Peak oil’s impact on energy policy

Don Stowers
Editor-OGFJ

In the past week, I’ve read several interesting commentaries that give pause for thought. Just this morning, Raymond James sent out its weekly newsletter with an observation about peak oil. Marshall Adkins and the folks over at Raymond James’ Houston office noted that global oil production peaked sometime in the first quarter of last year.

How do they know this, you may ask. Well, here’s their rationale: OPEC oil production reached a high point in the first quarter of 2008, while non-OPEC production peaked even earlier in 2007. Worldwide, they note, total oil production rose to its highest level to date in 1Q08 (about 79.3 MMbpd).

Although no one knows what future oil production may be, Raymond James explains, “It is entirely intuitive to conclude that if both OPEC and non-OPEC production posted declines against the backdrop of $100-plus oil – when the obvious economic incentive was to pump full blast – those declines had to have come for involuntary reasons, such as the inherent geological limits of oil fields.”

This makes sense. Why would countries or companies curb production when they could make so much money by producing more and more oil?

Although energy demands have since declined due to the global economic recession, the reality is that the economy will come back and when it does there are serious doubts as to whether the supply of oil will be adequate to sustain the economic engine. So all those doubters who criticized Matt Simmons’ view about peak oil may soon have to come to grips with the reality that oil scarcity may become a fact of life in the near future.

Paul Ziff, CEO of Ziff Energy, observed recently that the last decade saw a prolonged oil price uptrend, from the low teens in the winter of 1998-1999 to all-time highs reached in July of 2008, with a slight hiccup in the winter of 1997-1998.

“In my opinion, this surge originally reflected the fundamental economics of growing demand and more expensive supply, then acquired a ‘political premium’ regarding supply uncertainty, impacted initially by the war in Iraq, which tightened supply, and enhanced the impact of other uncertainties such as unrest in Nigeria and politics in Venezuela,” said Ziff.

“Two other factors were at play,” Ziff continued. “At its peak, oil traded at least 15 times each physical barrel, so it is clear that financial markets, including hedge and commodity speculators, played a key role in setting prices, including the volatility of technical trading models. For the majority of world producers, a weak US dollar (resulting from the ‘easy money’ policy of the US Federal Reserve Bank) depreciated the value of what they received and fed higher commodity prices in North America.”

Energy price volatility is a given. At its peak last July, oil traded for as much as $147/bbl – more than 10 times its 1998 low. Combine this volatility with alternating demand (depending on global economic conditions) and dwindling supply and we may be setting ourselves up for even higher prices than we experienced before the financial and economic crisis reined in prices in the second half of last year.

So, after the economy comes back and demand for oil goes up, what can we do to help protect the public from excessively high prices, which most in the oil and gas industry agree are dangerous to the economy? The answer is easy – bring more oil to market and improve energy efficiency in our homes, businesses, and vehicles, and give oil companies the freedom to drill on public lands and offshore. Credit markets also need to reopen so E&P companies can access capital for expensive development programs.

Paul Ziff suggests that management, including board members, need to “run their companies on a sound longer-term basis rather than bowing to short-sighted and inappropriate financial drivers from the (former) paragons of financial strategy. Several super-majors are pursuing a course of stability vs. kneejerk reaction. Respect for strong technical staff is a must, both as a principle, and due to the aging of the baby boom generation in OECD countries. The ‘hire and fire’ staff cycle creates a negative profile for the university graduates the industry needs to attract to replace the baby boomers.”

Similarly, says Ziff, countries need to recognize that energy is critical for economic well-being and national stability. He notes that China is continuing its purchase of world assets and to forge strong relationships with suppliers. Arguably, he adds, the worst energy policy has been that of the United States, which has had virtually none, and which has done little to promote energy conservation or provide incentive to develop our hydrocarbon deposits.

In all likelihood, the current administration will reshape the energy industry. Let’s hope they make the right decisions.