By James Pletcher Jr.
America and the world will face dire consequences in the next several decades if they do not prepare for a predicted peak in global oil production.
"We really have to start thinking about what the alternatives are, what we are going to do and start acting on it. Our future isn't written. It's all about anticipating the change and doing something about it,'' Dr. Robert Kaufmann, Ph.D. of Boston University and an expert on gasoline prices and world oil supply, said.
Oil, he added, is the ideal fuel for transportation. "But, say right now, you have an alternative to motor gasoline. That means you will have to replace every car, gas station, retrain mechanics, all over the world. These are things that do not occur overnight.''
Kaufmann was the main speaker during a Foundation for American Communications (FACS) tele-seminar, "Pain at the Pump: What Comes Next in the Gas Price Crisis.''
Basing his observations on data available from the U.S. government, Kaufmann said oil is a finite resource laboring under increasing demand.
"This is why foresight is really important. We have to get technologies in place,'' he said.
Kaufmann explained there is a net energy supply, which is the difference between supply and demand. "If you plan early, the net reduction of energy supplies in the economy will be manageable. If you wait until production turns down, then the net energy is really squeezed and that will have incredibly disruptive affects.
"We have to plan for what is coming next and start to invest well before the peak in global oil production occurs or we are really going to be in a tough transition period,'' he said.
Kaufmann also said predictions are that new oil fields in the U.S. won't offer enough supply to cut a growing demand for imported oil.
Among the issues Kaufmann discussed were:
- What's really driving the current spikes and what's next?
- Is the world running out of oil? Can the United States insulate itself from world oil shocks?
- Is there a reasonable policy response to oil prices?
- What are the economic consequences of high gas prices?
- Are environmental regulations responsible for refinery shortages? Would a change in environmental policy help solve the problem?
Prices
"Where are oil prices now? Crude oil is traded in New York Mercantile Exchange daily. There has been this very rapid increase in oil prices. Since about 2003, oil prices have run up fairly rapidly. There was a brief lull, but now they are back up again. Why are oil prices so high? Demand has gone up,'' Kaufmann said.
This situation, he said, has occurred in the 30 developed countries belonging to the Organization for Economic Cooperation and Development (OECD). However, demand has also risen in non-OECD countries, including Mexico, China and Brazil.
"We would be hard pressed to say there has been a sudden, rapid acceleration in oil demand in OECD or non-OECD countries. We are not looking at some kind of demand shock. It is a supply-side issue. Non-OPEC production has gone down in recent years, causing OPEC production to drop, so that even now, OPEC is barely back in terms of production as it was in early 1970s. As long as non-OPEC countries were able to push into the market, they were able to weaken OPEC's influence. Now OPEC is back in the driver's seat and it is responsible for the rise in prices since 2004,'' he said.
"The only time in history when there was a competitive market in the U.S. for oil was during the early part of the last century. There was a tremendous boom and bust cycle. Neither producers nor consumers were really happy with that cycle, so they petitioned Congress to get rid of it. In 1936, Congress passed an act that allowed states to set up commissions and allow them to decide what fraction of operative capacity they were allowed to produce each month. The Texas Railroad Commission figured how much oil was needed from Texas to balance supply and demand. So the fluctuation disappeared from 1940s through early 1970s. That was created by a benevolent monopoly. But, after 1970, boom and bust returns and this is the period when OPEC takes control of the market.
"The bottom line is there really never was a competitive market for oil because most is found in really large fields, making it easier for producers to conspire and set prices.
"OPEC controlled oil at the margin and that is what gives them control or ability to influence oil prices. OPEC controls a large amount of the world's oil reserves today.''
"Why does it matter that oil prices are high? In the early 1960s, 6 to 7 percent of our income was spent on energy. That went up to almost 10 percent during the oil crisis. Then, we spent about 4 percent and now as we approach the end of the first decade of the 21st century, it's back up to 6 to 7 percent.
