Oil: Peak performer

Is the oilpatch ready for a world with less black gold?

Methanex’s original decision in 1993 to set up near the Chilean city of Punta Arenas seemed to make sense at the time. Chile is a stable country in South America, and the Vancouver-based company would be able to hook its methanol-production facility up to a pipeline that delivered natural gas across the border from Argentina, natural gas being a key feedstock in the production of methanol. But when a cold snap hit that area of the continent last winter (summer for us in the northern hemisphere), it strained an already taxed Argentinean power system, one that is heavily dependent on natural gas. Plus, an election campaign was underway. The result? The government began hoarding its natural gas supplies. Exports to Chile were halted.

Methanex (TSX: MX) had to shut down three of its four production facilities in mid-June. It did manage to find two Chilean sources to keep one plant operating, but the company’s stock price dropped by about 25% to a low of $20.90 by Aug. 20. There is likely little Methanex can do until the tap for Argentinian natural gas is turned back on — if it’s ever turned on. But even worse is the idea that the chaos affecting Methanex could become more common in the years ahead. Some 148 years after the first oil well was drilled at Petrolia, Ont., the world has entered a period when insatiable demand for energy seems to be overcoming the ability of our traditional fuel sources to keep up. Take the Western Canada Sedimentary Basin (WCSB), the geological basin underpinning Alberta (and parts of Saskatchewan and B.C.) that has been the source of the West’s riches since the beginning the province’s oil and gas industry. When oil and gas basins are formed, the resources are distributed among a large number of different pools that vary in size. It’s the nature of hydrocarbon exploration that the largest pools are found first, and that’s been the case with the WCSB. The natural gas deposits that have been discovered so far represent 70% of what will ultimately be found, and those were found in 40,000 relatively large pools. It’s thought the gas left to be discovered will be contained in some 449,000 smaller pools. Of all the gas that is left, 90% will be found in 100,000 pools, which will be more difficult to profitably tap because of their size. The last 10% of the basin will be even harder to get out.

It is because of this ongoing depletion that the average amount of natural gas given up per well per day has fallen to less than 200 million cubic feet a day. That’s a third of what the average well gave up back in 1996. The total amount of gas being pulled out of the WCSB has stayed level during the first part of this decade, because of the greater number of wells that have been drilled. The National Energy Board recently forecast that Canadian gas production will fall 4% per year through 2009 as a result of the recent downturn in drilling. Whether the decline in production can be reversed by record amounts of new drilling is yet to be seen. Whatever transpires, it is increasingly the case that, outside of the oilsands, the WCSB is going into decline.

A similar story is playing out in the Permian basin, the source of natural gas along the Gulf Coast — the wells there were down another 10% last year. And that is raising the perennial question that lurks in the background of any conversation about hydrocarbons: How much do we really have left? With oil prices at a record “real” high of US$90, that question is being talked about in a way it hasn’t since the ’70s, and the number and type of people moving over to the it’s-time-to-worry camp this time has been quite interesting. Like Jim Buckee. The CEO of Talisman Energy Inc., who retired Oct. 25, recently returned from Cork, Ireland, where he attended the sixth annual Association for the Study of Peak Oil & Gas conference, which, he says, is becoming a serious debate. “When this group started, it was a lot of save-the-worlders, but there are more technically minded people showing up today,” says Buckee. Jeff Rubin, an economist with CIBC World Markets, also attended the conference and suggests the idea that oil production has peaked is gaining mainstream status in the energy industry. “When it comes to any new idea, Stage 1 is denial, Stage 2 is acceptance, and Stage 3 is ‘We knew it all along.’ We’re moving into Stage 3,” he says.

Should we be worried? Perhaps. Earlier this year the U.S. Government Accountability Office released a report suggesting a worldwide depression is possible if nothing is done about the approaching peak in hydrocarbon production, while the International Energy Agency has warned of “extremely” tight oil markets within five years. The idea we may be on the downside of global hydrocarbon production raises tough questions for business executives. There are certain aspects about the modern economy we’ve come to depend on during the past 50 years. One of them is that the economy will always expand, and it will do so at an astonishing rate. But if the deep energy flows that make everything run properly start to plateau or decline, what does that mean for society? Does the constant, continued expansion we’ve come to expect taper off? Or worse, go into reverse? Sobering questions, and the answers some experts in Canada are giving are not encouraging.

