add insult to injury (or injury to insult), much of this talk comes from European governments which are taking a large share of the economic rent on the exporters’ oil through extremely high taxes on end-consumers. Those consumer-country governments are thus hogging much of the current revenue stream from the oil producers’ major asset, while simultaneously planning to eliminate the demand for it.

Even hopes for a peaceful democratic Iraq cannot materialize without oil revenues. Major oil exporters might be forgiven for treating talk of eliminating dependence on fossil fuels as an existential threat to their societies, especially when such talk is based on hostile ideological agendas rather than market principles.

How Might Major Oil Exporters React?

Activists and politicians in oil-consuming industrialized countries may not intend their remarks to be seen as hostile by oil exporters. The sad reality is that Western advocates have likely not given even a moment’s thought to the implications of their anti-oil stance for oil exporters. Nevertheless, oil exporters can be forgiven for finding such statements quite threatening. In the face of such apparently hostile statements from across the political spectrum in oil-consuming countries, oil producers might react in a number of ways - depending on their perception of the seriousness of the threat.

Their simplest response would be to ignore escalating Western claims about weaning themselves off oil as some bizarre form of Liar’s Poker among Western political classes. Oil exporters might look at the actual continuing growth in oil demand and conclude that consumers do not intend to follow through with the necessary hard choices. Additionally, oil exporters could sit and watch Western developments, comfortable in the knowledge that currently-popular Carbon Capture & Storage (CO2 sequestration) is very energy intensive and (if implemented) will substantially increase the demand for fossil fuels, thus rendering their oil resources even more valuable.

Oil exporters could take Western commentators seriously and assume that oil importers will indeed reduce their demand for oil, leaving them with then-unmarketable oil sitting in the ground. Their logical response to this threat would be to accelerate production of their oil resources while they still have some value. This would of course drive down the price of oil and undermine the economic feasibility of alternative sources of energy. A collapse in the price of oil would be a death sentence for several new energy technologies, which would consequently increase the demand for oil. In fact, the oil-producing countries might view increasing oil production and lowering prices as a logical interventionist policy to counter the anti-oil interventionist policies of the governments of the consuming countries. Historical data from periods of oil price collapses support this point: low oil prices increase oil demand, decrease efficiency improvements, choke alternative energy resources, and increase wastage.8

Alternatively, expecting a decline in demand for their oil, producing countries might decide to reduce planned investments in production capacity expansion and maintenance and mothball some planned projects, which would quickly lead to declining oil supplies. If new technologies do not come on-line by the time oil production starts declining, the world will face a serious energy crisis, probably unparalleled in history. Reversing such a trend of declining investments would take years, despite a massive increase in oil prices. This alternative is not a mere possibility: several major projects have been mothballed in the past when the oil producing governments deemed these as not needed, given perceived future demand and prices.

As yet another alternative, if oil-consuming countries begin to reduce their dependence on oil, major oil exporters could seek to use their now less-valuable oil within their own borders as cheap fuel for a greatly expanded heavy industrial sector. Instead of exporting oil directly, they could export the energy from it embedded in metals, chemicals, and manufactured products at prices that far undercut anything Western producers could match, constrained as they would be by using higher-cost alternative energy sources. In fact, cheap energy in those countries might make their new industries completive with cheap labor industries in China, India, and south Asia. The net result would be a loss of jobs and economic strength, by West and East, without having any impact on the overall global consumption of fossil fuels.

Thus, Western posturing over reducing the demand for oil could cause major oil exporters to react in a variety of ways, most of which would exacerbate rather than help the global energy situation. Even in a scenario where Western countries successfully replaced their demand for oil from alternative indigenous energy sources, they would still have to live on the same planet as former major oil-exporting countries whose fragile societies would then be faced with the additional economic strain of the loss of their main current source of revenue. Energy independence for current oil-importers may carry a high moral price. If a sharp decline in oil revenues leads to instability in the oil producing areas, the West will not be able to turn a blind eye to such conflicts. In the age of globalization, these countries are economic and political partners of the West. Political instability that results from declining oil revenues must be added as a potential cost of oil independence. In addition, it is unclear what will happen to the world monetary system without the trade in oil and the associated recycling of petrodollars. A change to a world where most industrial countries depend on their own domestic energy resources would require a major change in the world’s financial and monetary system. Such a change will bring its own challenges and difficulties to all, including the industrial countries.

