Peak Oil Has Arrived

The Reality of Peak Oil and Its Impact

January 08th, 2008 |

Category: General

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“It is difficult to get a man to understand something when his salary depends on his not understanding it”. - Upton Sinclair

Introduction

Modern economies are heavily energy dependent. Globally, about 80% (slide 6) of this energy comes to us from fossil fuels. An energy shortfall of even a few hours can bring systems to a grinding halt, the severity of the impact being in direct proportion to the levels of complexity of our production, housing, transportation and communication systems amongst other systems. A prolonged shortage of a few months, manifesting itself in the form of unreliability of supply can cause recessions. If it is oil that is in shortage, even a low level of complexity of the above systems will not spare the economy in question. This is because our transportation systems are heavily reliant on liquid fossil fuels especially for the last mile. A shortage that persists year after year would mean we have to kiss economic growth, as we know it goodbye.

In short, if we liken the economy to an engine that propels us forward and in the process brings us more and more material rewards, then, the fuel that this engine runs on are fossil fuels, with oil comprising about 80% of that fuel.

Before going any further we have to understand what our main sources of energy are. They are: the food we eat, wood for our cooking needs mainly, coal, natural gas and oil. Renewables and nuclear chip in too.

In the case of India the breakup of the origin of electricity generation is as follows. Hydro provides about a quarter of our electricity (a drought for a couple of years in the concerned areas reduces generation). Geothermal, wind, solar and biomass provide about 5% of our total electricity supplies. Finally, conventional thermal provides about two thirds of our electricity. Nuclear makes a small contribution too. Electricity is not a source of energy as we commonly tend to think – it is an energy carrier; so is the case with hydrogen – they both need to be generated in the first place.

This is something that most policymakers know of, so what is the purpose of stating the obvious? The reason shall be made clear in a moment. Almost everyone agrees that oil in the ground is a commodity that is in finite supply. If that is agreed upon, then it follows that the rate of extraction is subject to geological considerations in addition to investment in extraction infrastructure and other variables. In the recent past a number of energy analysts, geologists, physicists and the occasional investment banker or economist have deduced that we are heading for peak oil in the very near future if we have not already encountered it.

Peak oil is the term that they use to describe that point in time when the world extraction/production/supply of oil hits a peak and thereafter goes into terminal decline due to the underlying geological conditions. Such a situation means that demand will thereafter be constrained by supply. What this means is that there has to be demand destruction in order to make do with available supplies. Demand destruction (when it comes to energy) is the politically correct word for recession or depression.

To quote Robert L. Hirsch, Senior Energy Program Advisor at Science Applications International Corporation writing in World Oil Magazine in October 2005:

Consider what happens in the development of an economically viable oil field. After a confirmed discovery, development proceeds, production rises to a maximum after which it goes into decline. Along the way, oilfield operators apply various technologies to increase production beyond what nature would otherwise provide, e.g., water flooding, fracturing, artificial lift, etc. Nevertheless, the geology of each oil reservoir will ultimately set an upper limit on the amount of oil that can be practically produced. In addition, the time-varying production profile for an oil field can be strongly influenced by management decisions and politics, that can affect oilfield dynamics.

One can depict how this would roughly play out as below, with time on the X-axis and oil volume on the Y-axis.

We have to be clear that the world is not going to run out of oil anytime soon. We are going to have to make do with diminishing amounts of oil year after year once we encounter peak oil. In other words, problems regarding energy supply begin not when you run out of oil, but when you are on the declining side of the oil production peak. As an analogy, an individual begins to suffer from dehydration not when he has absolutely no water to drink, but dehydration sets in when he/she has less than optimal fluids to consume.

We shall focus in this paper on the future of oil supplies, its reliability or otherwise:

We shall touch upon the findings of prominent geologists, geophysicists, physicists and energy analysts
How technology and/or high prices have not been able to reverse a declining oil production pattern after the peak is crossed
Depletion rates, and their profound importance when we have to deal with this problem
Fuzzy (overestimated) oil reserve figures that are out there and why they are there
Evidence of peaking in various oilfields and countries
The related problem of world demand matching available supplies, the consequent low spare capacity and the resultant volatility of oil markets
The impact of shortages / unreliability of supplies and some of the problems that we are going to encounter when we have to deal with peak oil
The alternatives that are out there and their promise or limitations will be the focus of another paper that will follow
Also, policy measures that can be taken today to help mitigate the fallout from this crisis that is to arrive shortly will be addressed in another paper

Before we go any further, the reader is advised to keep in mind that today; the world consumes about 85 million barrels a day (MBD). To put that figure in perspective, the US consumes about 21 MBD and India about 2.5 MBD. Both import 70% of their consumption. So, during the course of reading this paper if someone tells you that there has been a new oil find – ask him / her – how many million barrels a day will we be able to extract out of it?

