Easter Island earth

Examine this picture closely. It is the scariest picture you will see in a long time. It is from the International Energy Agency’s World Energy Outlook 2010. The IEA is the energy policy research agency of the Organisation for Economic Cooperation and Development (OECD), which represents the interests of the major developed market economies. Apparently.

So what’s so scary about this picture? The growing light blue wedge representing “Crude oil: fields yet to be found” is real cause for concern. Eliminate that growing wedge, and we do not have much more than five years before overall supply starts to decline.

The IEA argues that this is not a problem because any shortfall in supply will crank up prices, making it feasible to spend more on extraction - in effect squeezing more out of depleted fields. The problem with this prediction is that over the last three years while oil prices have hit new records and subsequently stayed well above the long-term historical inflation-corrected average of about US$30 per barrel, the IEA has downgraded their estimates of future supply with every annual Outlook. Another argument is that “unconventional” oil like tar sands will fill the gap but there again, the IEA’s forward estimates do not cover the shortfall.

How big a deal is that growing blue wedge? Oil fields have historically taken over 30 years to move from discovery to production and while this can theoretically be sped up significantly, the light grey wedge in the graph representing known oil fields that are not yet in production represents a massive investment in opening up new capacity. Even if the IEA’s phantom “yet to be discovered” oil fields actually exist explaining exactly how these will be brought on line almost instantaneously over a period of such massive activity in bringing known new oil fields on-line requires an extremely active imagination.

The factor missing so far from the picture is growth in demand, which has stalled over the last two years because of a worldwide economic crisis. Add in a return to growth and we will very soon hit the point were supply cannot keep up with demand. The market for oil largely exhibits inelastic demand - price changes have a limited effect on demand, because many uses either have no alternative, or require a change to a new technology to switch to an alternative. We can cut luxuries like overseas holidays and an unnecessary drive on the weekend, but farmers can’t switch to harvesting by hand on a large farm, nor can those who live in areas without public transport leave the car at home and take the bus or train to work.

In the long run, if prices remain high, the market will start to favour alternatives like public transport and renewable energy. The big risk with waiting for that market signal is worldwide economic collapse if the supply crisis happens rapidly, for the same reason that the demand is inelastic: we cannot switch instantly to alternatives that do not exist, even if the price signal favours them. Did the rapid rise of the oil price to $147 in July 2008 instantly convert every petrol engined car to electric, with all the problems of batteries solved? Clearly not, but that rapid price spike - terminated by a global financial crisis - is an indicator of what to expect.

How could we have allowed such a threat to develop? Did we have any basis to predict such a problem? Did we learn anything from 2008?

Incredibly, we have known that we would run into exactly this scenario since Shell Oil geophysicist M. King Hubbert in 1956 predicted the peak in USA and worldwide oil output as occurring respectively in 1970 and 2000. Historical records of US oil production show that his prediction for the USA was astonishingly accurate; that should have set off alarm bells in corridors of power around the world. Instead, a growing number of industry insiders have split with the official industry and government line, creating a worldwide network of peak oil researchers, and “official” organisations like the IEA have vigorously denied there’s a problem.

Why would anyone deny such a problem? The motive of the industry is clear, and is the same as their reason for undermining the political consensus on climate change. The rational response - call it Plan A - to both peak oil and climate change is a gradual transition over decades from fossil fuels. Such a slow transition would result in a gradual diminution of fossil fuels sales and profits. On the other hand an abrupt transition arising from depletion of fossil fuels results in a massive profits windfall for the industry, when shortage of supply runs into inelastic demand. As the industry well knows, a massive price increase can stimulate development of alternatives, as happened in the 1970s, but those alternatives take time to develop, and the industry has worked hard at avoiding massive price rises for this reason. As former Saudi Oil Minister Sheikh Yamani put it in 1973: “The stone age didn’t end because we ran out of stones.” The fact that the industry has not tried to pull prices back from current high levels by increasing supply is a further warning sign that we are fast approaching a major crisis of supply.

What is not clear is why a research arm of the OECD should deny the problem. They are supposed to be working for governments who ultimately represent us. One claim I have heard is that governments fear spiking panic in the markets; Plan A, begun a decade or two back, would not be a recipe for panic. The Plan B we are rapidly heading for, a war-like economy of rationing and massive government interventions to prevent chaos - certainly does have the potential to cause panic. The only explanations I can see for the failure of governments to act are corruption by fossil fuel interests, and a fear of moving out of the political comfort zone of addressing the electoral cycle, and nothing longer-term than that.