[Questions for: Ronald R. Cooke]

EnviroEngr · Last edited by EnviroEngr on Wed Nov 16, 2005 2:37 pm; edited 1 time in total

Biography

Ronald R. Cooke, The Cultural Economist, Co-Founder of the ASPO-USA

Ronald R. Cooke has over 33 years of professional marketing and business development experience. He has an extensive background in market research, industry analysis, and strategic planning. Prior experience includes technology assessment, operations analysis, and the evaluation of corporate financial performance. An economist by training, Ron has pursued the study of Cultural Economics since 1969. An author of multiple articles on economic issues, he has also written Oil, Jihad and Destiny, a book that provides an assessment of world oil production, characterizes the economic devastation of oil depletion and suggests solutions to the emerging energy crisis. It is available for purchase at BookSurge and Amazon.

Ron's Homepage
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EnviroEngr · Posted: Fri Aug 12, 2005 1:48 pm Post subject: Re: [Ronald R. Cooke]

{The following succession of posts are some articles Ron forwarded to me for posting. These can serve as a primer for both getting to know him and formulating questions to ask; EE}

Will Higher Oil Prices Fuel Inflation?

A news story that compares the rising price of oil to the rate of inflation made the rounds of American media last month. Reporters, pundits and some economists repeated the parable without giving it much thought. The essential claim is that in 2005, higher oil prices will not drive up the rate of inflation as much as they did in the 1970s because oil consumption, as a percentage of GDP, has decreased by half since then. We have become much more efficient in our use of oil, claim the analysts, and therefore higher oil prices will only have a modest upward impact on inflation.

Rubbish.

Although the statement is true, the concept masks a lot of dirty little problems.

Here is why.

Economics

The historical relationship between the price of oil and the rate of inflation gives us clues as to what we may expect in the future. In 1974, the price of oil on the world market increased by 252 percent, from an average of $3.29 per barrel in 1973 to $11.58 per barrel in 1974. Inflation (CPI-U) rose sharply, from an average of 6.23 percent in 1973 to 10.97 percent in 1974, and remained high at 9.14 percent in 1975. In 1979, oil again made a dramatic 121 percent jump in price as it moved from $13.60 in 1978 to $30.03 in 1979. It gained another 19 percent in 1980. Despite the fact that Americans had become more efficient in their use of oil since the price increase of 1974, inflation also increased, by a chaotic 11.26 percent in 1979, 13.52 percent in 1980, and 10.37 percent in 1981. One could argue that conservation had not done anything to slow down the inflationary spiral. By contrast, a 48 percent decrease in the price of oil in 1986 was accompanied by only a modest decrease in the rate of inflation from 3.57 percent in 1985 to of 1.92 percent in 1986. Given the percentage decrease we experienced in the price of oil in 1986, the rate of inflation remained stubbornly buoyant.

If we generate a chart that shows the average annual nominal price of oil versus the average annual rate of inflation for the period 1970 through 2002, we can see – by inspection – there is a modest correlation between changes in the price of oil and concurrent or subsequent rates of inflation. We have to remember, however, that the rate of inflation is influenced by many other economic factors: the level of current economic activity, speculation in the commodity markets, interest rates, changes in productivity, and so on. None-the-less, history suggests that if the price of oil effectively doubles, there has to be an increase in the rate of inflation.

In doing the research for my book "Oil, Jihad and Destiny" I developed a formulae to replicate historical changes in the annual average price of oil versus corresponding changes in the rate of inflation from 1970 through 2002. I discovered that the formulae's accuracy was greatly improved if it also included the annual increase in oil consumption efficiency. Unfortunately, the model can only project the rate of inflation based on changes in supply and consumption. It cannot account for futures speculation or changes in the value of the dollar. Never-the-less, if we use the formulae to project future rates of inflation versus projected increases in the price of oil, we must conclude that even with liberal assumptions about the rate at which we increase the efficiency of oil consumption, the rate of inflation is going to accelerate.

When the Federal Reserve increased the fed funds rate to 2.75% on March 22, 2005, it noted that "pressures on inflation have picked up in recent months." With the computer modeling tools at its disposal, its extensive information resources, and its staff of very bright people, the Federal Reserve must certainly be aware of the relationship between the price of oil and its inflationary impact on economic activity. The Fed knows that its previous policy of easy money has sown the seeds of increased inflation. In addition, Federal Reserve Chairman Greenspan has already warned that America's heavy burden of public and private debt, as well as the cost of sustaining a presence in Iraq, homeland security, Social security, and Medicare are a troubling financial burden. The Fed is very much aware that these factors – taken in the aggregate - create an inflationary economic environment. Even with computer models and bright people, however, it is still difficult for the Fed to judge the timing of future inflation.