M. King Hubbert

At the 1956 meeting of the American Petroleum Institute, M. King Hubbert, a geophysicist working for Shell Oil and who later went on to hold positions in UC, Berkeley, Stanford University and the US Geological Services made a bold prediction (pp 23-24). He said that the lower 48 United States would hit its peak oil production in the late 1960’s to early 1970’s. As predicted, the extraction / production peak occurred in 1970 and ever since has been in decline except for a brief while when the Alaska (Prudhoe Bay) find perked up the curve a bit, but even that did not enable the extraction / production figures to come anywhere near the 1970 figure. The peak production figure was about 10 MBD and today the US produces about 6 MBD.

He made this prediction based on his observations of individual oil wells and on the premise that oil extraction / production should essentially mirror oil discoveries with a time lag if demand is able to absorb the increasing supplies. You can only extract what you have discovered. Discoveries peaked in the lower 48 US in the 1930’s.

Another related observation was that after about half the recoverable oil in a field has been extracted, extraction thereafter takes a downward turn and never picks up again. The rate of extraction goes down at about the halfway point because, the first half is easy to extract and comes at high rates of flow. The latter half does not flow out as easily, is more expensive to extract and in many cases of a lower quality.

Other geologists, Colin J. Campbell and Jean H. Laherrère, both with over 40 years experience in the oil and gas industry wrote an article in the March 1998 issue of Scientific American – The End of Cheap Oil which looks at the same issue from a world perspective about four decades after Hubbert’s prediction for the US Lower 48. Kenneth Deffeyes, Professor Emeritus, Princeton University, and author of “Beyond Oil: The View from Hubbert’s Peak” with plenty of experience in the industry is of the opinion that we have passed the peak of global oil production.

Dr. David L. Goodstein, Vice Provost and Professor of Physics and Applied Physics at Caltech has come out with a book, “Out of Gas” which addresses this issue. In an interview to Newsweek he said: “The prediction that it will peak—that is to say the crisis will come when we reach a peak when half the oil has been used up—that prediction quantitatively is unquestionably true.”

Richard C. Duncan and Walter Youngquist, both petroleum industry experts published a paper in 1998 which details the past as well as projected production patterns of a number of countries. They studied 42 countries because those 42 countries produce above 98% of the world’s oil. (Video of Duncan’s presentation can be seen here. The paper contains tables and graphs which are referred to in the video presentation).

Hirsch Report

In February 2005, a report titled “Peaking of World Oil Production: Impacts, Mitigation &Risk Management” was submitted by Robert L. Hirsch PhD, Senior Energy Program Advisor at Science Applications International Corporation and his team. A disclaimer says that the views expressed are not the views of either the US Government or any agency thereof. (The disclaimer makes interesting reading but more about that later). This is one of the most comprehensive studies on this topic that have been done recently, and has been hailed as such by many experts in the field.

Table II -1 (pg 19) of the report lists the projected year that various experts in the field expect world oil production to peak. It is interesting to note that while everyone in the group thinks that there is some point in time when we will encounter a peak and then witness declining production, one person stands out in his opinion. That is Lynch M.C., an energy economist, he doesn’t see any foreseeable peak. Why would he alone stand out?

He being an economist probably explains his view. One of the fundamental laws of Economics is that – in a free market price equates demand and supply. If demand goes up, price goes up too - and will bring forth supply increases and / or alternative forms of energy will become competitive and will substitute oil. Hence, this may be why he does not foresee a peak.

This will definitely hold true in an industry / market where there is spare capacity or where production can be ramped up rapidly or there are close alternatives. In the situation that we are going to witness, not only are we looking at little to no spare capacity, but one of steadily depleting global production after peak. Regarding alternatives, if the price of cornflakes shoots up consumers will move to wheat / rice flakes. Oil is simply not such a commodity, there are no close substitutes. Natural gas is one such substitute, but the peak in that is close on the heels of peak oil.

Oil is a chemical that is formed from fossilized plant and animal matter that is subjected to tremendous heat and pressure below the earth’s crust for hundreds of millions of years. In an indirect way, it is stored solar energy. We are nowhere near developing anything as energy dense and special in terms of its ease of storage, transportability and other factors. Also, the Energy Return on Energy Invested in extracting oil is immense, but it too has been declining from about 100 to 1 in the 1930s to about 20 to 1 today. This is mainly due to the increasingly more difficult terrain that we have to go to (offshore etc.), to find it, declining sizes of the fields and / or other geological considerations and last but not least the poorer quality of the crude. Alternatives will help in lessening the impact of oil shortages, but are extremely unlikely to prevent the negative economic and social impacts.

