In 20 years I predict energy wars over oil and gas resources. By the time it becomes politically profitable to react to problems in the transport energy sector, it will be too late for significant development of alternatives and too politically risky not to fight over remaining supplies. -Len Gould (in EnergyPulse, Jan. 8, 2008)

I never contemplate the 'details' of energy wars, and that means the kind predicted for the future by Len Gould, as well as the one that Alan Greenspan -- the former director of the United States central bank (or Federal Reserve System) -- believes began in 2003, and to a limited extent is still taking place. For what it is worth, I have often preferred Dr Greenspan as a jazz musician rather than an economist, but even so there is no denying his intelligence, access, and the diversity of his interests. More important, I see no reason to disavow that energy wars are possible, and I cannot forget that the brilliant Professor Nicolas Georgescu-Roegen insisted that almost all wars have something to do with natural resources.

Armed conflict over an energy resource is a topic that I failed to consider in my course on oil and gas economics at the Asian Institute of Technology (AIT), but I was sufficiently alert to discuss a bizarre oil forecast for 2030 that was circulated earlier by the International Energy Agency (IEA). Their estimate -- since adjusted downward -- predicted a consumption of 121 million barrels of oil per day (= 121 mb/d) in 2030. When I commented on the improbability of this forecast -- employing what I knew about other production estimates -- the IEA director sent me an outraged mail professing that IEA forecasts were for consumption (and not, as I indicated, production). I found this strange, since almost all energy economics research dealing with oil concentrates on production, but since I never regarded the IEA seriously, it hardly makes a difference. As my colleagues at Uppsala University have reported, IEA publications are "political documents" designed to placate governments (and firms) that want to give the impression that oil production will remain high, and thus oil prices will be low.

In the lecture alluded to above, I put a linear approximation on a whiteboard at AIT which suggested that with a world output of 121 mb/d in 2030, Saudi Arabia would have to produce at least 20 mb/d. This approximation was based on a peaking of Gulf oil, as suggested by an article in the Oil and Gas Journal; the ongoing peaking of non-OPEC oil if Russia was excluded; and the aggregate peaking of non-OPEC oil about to occur, taking Russia into consideration. I sent this result to Professor Paul McAvoy of Yale University, and he assured me that I was wrong because Saudi Arabia would soon exploit four new fields. Unfortunately, Saudi Arabia appears geologically incapable and/or geopolitically unwilling to obtain a massive output from any new field, and according to the Energy Intelligence Agency (EIA) of the U.S. government, an increase in the oil supply due to e.g. an increased output in Brazil, and various non-Russian regions of the former Soviet Union, cannot compensate for declines elsewhere.

Assuming that the above is correct, or almost correct, then it is necessary to point out that 20 mb/d is exactly the amount that the Saudi government said they would not produce under any circumstance. They made this statement approximately 35 years ago, and have repeated it many times since. As noted in my book on oil (1980), I first detected this information about Saudi production intentions in an official U.S. government publication (1979), although I did not attach a great deal of importance to it until many years later.

Several of my students at AIT informed me that they had some difficulty accepting my conclusions about the future availability of oil. This was because I claimed that by 2030 the global production of oil would have peaked, by which I meant that it would have peaked many years before 2030, and possibly as early as 2015. Why not, when the director of the French oil major Total, Christophe de Margerie, has repeatedly said that the maximum global oil production will never be greater than 100 mb/d, and apparently challenges any corporate executive or decision maker who believes otherwise to discuss this subject with him in a public symposium. Someone else who finds the IEA projections dubious is professor (of physics) Kjell Aleklett of Uppsala University. He claims that by 2030 the peak will incontestably have taken place, and global oil production will only be 75 mb/d.

About the same time that I came into possession of the U.S. government document mentioned above, I obtained another publication with the same origin.. It showed 'possible' landing zones in the Gulf for paratroopers and marines in case the flow of oil from the Middle East abruptly decreased, and a military option was deemed necessary by one or more oil importing countries. Professor Douglas Reynolds of the University of Alaska also has some acquaintance with those materials, and according to him Dr Henry Kissenger had discussed the possibility of military intervention in one or more periodicals.