Unequal Distribution

There are gut wrenching reasons to fear the inflationary pressures of increased oil prices. Take the Law of Unequal Distribution. This law states there will be an unequal distribution of economic change among the economy's participants. We can classify these participants by various measures in order to make a comparison.

For example, increased oil prices will have only a marginal impact on organizations that use relatively little oil in the provision of goods and services. We can anticipate financial service, insurance, health care, education, government, and utility enterprises will experience little or no cost inflation as the price of oil increases. On the other hand – depending on their business model - transportation, retail, wholesale, agriculture, construction, and manufacturing enterprises may experience modest to sharply increased cost inflation. These costs, less gains in oil consumption efficiency and changes to the basic business model, will eventually have to be passed on to the ultimate consumer.

The Law of Unequal Distribution will be especially hard on consumers. I fired up my trusty spread sheet in order to determine how rising fuel costs would impact the finances of households making $25, $50, $100, $200, and $275 thousand dollars per year. Assuming one car per household that gets 18 MPG, and 10,000 miles of driving per year, each household consumes 555.6 gallons of fuel per year. Last year that fuel could be had for $1.44 per gallon. On average, households in this scenario would have spent .33 percent of their income on vehicle fuel. With gasoline prices moving up to $2.88 per gallon, the average household expenditure increases to .66 percent of income.

The trouble – as stated in the first paragraph of this article – is in the averages. The percentage change in vehicle fuel costs are relatively easy to absorb if your making $100, $200 or $275,000 per year. Households with $275,000 in annual income, for example, would only spend .58% of their income on vehicle fuel. However, lower income households take a terrific hit. Households with $25,000 in annual income would be forced to spend 6.4 % of that income on vehicle fuel. For households that make $50,000, their vehicle fuel costs would jump to 3.2% of their annual income. And it's important to note that these two groups, taken together, account for 56 percent of American households. Obviously, increases in the price of oil will have a serious impact on the available discretionary spending of the two lower income groups.

I then developed a second model, making suitable adjustments for the probable average mileage per vehicle (assuming wealthy households would retain their 15 and 18 MPG vehicles while lower income households migrated to vehicles getting 22, 27 and 33 MPG). If the price of vehicle fuel is $2.88 per gallon, the average percentage of household income spent on vehicle fuels would only be .42 percent of income. That's the kind of figure the media likes to quote in its "sound bite" news broadcasts. The average expenditure doesn't appear to be too bad. But unfortunately for a household having an annual income of $25,000, the cost of vehicle fuel actually increased from 1.75% of income in 2003 to 3.49 % of income in 2005. That's over $870 ! And households with an income of $50,000 will have to spend over $1,000 on vehicle fuel.

And how about the guy who wants to keep his beloved pickup truck that gets 15 MPG? If his household is in the $25,000 bracket, he'll have to pony up almost 8 percent of his household income for vehicle fuel.

Sorry.

But vehicle fuels are only part of the inflation story. These 112,000,000 households also heat their homes and buy other products made where oil is either consumed as a raw material or used in the production process. The big nut is heating oil and its natural gas equivalent, followed by oil intensive products (fertilizers, chemicals, lubricants, and so on) and products whose manufacture uses relatively small amounts of oil. Taken in the aggregate, America's economy consumes 3,450 gallons (or 82.1 barrels) of oil per year per household.

Non vehicle oil costs probably add over $1,000 (or 4 percent) per year to the budget of a household making $25,000 per year. They will add over $1,800 (but less than 1 percent) to the budget of a household making $275,000 per year. For households making $50, $100, and $200,000 per year, the percentages are 3, 1.5, and less than 1 percent, respectively.

The bottom line. If we add the annual cost of vehicle fuel oil consumption to the cost of non vehicle oil consumption, and if oil prices hold at the levels experienced during the first quarter of 2005, then American households – on average – will spend just over one percent of their income on oil. That's the figure we will see in the media. It's the same logic described in the first paragraph of this article. But for households making $25,000 per year, that number jumps to more than 8 percent of their annual income, and it's almost 6 percent for households in the $50,000 income bracket. The Law of Unequal Distribution shows us that at these prices, households in the lower two income groups (56% of American households) will be forced to make serious adjustments to their spending habits.

The Impact

Still think oil price increases aren't inflationary?

Well, here is another reality. Any claim that an increase in the price of oil will not drive up inflation is based on the implicit assumption there is no shortage of oil. Bad assumption. Shortages are coming. Competition for available fuel will drive up the price (as it has already done in 1974 and 1979). For manufacturers and retailers, supply chain and distribution costs will increase faster than other business costs. Transportation links will be less reliable and more expensive. Suppliers of both goods and services will be forced to develop business models that use less transportation. Logistics productivity will decrease.