The flip side of the above economics is that the price increase will drive down demand (demand destruction) and bring about equilibrium in the markets. However, using less oil, read energy, at a higher price means lower GNP, unemployment and more. This flows from the function that GNP is a function of the four factors of production - land, labour, capital and organization. Given that energy increases the productivity of labour tremendously, other things being equal, if there is less of energy it follows that there is less of GNP due to the decreased productivity of labour. Think of what a bulldozer with a few liters of diesel can do – how many man-hours would it take if it was to be done by human labour assisted by animal labour. (Come to think of it, is there a missing factor of production?). The information technology sector’s lifeline is energy – unreliability of supply or erratic supply will be a deathblow to such a sector. To those who think of back up generators – they run on fossil fuels too.

As an aside here – our Prime Minister, the Deputy Chairman of our Planning Commission and the person who looks after the nation’s finances are either economists or self labeled ones.

Neither technology nor high prices arrest decline

Let us come back to the Hirsch report, leaving the economists alone. Using the US as a surrogate, he examines whether price (which reached a record $94 approximately in 1980, in 2005 prices) or technology could reverse declining production. The graph below from the Hirsch Report shows that neither could arrest the decline in production after 1970.Justin Blum too, writing in the Washington Post outlined how despite the best of efforts, a decline in production in mature oilfields cannot be halted.

Hirsch has written elsewhere:

Some forecasters believe that higher oil prices and new technology will have a dramatic impact on oil production. The Lower 48 experience indicates otherwise. Oil prices increased dramatically in 1973 and 1979, but those price escalations did not alter the general oil production decline in the Lower 48 region … In addition, the period 1975 - 2000 was characterized by large improvements in oilfield technology, including affordable 3D seismic imaging, low-cost directional and horizontal drilling, greatly enhanced geochemical understanding, dramatically improved geological modeling, etc. Nevertheless, the decline in Lower 48 production continued, essentially unabated. This long-term, real-world experience provides strong evidence to challenge the thesis that high oil prices and advanced technology can mitigate oil production decline.

In the light of the fact that technology can do little to halt decline after the peak is reached it is alarming that our very own ONGC is still hopeful for a techno-fix. This should be especially alarming given that our gas-fired plants are running at a pitiable 58% of capacity.

The other parameter that should be responsive to oil prices is the discoveries of new oilfields. But, as we can see in the below graph from the website of Exxon Mobil, though the real price of oil was highest in the early 1980s worldwide discoveries did not stop declining. In fact, we see below that on an annual basis, since the early 1980s we have been consuming more than we are discovering.

Hence, neither production (in the case of US), nor discoveries (in the case of US and the world), seem to be positively correlated to price and / or technology. They are both determined by the underlying geology over which we have no control. Global discoveries peaked in the 1960s and have been going downhill ever since. Also, the size of the fields we are finding are getting smaller. In a nutshell, we have plucked all the low hanging fruit.

Source: http://www2.exxonmobil.com/files/corporate/hjlslide5.pdf

According to a report in the New York Times:

The world’s biggest oil companies are failing to get value for money when they explore for new reserves, according to research by Wood Mackenzie, the energy consultant.

The report shows the commercial value of oil and gas discovered over the past three years by the 10 largest listed energy groups is running well below the amount they have spent on exploration.

Maybe that explains why BP is returning money to shareholders rather than looking for more of the black gold despite record high prices.

Although this article is not about natural gas peaking notice above how the peak in global natural gas discoveries was around the early to mid 1970s. This is about 10 years after the peak of global oil discoveries. The time we began using more oil than we were finding on an annual basis was in the early 1980s. The same for natural gas was in the mid 1980s. Peak Natural Gas is also around the corner, but going into the details of that is outside the scope of this paper.

Natural gas is a cleaner fuel and we found it is better to use that in many of the uses of coal, oil and gas. Unfortunately we wasted huge amounts of gas in the early decades of the oil industry (gas flares), because natural gas has to be transported by pipeline and we did not have that infrastructure in many of the producing areas. Now, not only do we transport it by pipelines but, we also we cool it to 260 degrees Celsius and then put it in tankers and transport it.

Depletion Rates

The rate of depletion is a very important statistic. It determines what the levels of declines in production will be. The higher they are, the less time we have to take steps to reduce the impact of this event.

Matt Simmons who has done a detailed study of Saudi oilfields and published “Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy” talks about the impact of technology on depletion. He says that all they do is accelerate the rate of depletion and at times even damage the underlying geology. As an example he takes the case of the North Sea oil wells where some of the most advanced technology was applied. That field is now experiencing depletion rates of 8% and higher. Chevron is today witnessing decline rates of 4% and BP a decline of 2.5%.