David Hughes is a scientist and a 30-year employee of the Government of Canada as well as a member of the Canadian Gas Potential Committee, a group composed of industry and government scientists tasked with assessing the amount of natural gas this country has left. He travelled to Toronto this past September and was given a night’s accommodation at the trendy Gladstone Hotel in exchange for a presentation organized by Post Carbon Toronto, an activist group concerned about the future of energy supplies. His presentation took place on a rainy Tuesday night at city hall, but it was an eye-opening lecture for the 60 or so people who came out to hear it. As a respected scientist, Hughes has made this speech to many organizations, but he was careful to clarify that he was there as a private citizen. His presentation drew together basic data on global hydrocarbon supplies to underscore the need for humans to begin planning for the onset of peak oil. That there is a peak out there is something no one denies. The only question is when it arrives and whether or not we will face liquid fuel shortages.

Historically, humans have adopted ever-more efficient forms of fuel. From wood to coal to oil, our energy evolution has been one of adding ever cheaper, more efficient forms of fuel to our total energy mix. The industrial revolution began in England with the tapping of coal, a first step in our economic progress that was continued by the United States’ huge postwar build-out of its oil infrastructure. Each progressive, more efficient link in that energy chain has provided the hockey-stick-like growth patterns in nearly every measure of human activity, from population growth to crop yields to economic productivity, that we’ve seen since the mid-1700s. But by switching the majority of our energy consumption from a renewable, wood, to non-renewable fuels, such as coal, oil, gas and, finally, uranium, we’ve put ourselves on a highly unsustainable path.

Today, 89% of our basic energy supply comes from non-renewable sources. That’s a complete reversal from our energy regime 150 years ago when 85% of our energy came from wood. The switch to coal and hydrocarbons has allowed us to increase the energy consumed per capita some eight times, but that exponential growth is unsustainable over the long term says Hughes. Consider oil. Since we began using it back in 1859, we’ve consistently increased our use of it, and — just like natural gas in the WCSB — we’ve burned through a good chunk of what we have, anywhere from a quarter to one-half, depending on which estimate you use.

The temptation is to assume that means we have at least another 150 years left, if not more. But that assumption doesn’t take into account one major difference between today and 1859, which is, of course, the fact that the average global citizen uses far more energy than someone in 1850. There are now 800 million automobiles on the road and 70 million new ones are built each year. The important point here is that we’re increasing the amount of fuel consumed even though we’re about to start in on the last half or three-quarters of our oil at a flat-out 21st century, just-in-time-delivery kind of velocity. Hughes puts the grim realities of the exponential increase in our use of hydrocarbons in perspective when he points out that of all the oil we’ve consumed since 1859, we’ve used up half of it since just 1984, and 10% of it since 2001. “Humanity is locked in an upward spiral of consumption,” he says.

But as we increase the use of non-renewable fossil fuels, we’re find-ing increasingly smaller amounts of new supplies to replace that which we use. Most of the oil (and hence gasoline) we produce today comes from 322 so-called elephants — massive pools of more than a billion barrels of oil — that were all found in the golden age of oil discovery, the ’50s and ’60s. These few fields have provided the large and steady flow of cheap and easily producible oil that we have enjoyed over the past 50 years. But they were all found close to the peak in global oil discoveries and many are starting to go into decline.

Hughes runs through a list of countries that are now producing below their peak production levels. In the U.S., production peaked in 1970 and is now 40% below that; the U.K. peaked in 1999 and is now 40% below peak; Norway peaked in 2001 and Mexico in 2004. All in all, about two-thirds of current global oil production comes from countries that are now past peak. “The North Sea is basically collapsing,” says Hughes. Supplies in six of the 12 OPEC nations are also past peak, as is the North Slope in Alaska, which only dishes 800,000 barrels a day, much less than the two million of its heyday. And the mighty Cantarell in Mexico (the source of a lot of U.S. crude and Mexican government revenue) is now dropping at 15% per annum. Hughes points out in his speech that “we are now using three or four barrels for every one we find.” In fact, we’ve been consuming more oil than we’re finding since 1981, and one analyst calculated the gap between production (and consumption) of “already found” oil and the amount of new oil being discovered was 10.1 million barrels a day in 2006.