It's all inflationary.

For a country like the United States, there will be an outsized impact. This economy, and the business models of its individual enterprises, has been built on the assumption of readily available and low cost fuel. Both assumptions are now false. Depletion induced oil shortages will occur. Higher fuel prices are inevitable. Decreasing transportation flexibility translates into higher production and distribution costs. Just-in-time delivery will gradually migrate to local warehousing operations. Production will move closer to the consumer. Inventory costs will increase. Retail consumer traffic patterns and buying habits will change. Food costs will go up. The list of probable change is very long. Oil dependent enterprises will be forced to make significant changes to their business model

– or perish.

But the real change will be at the consumer level in the chain of distribution.

Productivity will decline. That drives up inflation. In an effort to drive down their costs, suppliers will attempt to accelerate their use of computer based inventory management systems and the Internet for consumer distribution. On-line transactions can be tracked in order to tighten the distribution channel and reduce the need for excess inventory. Consumers will be encouraged to make their purchases from the suppliers WEB site, rather than drive to the store. Home delivery services will proliferate. Companies such as Wal-Mart, Federal Express, Ford, and McDonalds will be forced to make a fundamental change to their business models.

Unfortunately, there is a limitation to the substitution of on-line transactions for in-person shopping and distribution. Because the Internet suffers from the imbedded faults of an inadequate architecture, defective software, and a deficient network, America lacks the communications infrastructure to fully substitute on-line interaction for travel. Why? Congress has thus far failed to establish a credible communications policy. Our representatives refuse to recognize the realities of the economic and cultural challenges that face us.

Too bad. If Congress was on the ball, we could avoid a lot of headaches.

Based on an average annual price of $41 per barrel, my model projects that the year-over-year change in the consumer price index (CPI-U) for 2005 will be a modest 3.1% because deflationary pressures are also working their way through our economy. Higher interest rates, a decrease in the rate of economic growth, and our policy of exporting jobs in exchange for low cost goods and services all tend to retard inflation. If oil continues to sell for more than $50 per barrel, however, the rate of inflation will be higher and the Fed will be forced to accelerate its pace of interest rate increases. (Please note: the economic impact of oil production, consumption and pricing on inflation, unemployment and GDP is detailed in my book "Oil, Jihad and Destiny").

Speculation and shortages will push up the price of oil. Speculation and surpluses will drive the price down. But the impact of oil depletion guarantees that the long term price trend is UP. Obviously something has to give. The consumer will have to make choices. Shoes for the kids or gasoline for the car? Meat on the table or fuel for heat? Make an impulse purchase at Wal-Mart or pay the rent? It's going to be rough. Tight spending control for two thirds of American households.

Or go broke.

They aren't going to be happy.

And a final note. The model I developed for the American economy can be applied – with some revision of the assumptions – to the economy of any industrialized nation. Japan, France, Australia, South Korea – it doesn't matter.

Inflation knows no borders. It will be everywhere.

Ronald R. Cooke
The Cultural Economist

{unformatted. will format later; EE}
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| Whose reality is this anyway!? |
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EnviroEngr · Posted: Fri Aug 12, 2005 1:54 pm Post subject: Re: [Ronald R. Cooke]

Oil Depletion? It's All In The Assumptions

Good News

In good news for the SUV set, Daniel Yergin's Cambridge Energy Research Associates (CERA), is predicting we will soon be awash in light, sweet crude - ideal for making gasoline.

CERA's Worldwide Liquids Capacity Outlook To 2010— Tight Supply Or Excess Of Riches predicts we humans will have 6 to 7.5 million barrels per day of excess capacity and we can expect an extended period of lower prices – perhaps by 2007. Petroleum production will be expanding faster than demand over the next 5 years. The report has tabulated 20 to 30 new projects with a capacity of over 75,000 barrels per day that will become available in each and every year until 2010. By then, worldwide production could increase by up to 16 million Bbl/day. However, most of the increased production will come from reworking existing fields, rather than new oil discoveries, and after 2010 the majority of new production will come from OPEC.

CERA doesn't believe in peak oil, at least not before 2010, and probably not before 2020. The report indicates that the “inflexion” point will come between 2030 and 2040. Moreover, rather than a “peak,” it will be an “undulating plateau” that will continue for several decades. OPEC, the company claims, will be able to add 8.8 Mbl/day by 2010 and can continue its expansion – at a somewhat slower rate – beyond 2010. Non-OPEC production will experience a robust increase through 2010, and then slow significantly thereafter. Unconventional oil production will increase throughout this period, supplying almost 35 percent of the world's oil by 2020.

Then Yergin adds a sobering caveat: "The main risks to our Supply Expansion scenario are above ground, not below ground – changes in the political and operating climate that could delay expansion.” In CERA’s downside “Delay and Disruption” scenario, capacity increases by only 11.5 million barrels between 2004 and 2010.