There is an optimal rate at which to extract and if one exceeds that, one is likely to damage the field. The Saudis too are scared of the same phenomenon and that was evident when Ghazi Al-Rawi, head of private equity at Gulf One Investment Bank, said in a recent interview, "The current out-of-control demand is not good for us. When you have this kind of demand, you’re forced to supply beyond the optimal rate. That’s not a positive thing."

Jon Claerbout a geophysicist from Stanford has made some comments on Simmons’ book and has made some very interesting points on depletion rates and how technology cannot stop depletion:

Failure to find any more oil than the Hawtah Trend since 1967 was not for lack of trying. Saudi ARAMCO has access to ample capital and the world’s top talent. Exploration technology has seen major developments since then, but technology does not guarantee results. In 2005 ARAMCO’s budget for exploration and development is $2.7 billion. Alaska’s Prudhoe Bay is a clear example that while new technology may add something, it cannot keep up with depletion, even with the recent run-up in prices.

Alarmingly, the development of horizontal drilling has added nothing to reserves while hastening the speed at which they can be drawn down.

(It may interest the reader to know that horizontal drilling is a technology that enables oil exploration and production engineers to change drilling directions deep underground in a horizontal plane. This was a supposed complaint of Saddam’s when he attacked Kuwait - that they were tapping into Iraqi reservoirs using this technology.)

The Hirsch report concludes by saying that the world will need 20 years of advanced planning if it is to mitigate the impact of a peak in oil production. However, those 20 years have to begin before we encounter the peak in production. Implied, is that we will need plenty of oil to put in place new infrastructure and bring into production alternative sources of energy. If we are on the other side of the peak we will have to make changes to our infrastructure and systems of transportation, production, distribution etc. during a time of energy shortages, and that would only make the effort that much more complicated and difficult if attainable at all.

Hirsch in a November 2005 interview said that his study had assumed a 2% year on year decline in global oil production. He added that this was an optimistic rate of depletion and that many experts have gone on record saying that depletion rates can be much higher. (As pointed out earlier this has been witnessed in the North Sea, which is why the Saudis are now hesitant to ramp up production much more than present levels). Therefore, he went on to say, if the decline rates we witness are more than the 2% assumed, then the advance preparation needs to begin maybe 30 or even 40 years before the peak.

A word here about natural gas depletion rates – since we are talking about a gas and not a liquid, experts are of the opinion their decline rates will resemble a fall off a cliff.

Fuzzy Oil Reserves Figures

Another issue of relevance is that world oil reserves statistics are very fuzzy since most of the Middle Eastern oil exporters do not allow independent assessments of their oilfields. In fact, they may be overstated. From the early 1970’s onwards, in order to manipulate the price of oil, OPEC set each exporter’s export quota. This export quota was / is based on the OPEC member’s stated reserves – the higher one’s reserves the more one can export. In the mid 1980’s the price of oil was dropping and in order to maintain revenues, many of the OPEC members one after the other enhanced their stated reserves.

The first graph below shows a steady decline beginning in 1980 and a steep fall in the mid 80’s in the nominal and real prices of oil. 1985 is the year when beginning with Kuwait almost all OPEC members, one by one, increased their stated reserves. They did this because they began experiencing falling revenues and most of the member nations, especially the Middle Eastern members had built up expensive welfare states and found it difficult to finance those expenditures. The only way to run those welfare states was to maintain revenues, which meant they had to increase production, which entailed increasing stated reserves.

It was this competitive increase in production that led to the per barrel price being maintained below $20 for almost a decade and a half except for a brief while during the First Gulf War of 1991.

This practice, which many oil industry analysts have talked about, became evident recently when industry newsletter Petroleum Intelligence Weekly lowered the reserves figure of Kuwait by almost 50%. Recently some lawmakers of Kuwait have demanded that Kuwait limit production in line with the reported lowered reserves.

Matt Simmons who has done a detailed study of Saudi oilfields has concluded that Saudi extraction / production is also likely to peak in the near future. He is of the opinion that when Saudi peaks, the world peaks. Its biggest field Ghawar (production of about 5 MBD), had a water-cut (the amount of water in the extracted crude oil) of about 30% at the time when his book went to press. This is due to the approximately 7 million barrels of seawater that is pumped into the reservoir to maintain pressure. Others have said that this has since risen to 50%.

Therefore, since we don’t have reliable figures on world reserves, it is impossible to say when we would have extracted half the recoverable oil and are thereby going to witness peak oil. However, given that we can reasonably assume that OPEC reserves are over rather than understated, it would be prudent to be cautious and assume we are very close to it since most of the geologists quoted above amongst others have concluded that we are close to having extracted half the recoverable oil.

