Tuesday, September 27, 2005

Belated: Fortune On Oil's Future

A bit late with this one, Fortune published a good article on the future of oil. Relevant to this blog:

REALITY: This one is true. Sort of. Unlike wind or water, oil is not a renewable resource. So by definition we're using it up, in the same way that we are all dying all the time. The real question is, When will it become impossible (or impossibly expensive) to recover enough to meet demand? Answering that question is not easy. New discoveries and new drilling technologies have transformed the science of exploration, which is why global reserves have doubled since 1980 (to 1.3 trillion barrels) even as consumption has soared.

There's no shortage of oil experts, however, who say that the industry cannot keep up the pace, and that the age of ever-expanding reserves is over. These "peak oil" theorists argue that we need to prepare for an era in which supply trails demand, particularly given the fast-growing needs of China and India. The guru of the peak-oil set—and author of its latest manifesto—is Matt Simmons. A leading energy banker in Houston, Simmons spent years poring over oilfield engineering reports and concluded that some of the world's most important fields are thinning out. "I believe the Middle East has no spare capacity," he says. He's even more pessimistic about some newer fields like those in Russia and the deep waters of the Gulf of Mexico.

Simmons is no kook—his book on the subject, Twilight in the Desert, is a must-read in energy circles. But there is a Chicken Little aspect to the peak-oil viewpoint. There have been a dozen or so oil shocks over the past 60 years—all replete with handwringing over in-the-ground reserves—and cheaper oil has returned each time. "The one thing I've learned," says Roach, "is that oil is a mean-reverting commodity." This time around, Roach expects high fuel prices to dent consumption—he's predicting a downturn in travel and other discretionary spending—while spurring oil companies to dig deeper and farther afield for oil.

The analysts at Cambridge Energy Research Associates have done their own painstaking global survey of oil production, and they couldn't disagree with Simmons more. In their view, production could rise 16 million barrels a day by 2010, leaving a comfortable gap between supply and demand.

The real problem with the peak-oil argument has less to do with engineering than with philosophy. It lacks imagination. Thirty years ago few thought it would be possible to produce price-competitive oil from Canadian oil sands. Today the cost of producing that oil is about $20 a barrel and is still falling (see "The Dark Magic of Oil Sands"). Similarly, you can't rule out the idea that today's speculative energy technologies (see "Here Come the New Fuels") will become cost-efficient by the time Middle East oil production starts to wane. "The peak-oil argument underestimates the potential for technological progress," says Economy.com's Thorsten Fischer, who expects oil to fall to about $40 a barrel by next year. Simmons thinks prices could triple by 2010.

Peak-oil theory also overlooks alternative explanations for why oil exploration hasn't been terribly fruitful in recent years. It may be that there is oil to be found, but investors haven't given oil companies the requisite incentives to find it. Blame the dot-com boom. Having been burned by accounting cheats and profitless wonders, post-2000 investors demanded cash flow, dividends, and stock buybacks. So despite booming profits and revenues, Exxon Mobil spent less on capital and exploration in 2004 than in 2003. And the $11.7 billion figure for 2004 was $3 billion less than the company earmarked for dividends and buybacks. Of course, $65 oil has a way of changing priorities. After years of stagnation, drilling-rig counts have soared 36% since April 2004. There are 2,895 active rigs worldwide, according to Baker Hughes, the most since 1986.