Whoops.

What is the implication? Will delayed projects and disruptions in the supply chain lead to temporary shortages before "Peak Oil" hits us? Perhaps we should review CERA's implied assumptions. They are, after all, the basis of CERA's optimistic conclusions.

Assumptions

Underlying every data analysis and series of conclusions is a collection of assumptions. In order to avoid oil shortages, temporary or longer term, for example, we have to make multiple assumptions about our ability to find, produce, transport, refine and distribute oil (the supply chain). At some point in our analysis, these assumptions have to be tested for credibility.

Will they hold up under careful examination?

Assumption # 1. Peace in Iraq.

A key element for any increase in Middle East oil production has to be Iraq. Estimates of found oil range from 46 to 112 Bbl, with another 100 Bbl a strong "maybe it's there". If there is no peace in Iraq, or if Iraq succumbs to the policies of an Islamic Theocracy, then Iraq's contributions to OPEC's annual production volumes will never reach the levels envisioned by the International Energy Agency (IEA). If Iraq's government is stable, and favors a high production policy, then world oil supplies will be a little closer to the IEA's projections through 2020.

The future of Iraq rests on the outcome of an escalating cultural conflict between Islamist and Western values. Until that gets resolved, we can only guess at the future of Iraqi oil production.

Assumption # 2. Political and labor stability.

Any optimistic analysis of oil production must assume there will be relative political and labor stability in the Middle East, North West Africa, South America, and Caspian regions. As recent events have shown, however, these areas are prone to conflict that disrupts the flow of oil. Up until 2004, temporary disruptions in one region could usually be replaced by production from other resources. Going forward, there may not be sufficient spare capacity to cover lost production from one or more regions. As a result, sporadic shortages are a possible reality.

Assumption # 3. Islamist terrorist activity will not disrupt the supply chain.

Islamist terrorist activity will continue to disrupt the supply chain from time to time. The land locked Caspian, for example, could be the source of 60 Bbl of oil. Maybe more. And these wells are coming on-line. But most of the oil in this region must pass through a very long pipeline in order to reach the consumer. History suggests political volatility in this region will eventually disrupt supply chain operations. Perhaps for multiple years.

Islamist terrorist activity, whether sporadic or sustained, will continue to be a potential threat to the flow of oil, not only in the nations of the Caspian, the Middle East, and North West Africa, but also within the borders of consuming nations.

Assumption # 4. The proven reserves claimed by OPEC actually exist.

It is unlikely the proven reserves claimed by OPEC actually exist. Many believe they are a fabrication of the quota justifications that occurred in the 1980s. Furthermore, the claim that "Proven" reserves are increasing needs to be examined because in a sense we are merely talking about definitions. Words. As the price of oil increases, it becomes economically feasible to spend more money on production. Make sense? So the reserves that could not be classified as "Proven" at $26.00 per barrel become damn attractive if the price for a barrel goes to $55.00. There isn't any more oil. It's just that "Probable" oil reserves become "Proven" oil reserves as the price of oil increases because we can afford to spend more money on recovery. All we did was reclassify the definition of the oil we already have in the ground. No one found any more oil. Not a drop.

Assumption # 5. There will not be a substantial increase in reserve depletion rates.

Only 4 "super-giant" oilfields have been found outside the Middle East since 1960 (in Russia, China, Alaska and Mexico) and all of these - except China - are now in decline. Oil production is in decline in 33 of the 48 largest oil producing nations. Using improved technology often increases the rate of depletion. New finds tend to be smaller and deplete faster. Worldwide, estimated rates of depletion run as high as 8 percent per year.

Assumption # 6. All proven and potential reserves will be produced on schedule.

This assumption only works if hundreds of exploration and drilling operations in multiple countries and oceans under a wide variety of operating conditions and technical challenges occur on a schedule that coincides with the IEA's demand projections. Everything has to work. No significant political or labor conflicts. No ideological confrontation. No financing or management Snafus. Cooperative weather. And a reasonably predictable growth in market demand so consumption can equal production (with a little to spare).

Assumption # 7. Middle Eastern production capacity will continually increase, reaching ~ 29 Mbl/d by 2010 and at least 43 Mbl/d by 2020.

Middle Eastern production capacity will increase. The goal of 29 Mbl/day by 2010, however, is ambitious, and few believe OAPEC will be able to deliver 43 to 50 Mbl/day by 2020. Exploration and production will be challenged by Islamist opposition in Iran, Iraq and Saudi Arabia (and perhaps elsewhere). There is a long list of reserve and technical restraints in this region. We must also understand that the creation of a large surplus capacity is NOT in OAPEC's selfish best interest. Faced with enormous population growth and big welfare bills, every Middle Eastern government knows that when the oil is gone, their regime is in trouble. Leaders may determine they can actually make more money, and enjoy greater personal longevity, - by pumping less.