Peak oil is an event that we will know only by looking at the rear-view mirror. And, since that is no way to design proactive policy, we will be well advised to take mitigatory steps today. We should have begun yesterday. One of the reasons that many policymakers brush peak oil aside, is that there have been many a time in the past when such a scare has been raised. However, this time the wolf is at the door, for real. One only has to look at the figures to figure it out.

To conclude this section on the peaking of world oil production Hirsch had this to say in a November 2005 interview, nine months after submitting his study:

"This problem is truly frightening. This problem is like nothing that I have ever seen in my lifetime, and the more you think about it and the more you look at the numbers, the more uneasy any observer gets. It’s so easy to sound alarmist, and I fear that part of what I’m saying may sound alarmist, but there simply is no question that the risks here are beyond anything that any of us have ever dealt with. And the risks to our economies and our civilization are enormous. And people don’t want to hear that. I don’t want to think about that. That is a very uncomfortable thing to think about. And I will tell you that it took some time after that realization set in to be able to emerge and try to be positive and constructive about this problem. This is really an incredibly difficult and incredibly severe problem.” Minute 20 approx

Evidence of Peaking

In the last few years there are some notable examples of this phenomenon. Oilwells, oilfields, and entire oil producing regions or nations have been observed to follow this bell shaped curve in their extraction/production figures. In the last year, a few of the supergiant fields have shown falling extraction/production levels – Kuwait’s Burgan field, Mexico’s Cantarell and the North Sea. As nations, Australia and Oman too are experiencing such problems.

Simmons in his book Twilight in the Desert has charted the production pattern of eight giant or super giant oilfields over time. Below is the chart.

Demand Matching Supply

Another problem that global oil importers face is the closely related development of global demand matching global supply for oil, they are almost equal to each other at about 85 MBD. The lack of a significant spare capacity has very serious implications for all importers of oil. A slight outage in extraction / production in one or more of the exporting countries due to any number of causes ranging from terrorism or the weather (read hurricanes damaging oil / gas platforms) or disruption of sea lane traffic due to geopolitical considerations (read Strait of Hormuz, Suez Canal) will lead to a sharp upward movement of the price. This is something we are witnessing today. The volatility in the price is very high.

There are many stress points in the long and fragile supply chain. Venezuela, Iraq, Nigeria, Iran, Saudi Arabia are some of the major exporters and all have either internal or external stress factors which can disrupt the smooth flow of oil. Since oil is a truly global commodity, (price increases are global and not local) none will escape the consequences of a price increase. As an example, the hurricanes that hit the southeastern US caused physical damage to the offshore and onshore oil and gas infrastructure there besides other collateral damage on the mainland. However, the repercussions to the global oil market in the form of spikes in prices were felt by every importer in the world.

The Energy Information Administration (EIA) of the Department of Energy (DOE) of the US government reported in its Short-Term Energy Outlook for March 2006 that Saudi Arabia is virtually the only producer with a surplus capacity. When one considers what Matthew Simmons has to say about Saudi oil reserves and production potential then we find ourselves looking at a very grim situation. Despite the above figures of the DOE, the US government has genuine doubts about whether the Saudis can ramp up supply if required.

Interestingly, recently Saddad al-Husseini, the former head of production at state-owned Saudi Aramco who retired in 2004 after working 32 years in the kingdom’s oil sector asked, “Can (global consumers) afford to keep increasing demand by almost 2 million barrels a day each year? Is it Saudi Arabia’s role to meet that demand?" adding, "You’re leading yourself to having to find an alternative source of energy very quickly." Other experts in the field from Saudi said that the US must start conserving.

When was the last time you heard an oil producer saying that less is better? In fact, the 30^th January 2006 issue of the Middle East Economic Survey stated that: “The huge spare capacity of the past is a luxury that the oil industry enjoyed for a while, but seems that can no longer afford.”

A news item like this should have had a shock and awe effect on political leaderships across the globe. Almost from the beginning of the oil market producers attempts have always been focused on restricting production, not consumption. At first, it was the Texas Railroad Commission which used to restrict the US production in order to maintain a pre-determined price band. After the peak of American production, it lifted those restrictions. Deffeyes said that when he saw the news item regarding the lifting of restrictions, that evening he told his family “Old Hubbert was right”. The enforcement of production restrictions then fell into the laps of OPEC in the early 1970s.

So whether we are talking about the imminent arrival of peak oil or the fact that global supply and demand are almost matched, the oil markets are in for turbulent times ahead. Jeff Rubin, Chief Economist and Chief Strategist of CIBC World Markets, an investment bank, in a recent study (slide 14) came to the conclusion that demand will outpace supply in 2006. Since oil suppliers cannot satisfy that increased demand, what it implies is that we can expect prices beginning to rise more rapidly to match demand and supply.

We may witness a seesawing of prices as recessions reduce demand. But every subsequent peak in price will be higher than the previous. If depletion rates are high there may not be this seesawing.