Private-sector CEOs often end up on the opposite side of the fence from government scientists, but Jim Buckee shares Hughes’s concerns. “We’re relying on a lot of oilfields, but most of them were discovered 50 or 60 years ago,” says Buckee. “The big 322 provide 80% of the world’s oil. The other 20% we get from 40,000 smaller fields. We’ve had bursts since then — the Caspian, the North Sea and West Africa — but that’s nothing to replace those big ones.” Even with all the improved technology and continued exploration, we haven’t reversed, or even really affected, the general downward trend from the global peak in oil discoveries that occurred in 1965. That suggests the problem is geological, rather than a human inability to find it. It’s not there to be found.

One key reason geologists think we may be reaching peak is the remarkable correlation between the peaks in oil discovery and the commensurate peak in actual production. The latter follows the former by a few decades, as was the case in the U.S., where discoveries peaked in 1942. That milestone was followed by a peak in production three decades later, in 1970. Assuming a similar logic applies to the earth as a whole, the idea that global discoveries of oil peaked in 1965 suggests there must be a peak around about now — or sometime soon.

Those in the industry have been dealing with the concept for some time. Buckee relates a story from early in his career when he was working in Alaska on the North Slope and John Browne (the recently deposed head of BP) was on the line from headquarters. “He was on the phone yelling at us that ‘it can’t decline.’ But what can you do? I’ve seen it. Once they go, there’s nothing you can do to stop it. Once these big fields go into decline, they can be irreversible,” says Buckee. He would know better than most. His company, Talisman, has been operating a large number of drilling platforms in the North Sea, which has seen better days. So when Buckee sounds a warning, that should be a clue we need to pay attention to the issue. “If all of these big old fields go into decline at the same time, the world has a problem.”

Sharpening the effects of this geological eventuality will be the geopolitical issues around global fuel distribution. In his address to the ASPO conference in Ireland, CIBC’s Rubin expressed worry about the capacity of OPEC, Russia and Mexico to continue to export crude into the world market. These countries are going to struggle with naturally declining reserves, but they must also satisfy their own populations. In many countries around the world, the price of gas is one-third to one-quarter of what it is in OECD countries, and there will be internal pressure in those countries to maintain those subsidies. That could see their governments stop exporting as much oil as they have in the past to the world market, as Argentina did earlier this year. “Domestic demand growth is 5% a year in some oil-producing countries, and they are already beginning to cannibalize their exports to feed that demand,” says Rubin.

National hoarding by the countries that do have oil left — a major concern for countries such as the United States, which uses 20 million barrels a day and only produces five — will become a bigger concern as supplies dwindle. In fact, hoarding might be the bigger worry than the actual decline, as exports to the world market decline faster than reserves themselves. With “domestic consumption growth of nearly 5–6% standard in the Middle East, OPEC’s future export capacity is increasingly called into question,” Rubin wrote in a recent report. These trends are likely to result in a sharp escalation in world oil prices over the next few years. It’s interesting to note that when Argentina ran into its natural gas shortage, Bolivia, which has lots of natural gas, sent a message: “Don’t look at us.” The country recently nationalized some of its gas assets and doesn’t seem to want to share, preferring, presumably, to let industry relocate within its borders.

To be fair, there are alternative scenarios to the ones offered up by forecasters who see a production peak in the next few years. Cambridge Energy Research Associates Inc. (CERA), a major U.S. global energy consultancy owned by IHS (a data and information company), has released its own anti-peak-oil analysis, which puts the total amount of hydrocarbons in the world at 3.74 trillion barrels. CERA, often considered to be an industry-friendly shop, maintains that unconventional resources, such as the tarsands (here and in Venezuela), as-yet-discovered oil and gas, oil shale, “gas to liquids” technology and enhanced recovery methods will push any peak in oil production to at least 2030 — at which point there would only be a plateau, not a decline.

Many geologists seem to disagree with CERA, however. Hughes’s analysis averages together the 20 or so estimates of the timing of the onset of peak oil that appear in the Hirsch report (a key U.S. government document) to arrive at an average estimate of 2014. Dropping the “outlier” numbers from the CERA and the Energy Information Administration from that calculation results in an average opinion of 2012 for peak. It’s worth noting that Matthew R. Simmons, a Houston energy industry investment banker, suggests CERA’s recent claim that oilfields are declining at only 4.5% a year is also misleading. He claims the real figure is closer to 8%–12% per year.