"Consumers are getting squeezed on all sides. Food prices are going up, energy prices are going up. What happens when consumers have less money to spend on everything else? They spend lots at gasoline stations, for food and health care, which means that all the other things - furniture, clothing, cars and personal items - they don't spend as much. What happens then is we get a recession,'' Kaufmann explained.
Another consequence of higher oil prices also is a weaker dollar, he added. But there is no evidence that as the dollar gets weaker, the price of oil goes up. "The causation goes from oil prices to the strength of the dollar, but not the other way around. So, there is no reason to believe if the U.S. did something to strengthen the dollar, oil prices would come down,'' he said.
Where will prices go? "In the short term, I think there is some room for oil prices to come back down. The belief is there is a significant speculative factor in oil prices. We would like to think that speculative bubble over time will burst and oil prices will come back down. But don't look for even $60 barrel oil anytime soon unless there is a real collapse in economic activity.
Oil supply
"Is the world running out of oil? You hear a lot about world oil production, that we are running out or it's about to peak. Today, we have produced about 1 trillion barrels of oil. If we predict the world has about another 1.5 trillion barrels, then we will never run out of oil.
"But, what if there are less than 1 trillion barrels left?'' he said. Kaufmann believes a peak in oil production will come in 2014 if there are less than a trillion barrels remaining to be pumped and the peak will come in 2035 if, as "optimists believe, there might be 3 trillion barrels left.
"If we believe these curves and follow the decline after the peak, and how quickly we need alternative supplies for oil, then we will need the equivalent of a new Saudi Arabia every decade,'' he said.
Kaufmann explained that from 1900 to 1970 the real price of oil was relatively flat, although production rose during those years. "You can raise oil prices like crazy, you can drill for oil but the production level continues to go down. There is nothing you can do that will reverse that peak in production so you will need those alternatives in a timely fashion.
"The bottom line is that people have to appreciate that oil is a wonderful fuel. It's liquid, easy to get at in the ground, and the last 150 years will be known in history as the petroleum age as much as history notes the bronze age or industrial age,'' he said.
However, Kaufmann added that there is no alternative at present that is as good as oil for fuel. "For the first time in history, we will be going from a good fuel to one that is not as good.''
Oil prices, Kaufmann added, are not going to collapse. "There are real supply-and-demand fundamentals that will keep oil prices high. One of the reasons oil prices collapsed in the mid-1980s is there was a huge drop in demand. The world reduced its oil consumption by 2.5 million gallons a day by generating electricity with coal and shutting down refineries.
"But, it's very hard to replace oil that we use for transportation. Then there are the non-energy uses to make plastics, fertilizer and other feed stocks and these uses are very difficult to substitute. Reducing oil demand now as we did in 1980s will be a much more drawn-out process.
"Demand is forecast to rise. In many regions outside OPEC, we have pretty much depleted the easily obtained oil. In the lower 48 states, oil production has been declining for about 35 years. In the North Sea, production has been declining, even though prices are skyrocketing. Production is going down, although prices are going up.''
U.S. oil independence
Kaufmann said data show world oil demand is 85.6 million barrels per day. "That means every day, the world burns this much. One barrel contains 42 gallons,'' he said.
OPEC produces 43 percent of the oil on the world market. Meanwhile, the U.S. consumes 20.6 millions barrels per day, or about one-quarter of the world production. Kaufmann said this figure isn't "really out of step since the U.S. produces about one-quarter of the world's economic activity.''
The U.S. imports 60 percent of its oil consumption. "How do we get rid of this and replace it with domestic sources of oil? You would have to come up with 12-13 million barrels per day (or an equivalent energy source) to make the U.S. independent of foreign oil sources,'' he said.
"Let's suppose the U.S. produces all of its oil domestically. Let's say there is a big shock in the markets and the price goes up to $146 a barrel? Would oil companies sell oil to U.S. consumers for one penny less than they could get for it on the world market? The answer is no. Consumers in the U.S. would have to pay the same world price as everyone else.'' Another issue, he said, is should the U.S. seek to reduce its reliance on unreliable suppliers?