Constructive Responses by Major Oil Exporters

Given that oil is an exhaustible resource, major oil-producing countries should not wait until consuming countries reduce their demand for oil. They might choose long-term, market-oriented, economically viable and sustainable options that ensure their economic growth, prevent a world-wide energy crisis, and reduce emissions.

In the transition to a new fuel, the oil-producing countries might choose to invest heavily in CO2 sequestration and various emissions-reduction technologies. This investment might include CO2 flooding of oil and gas wells, which would increase recovery and reserves. This is a transitional option that guarantees the availability of energy supplies and steady stream of oil revenues while reducing carbon emissions from fossil fuels. Oil-exporters might reasonably demand that oil-importers pay a higher price for this “greener” oil.

During a global transition from fossil fuels, the oil-producing countries have several long-term options such as:

Seek to become leaders in post-fossil fuels. Oil producers are keenly aware that oil is a finite resource. While nuclear power is the only practical option for large-scale sustainable non-fossil power, Western environmental activists are as negative about nuclear power as they are about oil. Among the potential power sources favored by Western environmental activists, windmills are at about the limit of their technical development and will continue to be non-competitive without subsidies. In contrast, photovoltaics and biofuels could potentially see the kind of order-of-magnitude improvements in technology necessary for them to become viable large-scale energy sources. Even with technological breakthroughs, those sources would still require very large amounts of vacant land and lots of sunshine. In short, North Africa and the Middle East might become the prime global locations for competitive large-scale production of post-fossil fuels. In a world that relies on alternative sources of energy, Middle East countries might be even more important suppliers than they are today.

Significantly improved technology is the key to practical, large-scale use of photovoltaics or biofuels. Major oil producers could be well-placed to attract patient long-term investors in those technologies. However, oil exporters’ ability to make such long-term investments is constrained by European governments, which are taking the bulk of the economic rent on the producers’ oil. Major oil producers might reasonably demand an adjusted allocation of that rent as a condition for committing to major investments in new energy technology while they continue to make major investments in oil production capacity. In other words, in exchange for a free oil market with lower taxes and fewer trade restrictions, the oil producing countries will be required to invest in new energy technologies. The question remains: will the posturing stop when oil consuming countries become dependent on new energy sources from the Middle East, even if they are environmentally sound? If politicians in the energy consuming countries continue their verbal attacks on the energy producing countries, wouldn’t that reduce these countries’ enthusiasm for developing new energy resources?

Most of the above options are market driven. They are not only long-term options, but they are also sustainable. Short-term political considerations might delay for few years the decisions that are necessary to reduce oil demand in the West, but they could backfire in the long run. They might also strain political relations between producing and consuming countries. The oil producing countries might pursue short-term, and sometimes unethical, options, which include:

Lobbying consuming governments to create legal loopholes to circumvent activities aimed at reducing dependence on oil. Lobbying might include offers of political favors, trade deals, and access to lucrative oil reserves.

Investing in the downstream sector of the consuming countries that would satisfy any actual growth in demand for petroleum products. Such investment in downstream might enable oil producers to influence public opinion and local officials through excellent service and job creation.

Providing funding for genuinely unconstrained scientific research into global climate processes, without any of the politically correct pressures involved in current research funding from Western government sources.

Conclusion

Western environmental and political enthusiasm for eliminating oil as the principle source of energy may generate major unintended consequences. It could have great impact on the decisions of a handful of key oil exporters. Also, a lower oil price would wreak havoc on the economies in the Middle East, one of the least stable areas in the world. The cost of such political instability in terms of lives, money, and pollution will render all the positive results from weaning consuming countries off oil negligible.

Developed economies depend heavily on imported oil. The EU and the US each imports over 10mn b/d, and Japan imports essentially all of its oil. It would be wise for environmental activists and the governments of the consuming countries to pay more attention to the valid concerns of the fuel suppliers on whom they depend. In fact, current cooperation efforts between consuming and producing countries are doomed to failure. Supporters of cooperation have yet to develop a theory that justifies cooperation. Consuming countries demand a liberalization of energy markets that, in the view of oil producing countries, would strip their governments and their national oil companies of the power to control their principle national resource. The recent International Energy Agency’s World Energy Outlook 2006 puts the blame for any future energy crisis squarely on the backs of OPEC members. It does not acknowledge that all the really big energy problems that the consuming countries have suffered from in recent years have had nothing to do with OPEC: the California power crisis, the sharp increase in natural gas prices in the US, the decline in the US oil and gas production that resulted from Hurricanes Katrina and Rita, and natural gas shortages in Europe after Russian actions against Ukraine.