Landing zones in the Gulf is a topic without interest for me, but if it was I might stress that Alan Greenspan was once the most important financial bureaucrat in the world, and he made the following statement in his widely praised book (2008): "I am saddened that it is politically inconvenient to acknowledge what everyone knows: the Iraq war is largely about oil" (page 463).

A comment is in order here, because there is a difference between the "everyone" a single individual (and his network) think that they know, and the everyone they actually know. Dr. Greenspan has a better grasp of energy realities and economic theory than most members of the financial community. He fully comprehends the role of energy in the global industrial/commercial structure, and especially the crucial significance of oil and gas. Accordingly, since the amount of easily producible oil available in Iraq is very large, he might have concluded that if the kind of people he meets socially and professionally were capable of performing a cost-benefit analysis, they would accept that another war in that country was well worth the trouble, even if they did not express this belief in public.

OPEC's Strategy

A goal without a plan is a dream -Antoine de St. Exupery

The EIA has apparently calculated that OPEC earned 575 billion (U.S.) dollars in oil export revenues in 2009, a relatively depressed year, and might earn more than 700 billion this year. If this is true, I choose to believe that OPEC's future strategy is almost identical to the one I would employ if I were in their place. I am sure that this confession will win me neither friends nor employers, however as we said in the United States when I was a boy, I would rather be right than president! To be explicit, OPEC's announced intentions are almost the same as those predicated by the late Howard Chenery of Harvard University, who together with Professors Tinbergen and Fritsch (the first winners of the Nobel Price in economics) was the most sophisticated development economist of the 20th century. His book on the analytics of economic development, written with Paul Clark of the Rand Corporation (1962), was used at the African Institute for Economic and Development planning (Dakar, Senegal) when I taught there, but it appears to have been ignored by later generations of teachers and students because of its heavy content of linear programming and input-output analysis.

Although not immediately obvious, Chenery's approach was similar to that recently adopted by several major (and perhaps minor) oil firms, and theoretically reduces to the following: in an inter-temporal framework, more emphasis will be placed on short-term profits than the expansion of exploration, and attempting to designate a future production scheme in the light of increasing uncertainty about the availability of reserves. The mathematics here is straightforward, and seems relevant even though -- for example -- the EIA estimates a demand increase of 1mb/d this year, 1.47 mb/d in 2011, and almost certainly more later.

OPEC's 'management' is also concerned with short term profits, but not for the same reason. The more far-sighted OPEC personalities and/or theoreticians have as an ultimate goal the use of oil incomes to reconfigure the economic structure of OPEC economies -- i.e. to move from being producers of petroleum to producing oil products and petrochemicals, and to a certain extent beyond. An intention of this nature logically means restricting the production of oil! Assuming that every barrel of oil reserves that is not produced now will be produced later, then many of these 'future' barrels will be transformed into oil products (e.g. naptha), and a large fraction of these items into petrochemicals. As the last Shah of Iran mentioned, "crude oil is too precious to be burned up in the air."

What about the consumers of oil: do they have a strategy? If we think of consumers as a group, they do not have a strategy: they have a dream. Their dream features a gradual rearrangement of the global oil picture so that the price of vehicle and aviation fuel descends to that experienced eight or ten years ago, and stays at that level. The genesis of this fantasy is a profound indifference to what has taken place in the great world of oil over the past few decades. Just the sort of deficiency that I told my students they should avoid if they preferred a passing to a failing grade. They were also told to learn the following perfectly!

Output in the U.S. peaked at the end of l970 at a value of about 9.5 mb/d -- which is approximately the present output of Saudi Arabia and Russia, the largest producers of oil in the world. When that peaking took place there was still an enormous amount of oil onshore or directly offshore the United States. Production then dropped to 7.5 mb/d, but when the giant Prudhoe Bay field in Alaska came on line, the total output in the U.S. turned up. Unfortunately however, the previous peak was never attained. Instead, total U.S. production stopped short of that peak and once again began to decline. Today U.S. output is approximately 5.5 mb/d, and it is almost certain that it will continue falling. The U.S. oil production experience is both a model and a paradigm for what will take place on the global level, and conceptually involves no more than intertemporal profit maximization!