Assumption # 8. The EROEI of all oil production exceeds 1.

EROEI. Energy Returned On Energy Invested means that the energy derived from exploration, production, refining, and transportation exceeds the energy consumed for these activities. We tend to forget. If the EROEI of any energy resource is 1 or less, then doing that activity no longer provides a net addition to our stockpile of energy.

The average EROEI of world oil production has been declining. I read somewhere that before 1950 the EROEI for oil was more than 100:1. By the 1970s it had dropped to 30:1, and by 2005 the average EROEI on new production had fallen to 10:1. As we go for oil in increasingly difficult environments (deep under the ocean, open pit mining, etc.) the EROEI will decline further. We have to face the facts. Just because there is oil in the ground does not mean it is practical to extract. Every well has its cost in money AND energy. At some point the EROEI for every well will fall to less than 1, making oil from that well an impractical resource for energy.

Assumption # 9. Unconventional oil production will increase throughout this period, supplying almost 35 percent of the world's oil by 2020.

We have inherited up to 7 Tbls of oil trapped in sand or shale formations. But that is a misleading number. Only 5 Tbl are worth mining and of that number, perhaps 25 percent will be feasible to produce because production cost and EROEI factors make extensive mining impractical. Given the production problems associated with squeezing oil from rock and sand, the rate of production will be painfully slow. A goal of 15 to 18 Mbl per day by 2020 from recoverable reserves of 620 to 910 Bbl appears reasonable.

We expect to find oil beneath polar ice and permafrost in the Artic. Although total recoverable oil is something of a mystery at this point, figure 55 to 100 Bbl (maybe more). Unfortunately, exploration, production and transportation in this frigid environment are no fun. And costly. So don't expect polar oil to yield enough production to avoid oil shortages.

We are learning how to drill in the deep waters (over 2,500 meters) of the ocean. There is oil in the Gulf of Mexico, along the coastal shelves of South America and Africa, and a number of other locations around the world. Recovery takes time, is a technical and operations challenge, and is very costly. Add another 80 to 120 Bbl of oil to the reserves we will ultimately recover.

In addition, one can expect we humans will pump out a limited amount of heavy oil and oil from coal bed methane deposits.

If we add up all of these resources, we probably have up to 1.1 Tbl of unconventional oil to play with over the next 20 years. But our estimate of annual production is much lower. Technical, weather, geography, political, environmental, cost and EROEI factors will limit total production to around 100 Bbl from 2005 to 2020. This estimate – by the way - mirrors the Energy Outlook projections made by ExxonMobile in its "World Liquids Production Outlook" presentation.

To these numbers we need to add, as CERA does, Natural Gas Liquids (NGL) and condensates as unconventional oil. If we add all of these forms of unconventional oil together, CERA's projections appear reasonable.

Assumption # 10. There is sufficient infrastructure to support a vigorous increase in production.

Oil is a cyclical business. Prices bounce up and down because there is almost always a mismatch between supply and demand. For a number of reasons, exploration and production investments have not kept up with projected increases in demand. That investment deficit has left us with insufficient spare production capacity to sustain the world's projected economic growth. Even if we have ample reserves in the ground, there is no guarantee enough oil wells will be developed in time to avoid sharply higher prices and possible shortages. We don't have enough oil rigs, tankers, petroleum engineers, or refinery capacity. The problem is systemic and will take several years to resolve.

Assumption # 11. Non-Muslim engineers, technicians and laborers will be permitted to work in the fields of the Middle East, North West Africa, and countries adjacent to the Caspian basin.

Non-Muslim engineers, technicians and laborers will be permitted to work in the fields of the Middle East, North West Africa, and countries adjacent to the Caspian basin. However, Islamist activity and local sociopolitical conflict could jeopardize personnel security. Iran's new government, for example, has made it clear that non-Muslim foreigners are not welcome to bid, or work, in Iran's oil patch.

Assumption # 12. There is sufficient capital to fund the proposed supply chain activities.

There is sufficient capital to fund all of the proposed supply chain activities if one assumes the credit markets will not be overly stressed by other economic events, such as a collapse of the market for Mortgage Backed Securities or a massive default on the loans outstanding to Hedge Funds.

Assumption # 13.There will be a dramatic decrease in the growth rate of oil consumption.

Emerging nations, like China and India, will increase their per-capita and total consumption of oil. Although I fully expect a decrease in the growth rate of oil consumption will occur, it will - as I point out in "Oil, Jihad and Destiny" – be due to recessive factors. Production will equal consumption only if there is a destruction of natural demand or if shortages force reduced consumption. In either case, the rate of growth decreases.