Genuine cooperation requires market-based policies that divide the burden equitably between producers and consumers and reward the most efficient investments. Neither the demands of consuming countries nor the calls for energy independence are market-based and thus current efforts at cooperation will not succeed. Nor do the policies of consuming countries indicate a willingness to adopt the sort balanced assessment of costs that would encourage true cooperation between producers and consumers.

From the perspective of oil-consuming countries wishing to reduce the global use of fossil fuels without provoking an economic depression, the objectives of cooperation should be (1) ensuring adequate supplies of oil during the transition away from oil, and (2) keeping the oil price stable at a level which is sufficiently high to encourage investments in alternative energy sources. From the perspective of major oil-exporting countries, the objectives of cooperation should be (1) maintaining their national revenues as demand for oil is progressively reduced, and (2) replacing the asset they will sacrifice as their patrimony of oil in the ground becomes less valuable.

Balancing these diverse objectives will be a very challenging task, requiring a lot of cooperation and trust from all parties. It may require some major sacrifices from oil-consuming countries, such as turning over a growing share of their revenues from taxes on end-users to oil exporters to make up for the latters’ declining sales volumes. It may also require developed countries to mothball their own oil production capacity to maintain demand for oil from oil-exporting countries, which would lead to increased global dependence on oil from the Middle East. The willingness to make such sacrifices and accept such risks will be a stern test of how serious oil-consumers are about weaning themselves off fossil fuels.

Some developed countries want to cut back oil use for global climate reasons. Most OPEC countries need to keep selling oil. These developed countries have “extra-territorial” ambitions – they want to cut back global oil use, not just their own oil use. It does no good (in their world view) if they cut back oil consumption and OPEC members simply sell more oil to China and others.

OECD is a convenient proxy for countries that fear global warming. They produce about 19.8mn b/d (24% of global oil production); OPEC countries produce 33.8mn b/d (42%). Perhaps a “confidence building” measure would be for OECD countries to cut back on their own oil production. They could put their oilfields into standby mode, and pay all the costs for that. This policy would leave more of the (supposedly declining) global oil market to OPEC countries and allow them to maintain their own production and revenues. The standby production capacity within OECD borders might let those countries feel more comfortable about relying on OPEC producers. And this way global oil production would be reduced while maintaining the price of oil as demand decline.

If OECD countries are reluctant to incur the costs of mothballing their own sizable oil production capacity, or are unable to agree on equitable sharing of the costs of this policy among themselves, then they will have demonstrated to the world that they are really not serious about reducing global oil consumption. OPEC countries will comfortably invest accordingly.

Notes:

1. An abridged version of this article was published in the Oil and Gas Journal, Volume 105 Issue 6, 12 February 2007.

2. “A dot-com energy vision” Oil and Gas Journal, 23 October 2006.

3. See “Sweden aims to eliminate oil” 2 September 2006 at http://www.eubusiness.com/archive/Energy/sweden.2006-02-09

4. For instance, on 31 January 2006, he stated in his State of the Union address “…make our dependence on Middle Eastern oil a thing of the past." For more information see the speech on the White House web page at http://www.whitehouse.gov/stateoftheunion/2006/

5. “CERA Estimates Remaining Oil Resources at 3.74 Trillion Barrels, ”Middle East Economic Survey, 20 November 2006.

6. See, for example “Bush and Saudi Prince Discuss High Oil Prices in Ranch Meeting.” New York Times, 28 April 2005.

7. “Naimi Outlines Oil Capacity Expansion Plans, Reiterates Oil Reserves Position.” Middle East Economic Survey, 25 April 2005.

8. Alhajji, A F "What Have we Learned from Lower Oil Prices?" OPEC Review, Vol 25, No 3, September 2001.

 

 

Gavin Longmuir is a Stanley, NM-based consulting petroleum engineer, affiliated with International Petroleum Consultants Association Inc of Evergreen, Colorado (LongmuirG@aol.com). AF Alhajji, Phd. is an Energy Economist and Associate Professor at Ohio Northern University, Ada, Ohio (a@aalhajji.com). Their views are not necessarily those of PETROLEUMWORLD.

Editor's Note: This article was written for Middle East Economic Survey (MEES) and originally published by MEES, on February 2007. Petroleumworld reprint this article in the interest of our readers.

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Petroleumworld News 03/05/07

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