Memorandum submitted by Chris Skrebowski
FEI
THE "UK ENERGY
AND CO2 EMISSIONS
PROJECTIONS—UPDATED
PROJECTIONS TO
2020"
It is my contention that we now have an effective
oil floor price of $35/b to $40/b. This arises because, with little
or no low cost oil being found or remaining undeveloped, the marginal
new and future supplies will come from Canadian oil sands, a very
limited number of non-Opec, non-OECD producers—Angola, Kazakhstan,
Russia, Azerbaijan, Brazil—and some minor African producers
such as Mauritania. Possible sources of incremental Opec production
are also limited and effectively confined to Iraq, Kuwait, UAE,
Saudi Arabia, Libya and Algeria.
For a variety of reasons all these incremental
supply sources will require relatively high prices if they are
to be developed. In the case of Canadian oil sands, prices of
$35/b to $40/b are needed for investment. Lower prices, or the
expectation of lower prices, would simply lead to project cancellations.[The
recent record price paid by Shell for some Canadian oilsands resources
effectively confirms oilsands higher cost/higher value status]
The non-Opec, non-OECD producers have been aggressively
seeking higher revenues—low prices would lead to supply
curtailment, notably by Russia, but others might follow in order
to induce higher prices.
Opec producers would certainly curtail production
to drive prices above $40/b. Cost of new supply are escalating
rapidly, so I see no realistic possibility of oil prices below
$35/b. All the alternatives and biofuels—ethanol and fuel
oilseeds—all require prices of over $35/b for long-term
viability.
In terms of gas prices, the world appears to
be moving towards a global price. The realistic possibility of
Russia heading up a `Gas Opec' (see Petroleum Review, May
2006) also contributes to the idea of gas prices remaining closely
linked to oil prices going forward. Whereas only a year or two
ago the predictions were for ample, even excessive, gas supplies,
the current view is that, with recent discovery rates of no more
than half of consumption, gas supply may soon become quite tight.
This view is underpinned by the fact that virtually all the gas
becoming available from upcoming LNG plants has already been contracted.
A spectacular example of this was the Pluto gas discovery offshore
Australia in April 2005. By autumn 2005, an LNG project slated
to start in 2010 had been committed to, and by end-2005 most of
the gas had been contracted.
It appears that, barring a broadly based international
recession/depression, we now have an effective floor price of
between $35/b and $40/b, and its gas equivalent.
Determining the high end of a realistic oil
price range is rather more difficult. If, as I predict, global
oil supplies peak around 2010/2011, then oil prices will have
to rise to the point where the available supply is rationed to
the highest values uses, with prices rising further if, and when,
supply declines. The principal danger is an economic collapse
and the consequent move into recession/depression.
Assuming, for the moment, that supply merely
remains very tight, there are two reasons for believing that prices
will remain high or escalate further. Firstly—until economic
setback—there will be aggressive bidding for available supplies.
Secondly, the perception among suppliers will be of the great
value of their resource, which is likely to mean they would only
sell at high prices and might actually restrict supply on the
"saving it for later generations" or "saving it
for our own people" rationalisation.
The basis of the "favouring gas" scenario
seems to me to be dubious on the grounds that gas supplies are
unlikely to be markedly easier than oil supplies, so only limited
fuel switching would be possible. Most of the straightforward
switching between oil and gas has probably already been done as
there has been a financial advantage since the oil shocks of the
1970s. In the case of the UK gas is already a larger supplier
of primary energy than oil suggesting that a move back to oil
is probably as likely as a further move to gas. With oil and gas
prices now broadly equivalent on a calorific basis, and likely
to remain so there would be little financial benefit from fuel
switching, although there would be a CO2 emissions
benefit.
The "favouring coal scenario" looks
more plausible. However, with other countries looking to make
the same shift, and considerable investment being required to
significantly increase coal supplies, it appears inevitable that
coal prices will rise quite rapidly—even with carbon emission
penalties.
Thus the falling coal prices used in all scenarios
looks implausible.
My general conclusion would be that all hydrocarbon
prices will remain at or above current levels until well after
2010. The only way they could be significantly lower would
be if there was a major and sustained economic recession. Professor
Oswald of Warwick University has done work suggesting that the
economic impact of an oil price rise is lagged by around 18 months.
If this is so we are so far only experiencing the impact of $40
oil and have yet to see the economic impact of $50, $60 and $70
oil.
In all planning, the primary pressures are usually
fairly obvious—it is spotting the size and timing of the
secondary reactions that is difficult.
The experience of the 1973 and 1979 oil crisis
may be instructive. The immediate reaction to the rapid price
rises was recessionary. Over time, redesigned equipment, fuel
switching and substitution started to impact. Oil production/consumption
volumes fell from 1973 to 1975, but had recovered to 1973 levels
by 1976, with the next price hike coming in 1979 after the Iranian
revolution. Demand then fell away after 1979, not reattaining
1979 levels until 1990. Prices, however, held high from late
1979 to late 1985, when the price collapse occurred. This extended
period of high prices was achieved by Saudi Arabia cutting production
to take the slack out of the system and defend the high price
level.
Parallels with the present should be treated
with some caution. It is, however, true that in the post-1979
period most of the easy oil substitutions were made. Fuel oil
was largely backed out of the power generation market. Fuel oil
currently accounts for just 9% of global power generation, largely
confined to islands such as Madeira, the Canaries etc and the
Far East. Much heating oil demand was displaced by gas usage.
The displacement of heavy industry to the Far East from Europe
and North America has transferred a lot of heavier oil products
demand from Europe and North America to the Far East.
In my opinion, excessive attention has been
paid to the rapid improvement in the energy intensity of economic
growth in Europe and North America. But, this is partly a function
of the displacement of heavy industry to the Far East, so in global
terms the overall improvement is much smaller. Global demand determines
global energy prices, so any extrapolation of European/North American
experience can be very misleading.
In summary, my conclusions about the price assumptions
used in the report are:
— Table 5a—all prices are too
low for 2010, 2015 and 2020.
— Table 5b—oil and gas prices
are slightly too low for 2020, 2025 and 2020; coal prices are
far too low for 2010, 2015 and 2020.
— Table 6a—oil and gas prices
are reasonable; coal is too low for 2010, 2015 and 2020.
— Table 6b—oil and gas prices
are ridiculous for 2010, 2015 and 2020; coal prices are also ridiculous
for 2010, 2015 and 2020.
I personally think that, overtly or covertly,
two other scenarios should be examined:
1. High energy prices and geopolitical upheaval
causing an extended economic recession/depression, probably starting
around 2010.
2. Availability of oil and, at some later
point, gas becoming so constrained that governments are forced
to intervene, rationing and allocating available supplies.
May 2006
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