Assumption # 14. As a result of over production, we will be awash in oil.

It is more likely that Saudi Arabia will continue to act as a swing producer, restricting its production in order to encourage higher prices. Indeed, Saudi Aramco engineers may welcome the opportunity to take key wells off-line for service if the world appears to be "awash" in oil.

Assumption # 15. The price of oil will decline.

It is highly likely that the price of oil will fall below $40.00 per barrel. The history of the oil industry is characterized by volatile changes in price because of the chronic imbalance between supply and demand. But a temporary decline in price is no basis for making either public policy or personal choice decisions. For every short term decline, expect a subsequent increase in the price. The long term trend for all petroleum prices is UP.

Assumption # 16. Resource nationalism will not disrupt world oil markets.

If there is so much oil available for production, why are we drilling new wells in deep water? They are very expensive, challenge our best technology, pose an environmental hazard, and are at the mercy of the sea. Why don't we just drill on land?

Because the North Sea fields are declining, West Africa is in turmoil, Venezuela is politically unstable, Iraq is a crap shoot, Saudi Arabia is vulnerable to revolution, and Putin plans to use Russia's petroleum as a political weapon. China is buying up every drop it can find. The Italians have pointed out that the geographical flows of crude oil favor refineries on the Mediterranean coast over refineries located in North America.

Hmmmm. Are we witnessing an increase in resource nationalism?

The industrialized nations have no choice. Oil shortages will create a growing cadre of unemployed citizens and declining GDP. Political survival means drilling in every plausible location on this planet and competing with other nations for the oil that is left.

The race is on.

Assumption # 17. Technology will save us.

Optimists claim that continuing improvements in computer, exploration, and drilling technology will sharply increase oil production. In truth, the oil industry has been continually improving upstream exploration and production technology since the birth of the oil age. Engineers are currently hard at work on improvements for drilling fluids, drill bits, directional drilling, multilateral drilling, sensors, GPS, drill casing materials, CO2 injection, reservoir modeling software, and a thousand other opportunities to increase recovery operations. The point is, there is no magic solution that will suddenly increase our reserves. Almost every technical solution has already been explored. Yes. New technologies will increase production. But the net impact is more likely to be incremental – not revolutionary.

For example, much has been made about the use of CO2 injection to increase recoverable reserves. Granted. It is possible to recover 60 percent (or more) of the oil that in the ground as we humans struggle to liberate every drop of oil from existing reservoirs. But many of our older oil formations have already been flushed with fluids and chemicals in an effort to increase production. Consequently, the use of newer technology will not always yield dramatic improvements in mature field recovery. New finds, on the other hand, provide an opportunity to secure higher increases than older formations. Recovery rates will also be higher and faster for light oils than for heavier crude. And finally, it may - or may not - be economical to use newer technology, such as CO2 injection, on some wells. What does this all mean? Over a period of years, average world recovery rates are more likely to be in the 45 to 50 percent range.

And there is a downside to the application of reserve enhancement technology. If we increase the rate at which we drain our available reserves, - depletion happens sooner.

Assumption # 18. Higher prices will encourage the production of more oil.

The classic economist assumes higher prices will stimulate greater production. And it usually works. But our hydrocarbon resources are finite. New production involves a complex series of challenges that can take several years to overcome. In order to continue along the growth curve of projected demand through 2020, we humans will have to consume most of our "Proven" reserves, convert most of our "Probable" reserves into "Proven" reserves, and maximize a phenomenon peculiar to the petroleum industry called "Reserve Growth". Oil prices will have to increase in order to justify the economics of this sequence. Total oil production, however, will continue to be limited by the factors discussed above in Assumptions 1 – 17.

Reality Check

CERA's optimistic views are in the minority.

John S. Herold, Inc.
Wall Street firm John S. Herold Inc. of Norwalk, CT http://www.herold.com/ has estimated peak production for about two dozen oil companies. Without substantial new investment and additional discoveries, the company believes that French oil company, Total S.A., will reach peak production in 2007. Exxon Mobil, ConocoPhillips, BP, Royal Dutch/Shell Group, and the Italian producer, Eni S.p.A. will hit peak production in 2008. In 2009, Herold expects ChevronTexaco Corp. to peak. In Herold's view, each of the world's seven largest publicly traded oil companies will begin seeing production declines within the next 48 months or so.

PFC Energy
From the July 1, 2005 edition of the Washington Post comes this commentary by Robin West, in an article entitled "Crude Courage"

"J. Robinson West, chairman of the consulting group PFC Energy, has floated with administration officials his idea of a sustained national dialogue on energy that includes all stakeholders. And his group has gathered what may be the best statistics available on the seriousness of the supply-demand crunch.

