Select Committee on Environmental Audit Written Evidence

Memorandum submitted by Chris Skrebowski FEI


  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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