Of course, there are alternatives such as biofuels, wind, nuclear, tidal, methane hydrates and others. These will relieve some of the pressure on oil and gas (especially if cars were mandated to be lighter and more electric). Canada is even experiencing a boom in alterative-energy technologies. The mainstream auto industry may be downsizing, but we’ve just seen the birth of a new electric car company, Zenn Motor Co., in Toronto, which is now selling cars globally but has not been licensed in Canada yet. There are also other technologies that will help get more oil and gas out of already-drilled wells. For all of these reasons, many are confident that demand reduction will be part of the creative economic destruction we need to do as we move out of the oil age. “We’re in the ninth inning for oil use in the OECD,” says Rubin.

There are others who agree with Rubin. Earlier this fall, the Greater Houston Partnership, a sort of chamber of commerce for the city, hosted Canadian and Chinese journalists in an attempt to explain the city’s 10-year strategic plan to diversify away from fossil fuels but still maintain its leadership as an energy capital. “The question being asked in Houston now is how do we perpetuate Houston as the energy capital of the world?” says Lane Sloan, a former CFO of Shell Oil, co-author of Terra Incognita: A Navigation Aid for Energy Leaders, a book targeted at the next generation of oil executives, and chair of the Greater Houston Partnership’s energy committee. According to Sloan, many in the energy industry in Houston assume the world is in another next investment cycle. The last time we went through the “high-prices, world-is-coming-to-an-end” thinking was in the ’70s, and the world came out of that era awash in a flood of new oil. Many assume that’s going to happen again and we’ll see a flood of new supplies some time after 2010. But Sloan, for one, isn’t convinced that will be the case, and his analysis of the future of the energy industry is similar to what the peak-oil types are saying.

“My take is that this isn’t just another investment cycle. We’re facing a true phase change,” says Sloan. “The next strategic fuel has always been found on the margin. That was the case when coal was dominant and oil was on the margin. But, today, there isn’t that obvious next fuel. So the next strategic fuel won’t be any one source, but a portfolio of energies.” He sounds a lot like a dot-com type from the ’90s when he describes what the international western oil companies (the Shells and Chevrons of the world) need to do to stay in the game. “The key is going to be managing the network between a portfolio of energies. Houston has realized that the network is the solution. If you believe it’s a phase change, it’s not the fuel, it’s the network.” Like Rubin, Sloan expects we will avoid real chaos. “We won’t see $150 oil like some say. But we will be in an era of high prices. Nothing could compete with $20 oil, but once you get to $50, things begin to step out,” says Sloan. “Ideas are flying around. People might be surprised at how fast these come out.”

An expansion of alternative energies coming together with a program of demand reduction could move the West’s dependence off oil and into a smartly engineered future of multi-option energy networks that are made up oil, gas, tidal, wind, nuclear and biofuels. That would allow humanity to continue along its path of increasing complexity. But is that realistic? Both Hughes and Buckee are pessimistic about the alternatives. “They are way out of scale,” says Buckee. “For volume and weight, fossil fuels can’t be beat. They’re just on completely different scales.”

Although many think of biofuels as a replacement, they really aren’t. To make a remarkably crude analogy: the energy from, say, corn ethanol represents a summer’s worth of sun energy; fossil fuels represent millions of years of trapped sun energy. To think we can replace a massively efficient, brilliant energy source such as hydrocarbons with “real-time” energy generation from wind, tides and alcohol is to misunderstand the how powerful fossil fuels are. “The truth is that gasoline and oil are such massively efficient fuels,” says Hughes. “I wish [alternative fuels] worked. But the fact is nothing can replace the efficiency of oil and gas. We need to reduce the amount of energy we use.”

Hughes is careful to note that we’re not going to run out of oil tomorrow. He points out that the world’s first oil well at Petrolia still produces 10 barrels of oil a day. The U.S. is still the world’s third-largest producer of oil even though production peaked in 1970. What is of concern, says Hughes, is getting enough liquids to market to satisfy soaring demand at a price that doesn’t cause economic chaos. “We’re not running out of oil. We’ll have it 100 million years from now, so this is not a resource issue. It’s a deliverability issue,” he says.

Should Canadian companies take peak oil seriously? Buckee’s answer is unequivocal: “Yes. I think we’re going to see this unfold over the next five to 10 years. We should stop worrying about CO2; that’s going to be like Y2K. City planners have to start thinking about this. There are more than enough signs that cheap oil is running out. Public and private decision-makers need to start making decisions with this in mind.” As much as we may like the current energy equilibrium, there is the possibility of serious economic adjustments coming. “You might have to live closer to work,” he says.