Impact

Lets look at the consequences of a peaking of global oil production. The 1973 oil embargo was an event we can learn from. In about three months oil prices increased by almost four times. By the end of the decade, oil rose from about three dollars in the mid 70’s to about $38 for a barrel; close to a thirteen-fold increase.

Oil has many uses. The obvious list would include petrol, diesel, jet fuel, kerosene, heating oil, lubricating oils, military specification fuels and lubricants, industrial oils, process oils, petrochemical feedstocks for the plastic, rubber, cosmetic and pharmaceutical industries amongst others.

Other than these direct uses, virtually every industry is a user of oil in some form or the other. Even our agriculture is based on fossil fuels. We use natural gas for the fertilizer and oil for the petrochemicals that go into pesticide manufacturing. In India 70% of our fertilizer production is based on using natural gas as a feedstock. 70-90% of the cost of fertilizer is attributable to the cost of natural gas (see relationship in below graph). Our tilling and irrigation systems are based on fossil fuels, though not completely – we do use animal power and renewable energy sources to a certain extent.

Richard Manning in an article in Harpers Magazine refers to how western agriculture uses 10 calories of energy to get one calorie of food onto the table. Others have arrived at higher numbers. As fertilizer shortages appear, food production will suffer, consequently pushing up prices of daily consumables. We need to be concerned about costs in western countries too since, today we are importing not only wheat but also pulses.

Our agriculture though not as dependent on fossil fuels as the industrial agriculture of the west is, is still dependent on fertilizers and pesticides. We will have to learn to wean ourselves away from that and turn to organic agriculture and permaculture as solutions.

About ethanol, methanol and biodiesel as solutions, suffice to say here that when we face declining fertilizer availability in conjunction with global warming and the consequent climate change and erratic and unpredictable weather patterns, we will need our best lands for food production and will have to maintain huge buffer stocks to tide over temporary shortages, since world markets are going to be in a similar fix.

According to Lester Brown, Founder of The Worldwatch Institute

This year’s world grain harvest is projected to fall short of consumption by 61 million tons, marking the sixth time in the last seven years that production has failed to satisfy demand. As a result of these shortfalls, world carryover stocks at the end of this crop year are projected to drop to 57 days of consumption, the shortest buffer since the 56-day-low in 1972 that triggered a doubling of grain prices.

We are already facing rising foodgrains prices in India.

Our forests will be affected as people turn to them for fuel wood. Degradation of our forests will lead to soil erosion and consequent loss of soil fertility. Our waterways will be impacted due to deforestation.

Our urban areas will be susceptible if food supplies cannot be brought in from the food producing areas due to non-reliability of fuel supplies. Spikes in prices of essentials can ensue. The farmers will consequently suffer too as their perishables do not reach markets in time. Even maintaining law and order on our streets is dependent on reliable supplies of fuel for the patrolling vehicles – (call back the mounted police?). All of the points just mentioned occurred in 1991.

Water supplies to our cities are dependent on the energy infrastructure. Our waste disposal and sewage systems depend on timely and reliable availability of fuel supplies. The public health consequences of this can be immense.

Our cities’ overall infrastructure over the decades has become more and more energy dependent. The construction style of our homes and workplaces (closely packed, poorly ventilated – at times not ventilated at all and thereby requiring artificial cooling, high-rise buildings requiring elevators) has metamorphosed to the point that most new buildings are energy monsters.

Industries where oil / energy forms a high part of their operating costs like the airlines will feel the impact first. We have already seen more than a couple of airlines filing for bankruptcy in the US. Auto companies will be impacted because use of their product will decrease as the price at the gas pumps increases. Those that make fuel-efficient vehicles may benefit because of the transfer of customers.

Shortages will lead to supply disruptions and they will be events that we will see more and more frequently. This will impact our globalised, Just-In-Time inventory management systems and global supply chains. Allocation of many commodities will have to be done by rationing since if that is left to the market many of the poor will be priced out. This will ensure the return of black markets in essential commodities like in the 1970’s.

As industries and individuals struggle, tax revenues of governments will plunge and deficit financing will be the norm. Governments will resort to tax increases to control deficits. In the past such situations have seen irrational tax rates and there is no reason that this time will be any different. Nationalizations will be seen as a remedy. However, since this is not a problem of exploitation of the many by the few but a geological constraint this tool will be of limited value.

Inflation will rear its head. Exacerbating this situation, oil price increases will lead to cost push inflation. While demand pull inflation is typically tackled by raising interest rates and reining in growth, one cannot do that with cost push inflation. If one does, then we will have deep recessions if we escape a depression. This was what was called stagflation in the 1970s. So, cost push inflation is just something that we have to live with, we don’t have a choice other than causing demand destruction or recessions.