West argues that the oil market squeeze will only get worse -- and more vulnerable to political disruptions. By his estimate, about 77 percent of proven oil reserves are controlled by nationalized oil companies rather than by the international majors such as Exxon Mobil. Meanwhile, non-OPEC sources of supply are slowly declining. …. Even if more crude were suddenly discovered, there's a worldwide refining squeeze, with almost no spare capacity left.
The day of reckoning is less than 15 years away, by West's calculation. Assuming fairly slow growth in demand of about 1.8 percent annually, he reckons that by 2020 demand will total over 100 million barrels per day, and OPEC will be unable to fill the supply gap. Unless the United States and other consuming countries have taken steps to reduce consumption, the supply-demand imbalance will throw the world into economic chaos ….. "

ChevronTexaco
Dave O'Reilly, the chairman of ChevronTexaco: “The time when we could count on cheap oil and even cheaper natural gas is clearly ending.” Chevron has started a petroleum resource discussion on the WEB at http://www.willyoujoinus.com/. Vice President of Policy, Government and Public Affairs, Patricia Yarrington believes the site is an important first step in a new dialogue. "We developed a campaign that is rooted in the real issues facing our industry. They are issues that affect everyone who has a stake in energy – consumers, businesses, policymakers, environmentalists, educators and political leaders. We think it’s a very compelling campaign about a very compelling subject."

ExxonMobile
ExxonMobile projects non-OPEC Crude and Condensate production will plateau before 2015 in its Energy Outlook presentation. ExxonMobil proposes that increased demand be met in two ways. The first is greater fuel efficiency. (How often do you hear oil companies pleading with us to buy cars that use less gas?). The second way is for OPEC to vastly increase production.

We should pay attention to ExxonMobile's judgment. "This assessment (of increased OPEC production) is somewhat ominous" writes Dr. Colin Campbell, a founder of ASPO, "… such production increases are only possible from Iraq, Saudi Arabia, Kuwait, and the United Arab Emirates. For these countries, and indeed for most OPEC members, petroleum and petroleum products are their only significant export. As such, they have a vested interest in obtaining the best possible price for their non-renewable resources. OPEC nations would be quite unlikely to increase production as rapidly as needed unless compelled to do so." And in the ASPO Newsletter 55 (July 2005), Dr. Campbell writes "It is significant that the first quarter production of most of the major oil companies is falling : ExxonMobil -3%; Chevron -6% ; Shell -8% ; Repsol YPF -7%., while Phillips-Conoco maintained its level with BP at least reporting a 2% increase (see Petroleum Review, June 2005). All the more reason that the public should heed the silent alarm sounded by the ExxonMobil report, which is more credible than other predictions for several reasons. First and foremost is that the source is ExxonMobil. No oil company, much less one with so much managerial, scientific, and engineering talent, has ever discussed peak oil production before. Given the profound implications of this forecast, it must have been published only after a thorough review."

Shell
The Royal Dutch/Shell Group of Companies, in their presentation "Visions of the Future: Shell launches new Global Scenarios looking forward to 2025" lays out the risks: " The energy scene will be reshaped by the combination of three discontinuities: a relinking of energy consumption and economic growth as a result of the faster development of emerging countries, the emergence of carbon as a commodity in its own right, and the search for energy security. The latter will remain a key consideration during the scenario time span, potentially leading to far more politicized energy relations and creating new sources of tensions among countries as well as new opportunities for entrepreneurship and cooperation. Ambiguity will persist as to what the term “energy security” covers: physical supplies can be threatened by rising international insecurity as well as by depletion of supply sources. Insecurity can also result from the lack of investment in enhanced recovery of existing sources, in new energy sources and/in infrastructures."

Aramco
Although Aramco, Saudi Arabia's national oil company (and the largest oil company in the world), has launched a massive expansion program, it could be 5 to 7 years before we see any meaningful increase in production from this additional investment. Worse, Saudi officials have apparently told the Bush Administration that OPEC will be unable to meet projected oil demand in 10 to 15 years. Saudi Arabia would have to produce up to one half of the increased demand, with most of the remainder coming from Kuwait, the United Arab Emirates, and Iraq. In order for the CERA scenario to work, the cartel would have to boost its production to 50 Mbl/d. Few believe that will happen. Saudi Arabia, for example, has apparently calculated that its contribution will fall short by up to 5 Mbl/d by 2024.

BP
Only BP appears to agree with CERA. There "is no shortage of oil and gas resources for the long term" (From "Making the right choices, The energy year in perspective"). The world has enough proved reserves of oil to last 40 years "at current consumption levels". Higher prices, BP claims, have been caused by a supply-demand imbalance that should be resolved with the addition of new production over the next few years. Incidentally, BP is the only major independent oil company that had more reserves at the end of 2004 than it had at the beginning of that year.