The extreme scenario is a decline after a peak in total production in 2010 or 2012 that results in, say, a 5% annual reduction in the amount of oil produced daily and extends for 10 years. That means total production of liquid fuels will be 60% below where we are today. Energy Watch Group, a think-tank started by Hans-Josef Fell, a member of German parliament, has just released a study claiming that the world has already peaked and is now going to experience declines of 3% annually. Assuming that is correct, the upside for the price of a barrel of crude (and hence gasoline) is, in theory, unlimited. A good time, then, to be an oil executive in Calgary, but maybe not for many others.

In “The end of exponential growth: Why (real) growth may end soon,” a recent article in the Joseph L. Rotman School of Management magazine, author Robert Ayres suggests that our primary energy sources are no longer getting cheaper, and the “rate of increase in the efficiency of energy conversion in industrial societies” has slowed. As the total amount of energy available to us drops, it may be that permanent economic decline will be an unalterable fate. In other words, just as the growth in a feedback system drives more growth, reverting back to real-time solar energy, biofuels, wind and tides, and away from the one-time energy bump that came with non-renewable fuels, just might result in a future economy where “decline begets decline.”

In the U.S., they’ve seen demand for gas in the industrial sector of 22% since just 1997 as industries and companies — such as fertilizer makers, which use huge amounts of gas — moved offshore to gas-rich locales in the wake of high natural gas prices earlier this decade. There will be interesting consequence for Canadian confederation in a post-peak world, one of which will be a shift in power in this country. The oilsands has boomed on production of just one million barrels of oil a day. As one of the few areas of the world set to increase production, Calgary will grow into something entirely different on, say, four million barrels a day at $100 a barrel. “We’re becoming an energy economy. You can see how unique the oilsands are becoming,” says Rubin.

But, according to the EIA, coal will see the greatest increase until 2030, and will take market share from natural gas in the electricity sector in North America, which will lose market share because of supply issues. It is key we make widespread use of ultra super critical combustion (clean coal) technology,says Hughes. He also counsels a general conservation strategy including the restriction of natural gas to the highest, most important uses. Hughes isn’t convinced we’ll get enough liquefied natural gas (LNG) infrastructure up and running to meet demand as many other countries are also looking to buy up LNG supply.

But the really frightening notion in all of this is the nature of humans to come to blows when available resources decrease. As energy supplies dwindle, countries will be even more tempted to use militaries to maintain energy flows into their home economies. Not that we haven’t already seen that in Nigeria and Iraq. In his article, Ayers warns of the possibility of “a large-scale war between Judeo-Christian and Islam worlds” as resources dry up.

During Hughes’s presentation, members of Post Carbon Toronto handed out copies of The Oil Depletion Protocol, a document produced by Dr. Colin J. Campbell, a former geologist of Amoco, once a large international oil company now part of BP. Campbell has been a key voice in the debate about peak oil, and he hopes his document will act as the basis for a global agreement between nations to manage the decline of petroleum, which, among other things, mandates that each and every country reduce its oil consumption internally by the global decline rate in production. This could be one way to ameliorate the potential for violence that comes with peak oil. Other recommendations for dealing with the issue include a field-by-field production report, having people work from home, shipping goods by rail rather than by truck and growing more food locally. It will be important to avoid using new fuel sources (such as corn ethanol) that are energy intensive. But all are agreed: the general rate of consumption will have to come down if we have any hope of dealing with the issue. Even Sloan, the former Shell CFO, suggests that our “cheapest energy investment dollar is conservation.”

As the consequences of peak oil become clear, the attention being paid to the issue is ramping up quickly. The theme of this year’s ASPO international conference was an appropriate question: “Time to React?” What other issue is as all-encompassing, all-consuming as a one-time reversal from human expansion to contraction? If something has to give, it’s not going to be geology. It will be us. There are valid concerns around large-scale food production and mass population control that must be dealt with.

The kicker, of course, is that we may already be at peak. We have yet to move back above the peak in liquids production levels that the world hit in 2006. When legendary Texas oil man T. Boone Pickens was asked at this year’s ASPO-USA conference when we will hit peak production, he reportedly answered, “That’s an easy one. We have already peaked; 80 million barrels [per day] is as high as we’re going to get.” Hughes, ever the scientist, wraps up his presentation with a warning: “We need to prepare for this,” he says. “We probably should have started already.”