When Paul Volcker brought inflation under control in the US in the early 80s (mid teens levels of inflation called for interest rates in the high teens) he was riding on a downward sloping curve for the price of oil. We don’t know how much this helped and if we will be lucky to experience that again this time around. It depends partially on how much demand destruction is there (demand) and also on the rate of depletion in oil extraction (supply).

Interest rates may still ratchet upwards due to inflation and also to avoid negative real rates of interest. Businesses do not operate efficiently in inflationary times. Inflation adds to uncertainty and hence impacts stock markets negatively.

The banking system, stock markets and capital markets operate as they do because we have growth. Individuals take loans and contract to pay interest in the expectation that their income / business will grow and they can repay part of the principal and the interest for that time period. Individuals invest in the stock market in the expectation that corporations will make more profit next year than they did this year. If growth is stalled across the economy except for the alternative energy sector there will be widespread and severe repercussions. Financial markets will go into free fall. Bankruptcies will be a dime a dozen.

Subsidies to the poor will be seen as another remedy. This will be unsustainable since every year will witness a bigger energy deficit than the previous. The subsidy bill will have to grow every year and also, the system will have to take a larger number of people under its coverage. Only intelligent planning can make a dent on this problem.

The poor will be the first to feel the impact of rising oil prices. We are already witnessing this in the poorest continent, Africa. Within the rich countries too, the poor will suffer and social safety nets will be strained to handle the situation.

At an institutional level we will witness strange changes. Traditional bedfellows will jab at each other. There is very likely to be a head in the sand reaction because the consequences are just too severe to comprehend for the human mind. As Vincent Matthews, Director Colorado Geological Survey said about the reaction of some agencies n the US after their peak in 1970.

I was teaching environmental geology in Greeley at the time, and after I heard that oil had peaked in the U.S. I wanted to talk about it to my class, to show it in a graph. And I remembered that the Oil & Gas Journal each week had published the production curve. But when I went to the Oil & Gas Journal to find it, it was gone. Later, I discovered that when oil production in the U.S. peaked, they just stopped publishing it. People just didn’t want to admit that oil could peak, because it has implications for stock prices that people don’t understand.

Today we witness the same reaction from the government in the USA. This is where I return to the Hirsch Report’s disclaimer. Despite the fact that it is sitting on the Department of Energy’s (DOE) website and despite the obviousness that it was commissioned by the DOE the sentence below resonates with a head in the sand reaction.

The views and opinions of authors expressed herein do not necessarily state or reflect those of the United States government or any agency thereof.

If we assume that the government and the DOE are aware that the contents of the report are accurate but they still state the above, then the government and its agencies are guilty of a far more grave error, that of deliberately keeping the citizens in the dark about impending problems of immense and unforeseeable magnitude. In fact it was widely reported on the internet that the report was removed from the website for a while until questioning of why it was removed made them put it back up.

If on the other hand they refuse to accept that the contents of the report are accurate it is the same head in the sand reaction that they had three and a half decades ago. Will we be different?

If it can happen in one nation state what prevents it from happening in any other? States function under similar mindsets, especially democratic states. No one can conceive of standing for an election on a platform of peak oil, so leaders will keep the citizenry in the dark and promise them ever increasing standards of living, in spite of the fact that they know that the opposite is the truth.

If anyone has demonstrated that peak oil can be handled in a humane way it is Cuba under Castro, more about that in the paper addressing mitigatory steps.

Jeremy Leggett writing in the Guardian had this to say about the opinions of a former Director of the CIA on this issue.

History shows that James Schlesinger, a former director of the CIA, is not a man to mess with. As secretary of defence during the first oil shock in 1973, he threatened to invade the Arabian peninsula if the Saudis didn’t reopen the oil pumps they had shut down in ire over the October war, thus precipitating the crisis.

In an interesting contrast with the US’s current professed intentions in Iraq, Mr Schlesinger was on record then as saying: "Militarily we could have seized one of the Arab states. And the plan did indeed scare and anger them. No, it wasn’t just bravado. It was clearly intended as a warning. I think the Arabs were quite worried about it after 73".

So it was with some surprise that participants in last week’s oil summit in Rimini, Italy, heard Mr Schlesinger give a speech warning of a grave threat to the world economy from a coming peak in oil production.

Addressing a select audience that included oil ministers and senior officials from the oil cartel Opec, the energy watchdog International Energy Agency, and the UN, plus advocates of a premature oil peak such as the former British cabinet minister Michael Meacher, Mr Schlesinger offered a graphic analogy.

The peak-oil threat and the response to it are reminiscent, he said, of the rumbles under Vesuvius and the reaction to them of its hapless residents. "The peak or plateau is coming," he said.