Conclusion

Delayed projects and disruptions in the oil supply chain, coupled with current rates of depletion, could lead to temporary shortages long before "Peak Oil".

Why? Because the issue is NOT how much oil do we have left in the ground. The issue is – How much oil can we produce? Sure. Calculating available reserves (proven, probable, and possible) is important because these projections give us a rough idea when peak oil production will occur. But when we talk about oil as a business, we have to include the challenges of exploration, production and transportation. It will be tough, for example, to find and pump this stuff from black holes in remote Siberia or the cold blue ice of the Artic. Emerging technologies may permit us to drill 10,000 meters below the surface of the ocean, but it's still an incredible operations headache. Producing oil from shale and sand is possible, but finding enough water and natural gas to sustain production will be difficult. And then there's another problem. Most of the world's remaining reserves and transport routes are located within the boundaries of nations that are politically unstable, have unpredictable regimes, may ignore their contractual obligations, or have a large faction of politically active extremists.

Given the seemingly infinite number of imponderable variables and assumptions, a credible forecast based on available information (facts) is impossible. That's why I developed a series of scenarios for my book - Oil, Jihad and Destiny. Each scenario provides a way to organize a set of related facts and assumptions. Because they begin as a hypothesis, scenarios can be tested against known data points. We can also estimate each scenario's probability. Although the resulting "Best Case" scenario in my model projects adequate oil production through 2020, I gave it a probability of only 40 percent. The "Production Crisis" in my book describes a more likely scenario. Oil shortages will drive intermittent periods of recessive economic activity. Recession drives down demand. Oil surpluses appear and prices decline. A sluggish economic recovery occurs until oil production again falls behind demand. Consumption then decreases or is stagnant, and the cycle is repeated.

In the final analysis, however, the pivotal point for all of these assumptions and scenarios rests on the motivations, political realities, and production capabilities of the Middle East. If they are willing to act in the selfish-best-interest of the industrialized nations, then CERA's "Best Case" scenario is possible.

If not, we are in for a long period of cultural and economic agony.

Ronald R. Cooke
The Cultural Economist
Author: Oil, Jihad and Destiny – a comprehensive examination of oil depletion, its probable economic impact, and the alternatives that lie ahead.

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EnviroEngr · Posted: Fri Aug 12, 2005 1:56 pm Post subject: Re: [Ronald R. Cooke]

Insidious Inflation

Although economic change can happen with dramatic ferocity – as it did in 1929 – it is far more likely to occur over a period of time. We can expect the inflationary impacts of higher natural gas prices, for example, to take several months to work their way through the chain of distribution from raw material to consumer product. At each step, business decisions are made about margins, material substitution, alternative resources, production volumes, and so on. And it's not unusual for a manufacturer to hedge forward commodity prices. Until these contracts expire, there is less pressure to increase end product prices.

But eventually, higher producer costs mean higher consumer prices. Increased oil and natural gas prices create a relentless upward pressure on inflation. And the forces of inflation are insidious – because they are often difficult to identify.

For example.

Chris Krug writes for the Oklahoman. In a recent article he shows how the farmers of Texas County, Oklahoma are being forced to dramatically reduce the size of their corn crops. Corn needs a lot of water. The water has to be pumped from the Ogallala aquifer from a depth of 300 to 350 feet and then pressurized for irrigation. The farmers use natural gas to power the pumps. Higher natural gas prices have almost tripled their pumping costs. So the farmers of Texas County are looking to plant other crops that need less water.

The price of natural gas has about doubled over the last two years. Higher natural gas prices force up the cost of irrigation. Planting corn becomes a higher risk business. That leads to less corn production. Less corn pushes up the price of corn. Higher corn prices push of the price of everything made from corn – including fuel amendments and cattle feed. Higher fuel amendment costs push up the price of gasoline. Higher cattle feed costs push up the price of that steak you plan to eat.

And the higher cost story doesn't end with pumping water. Higher oil and natural gas prices push up the cost of fertilizer, insecticides, and herbicides. It costs more to operate motorized farm machinery. It costs more to transport and process the crop. It costs more to convert corn, as a raw material, into consumer products. And it costs more to distribute these products through the chain of distribution.

It might take 2 or 3 years (or more) for these cost increases to work their way through the supply chain. But every link eventually gets more expensive.

Consumer prices go UP.
So the next time you hear someone say that increasing oil and natural gas prices have little impact on inflation, just remember the farmers of Texas County, and a supply chain that stretches all the way from Oklahoma dirt to your dinner table.

Ronald R. Cooke
The Cultural Economist
Author: Oil, Jihad and Destiny

Ron is a founding member of ASPO-USA

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