"That's really a giant myth because there is nothing the U.S. can do to insulate itself. The world has one big pool of oil so whatever happens on one side of the market ripples clear to the other side.
"What if the U.S. gets all its oil from Iran and they decide they are not going to sell it to the U.S. anymore? The U.S. would have to find other sources of oil to buy. But Iran would also have to find other customers to buy its oil. On the net, nothing would really happen in the world oil market, other than the price of oil might go up a little bit because by rearranging the lines of supply, the cost to transport oil around the world would increase. The downside to reducing the U.S. reliance on imported oil is that, ultimately, it is more expensive to produce oil here than to import it,'' Kaufmann said.
"If you try to produce it here you will be devoting more effort to producing a good or service that you could get someplace else more efficiently.''
Kaufmann said that happened in the 1970s and 1980s oil crises. "It was the express U.S. policy at that time to reduce dependence on imported oil and the government offered all kinds of incentives for domestic drilling. But we see that the U.S. in doing that squandered a huge chunk of capital by drilling a lot of dry holes that never produced,'' he said.
"What about opening the Arctic National Wildlife Refuge for exploration? Even if you found the stuff it wouldn't come on line for five to 10 years. If we started producing now, the best-case scenario is that in about a decade we would produce about 1 million barrels of oil a day. But now we are using more than 20 million barrels a day. Would such production make any difference to the world supply-and-demand balance? The answer is no. It would not really lower U.S. imports or the world price significantly.
"If we can't get oil from the U.S., where will it come from? The big supplies are in OPEC countries. Over the next 10-20 years, the U.S. and world in general will become increasing reliant on OPEC for oil and, geologically, there really is nothing that will change that.
"That's important, because in order to balance supply and demand, OPEC will have to embark on an incredibly ambitious plan to expand its capacity from a low of million barrels it is now producing per day to 50 million per day, according to the U.S. government.''
"So, one of the issues is can OPEC really influence prices when it is responsible for producing less than half the world's supply of oil? And, should OPEC increase its capacity? Is it in OPEC's best interest to expand its ability to produce oil? As OPEC increases capacity, it will put downward pressure on prices, and as prices drop the demand goes up and non-OPEC countries will reduce their production because prices are down.
"If you do the math, it is not really in OPEC's interest to expand production significantly because oil prices drop faster than OPEC production increases. We are basically saying that OPEC it needs to expand its capacity and let its revenues decline so the U.S. and the rest of the world can have less expensive oil.''
Gasoline prices
"What about the idea that motor fuel prices rise very quickly when oil prices rise and yet fall very slowly when oil prices come down, thus allowing the oil companies to make huge profits?
Oil and gasoline prices, he said, "are rising together at a fairly rapid rate. And, consumers are pretty smart. Myself and others have done some pretty sophisticated analyses of the data and it's true that in some states gasoline prices to not fall as rapidly when oil prices come down,'' he said.
Those studies show one of the states is Pennsylvania. The others are Texas, Michigan, Florida, Illinois, Minnesota, Ohio, Louisiana and Idaho.
"We can explain that behavior is based on stocks and the way refineries speed up and slow down production of gasoline. What happens is that when crude oil prices rise, the only way to cut demand is to have gas prices rise with it. However, when crude prices fall, refiners slow down the rate at which they refine motor gasoline and sell what they have from their inventories,'' which slows down the drop in gasoline prices. Then, as demand rises, refinery capacity limits supplies.
Regulations
There is a myth that environmental and government regulations have hurt refinery development, Kaufmann said.
"Oil refineries are very capital intensive and the only way to make money is to run them 24 hours a day, 365 days a year. When demand dropped off in 1970s, a lot of companies closed refineries. They are reluctant to expand refinery capacity until they are sure that demand would be there. There really is little evidence that I can find that environmental regulations are responsible for a drop in refining capacity.''
James Pletcher Jr. is Herald-Standard business editor. He can be reached at 724-439-7571 or by e-mail at jpletcher@heraldstandard.com.