Yet demand is soaring. "Political systems do not deal easily with long term threats, even if they have a probability of 100%," Schlesinger warned.

Jared Diamond in his book “Collapse: How Societies Choose to Fail or Succeed” while discussing how the desperately poor sometimes exhibit a very short term focus because their immediate concern is to put food on the table that day, states (Page 434):

Governments, too, regularly operate on a short term focus: they feel overwhelmed by imminent disasters and pay attention only to problems that are on the verge of explosion. For example, a friend of mine who is closely connected to the current federal administration in Washington, D.C., told me that, when he visited Washington for the first time after the 2000 national elections, he found that our government’s new leaders had what he termed a “90 day focus”: they talked only about those problems with the potential to cause a disaster within the next 90 days. Economists rationally attempt to justify these irrational focuses on short-term profits by “discounting” future profits. That is, they argue that it may be better to harvest a resource today than to leave some of the resource intact for harvesting tomorrow, on the grounds that the profits from today’s harvest could be invested, and that the investment interest thereby accumulated between now and some alternative future harvest time would tend to make today’s harvest more valuable than the future harvest. In that case, the bad consequences are borne by the next generation, but that generation cannot vote or complain today.

He goes on to talk about the concept of group psychological denial. Pollsters have observed that people closest to the downstream side of the dam are less concerned about the dam breaching than those who are further downstream even though it is a given, that the plight of the former will be far worse than the plight of the latter in such an eventuality. This is because, the consequences of accepting such a possibility is overwhelming for the mind. He goes on to add (Pg 438):

Thus human societies and smaller groups may make disastrous decisions for a whole sequence of reasons: failure to anticipate a problem, failure to perceive it once it has arisen, failure to attempt to solve it once it has been perceived, and failure to succeed in attempts to solve it.

Just a word about the oil sands (Venezuela and Canada) as an alternate source of supply since it is widely touted as a promising source of future supplies. Oil sands have to be ‘mined’ since the oil is in the mud, compare this to pumping oil out of the ground. The extraction process requires large quantities of water for every barrel of oil that it extracts. Other than the environmental damage due to the wastewater disposal etc., there is the issue of the sustainability of the water utilization. Natural gas is used as the fuel to literally boil the oil out of the mud. Natural gas has peaked in North America according to Exxon. How is production going to be ramped up if either of two crucial raw materials not going to be available in enough quantities?

Globally, natural gas is likely to peak with a lag of maybe 5-10 years (maybe less too). The damage that will be inflicted on our environment as oil and gas peak in production and as all this plays out will be immense. Fuel-wood consumption will be a strain on our forests as the price of natural gas shoots up. Forest health deterioration will have impacts on our rivers, streams and soil. To sum up, we are looking at two major sources of severe economic and social trouble.

The matching of demand and supply in global oil production.
The peaking of world oil production may have already occurred or is going to occur within the next 3 years according to many experts in the field.

For those who are of the opinion that these are problems in the far distant future, looking at the current geopolitical scene in the world should be sufficient to set your doubts at rest. History shows us that whenever a vital resource is in short supply bands, tribes, states or nations tend to resort to war for control of that resource or preferential access to it. It was the wood shortage in the middle ages in Europe which played a contributory role in the competitive quest amongst the European nations for colonies.

It was reported in the FT:

The world is on the brink of a big switch from gas to coal as the preferred fuel for power stations, according to projections from Alstom, Siemens and General Electric, the world’s three biggest power equipment makers.

This would be the first time in our history that we are moving to a less dense source of energy. We have moved from human and animal muscle power coupled with wood to wind to coal to oil and gas to nuclear. Returning to coal should ring an alarm bell. When an energy dense source runs into supply problems there are direct ramifications on the availability of the most basic form of energy that we use, namely, food. We are going to see a fossil fuel famine and that is going to lead to the other energy famines that we are familiar with, unless we make Herculean efforts to put in place infrastructure and practices that will stave off such an ugly situation.

If we don’t make ourselves aware of this development and the impact it is going to have, we are going to be searching for solutions and are likely to be a confused society. We are already exhibiting signs of this confusion by spending thousands of crores on unsustainable urban and long distance road transportation infrastructure that is being set up with the assumption that we have many decades of cheap fossil fuels ahead of us. Maintenance of that road infrastructure let alone the fuel required to power the vehicles that use them requires a by-product of fossil fuels.

This smacks of irresponsibility and a betrayal of the citizens’ trust who have elected the governments to guide the development of the nation. They have put them there as the custodians of the nation’s resources, finances and economy. The country, very likely along with the rest of the world is not going to be a pretty place when they realize that their trust was misplaced.

“Complex problems have simple, easy to understand, wrong answers." - Henry Louis Mencken