Now find and examine production curves for the 300 largest oil fields in the world, and after satisfying yourself that a majority of these curves have turned down or flattened (i.e. plateaued), ask how is it possible, in these circumstances, for anyone to sincerely believe that a global peak will not take place. Please note very carefully the word "sincerely". What it means in the present exposition is that there are people who know better than I do that a global peak will arrive, but have excellent reasons -- of a career and financial nature -- for claiming the opposite. For example, at least one of my best students in Bangkok was informed by his supervisor that it was taboo to engage in wanton chatter about 'peak oil'.

A supposed peak oil sceptic at an influential consulting firm has employed the picturesque word "garbage" to describe the work of peak-oil believers. If you encounter him some fine day, remind him that the output of the U.S. has peaked, as has production in the UK and Norwegian North Sea. Given the opportunity you should also mention that what was the second largest field in the world just a few years ago -- the Cantarell field in Mexico -- is declining at a startling rate. None of this is likely to upset him, because his organization claims that the production of oil will reach 115 mb/d by 2030, and moreover will remain at that level through 2050. This kind of forecast is not even wrong -- it is psychopathic.

The Russian output may be close to peaking, and a director of one of the largest Russian firms says that his country will never produce more than 10 mb/d. This may or may not be correct, but in any case Russian exporters will do an increasing amount of business in Asia, to the detriment of European importers. Oil importers everywhere though can consider the following. The discovery of conventional oil peaked in l965. In the early l980s the annual consumption of oil became larger than the annual discovery, and at the present time only about 1 barrel of (conventional or near-conventional) oil is discovered for every 3 consumed. According to a British Petroleum document, of 54 producing nations only 14 still show increasing production. 30 are past peak output, while output rates are declining in 10. To claim that all of this bad news does not imply an eventual peaking, is the same as implying that the (oil) whole is less than the sum of the parts, which is a myth that no intelligent observer would rush to endorse.

One more thing needs to be mentioned here: regardless of production, there will be a downward pressure on exports, as OPEC countries 'consume' larger amounts of their oil output in both consumption and investment activities.

Speculation vs. Fundamentals, and Final Remarks

On the few occasions when I dream about oil, those dreams show me insisting, often in non-academic language, that oil price movements of the last two years can be explained by supply and demand, or fundamentals, and not speculation.

But regardless of what I say, or how I say it, there are always persons who refuse to share my belief that fundamentals -- in the broadest possible sense -- are the items on which to focus. Fadel Gheit, the 'senior' oil analyst at Oppenheimer, ostensibly claims that supply and demand have not determined oil prices for years. That influential gentleman posits that the financial market, speculation, is behind price movements over the past few years. As it happens, that claim was first circulated by OPEC, because it is in their economic interest to do so. Please try to remember that OPEC has morphed into a genuine and strong cartel, with a decisive influence on the price of crude oil, and since this is made clear virtually every day, they have no choice but to pretend that someone else is responsible for high oil prices. Wouldn't you do the same thing if you were in their place? For instance, with demand weak, the price of oil is still rising. My favourite short comment on the present topic begins with a diagram of oil prices, provided me by one of the most important oil economists, David Cohen (2009).

In this diagram we see a genuine oil price spike -- associated with the first Gulf war -- and a spike-like movement at the end of the last century, caused by OPEC cutting production by about 1,500 b/d, together with cold weather in the large oil importing countries. Other genuine spikes took place in l973-74 as a result of the nationalization of oil by OPEC members, and in l981, due to a change in the government of Iran. After 2004 we get a sustained rise to late 2008

The most important of these occurrences was the spike-like movement at the end of the century, because that demonstrated to the OPEC management what solidarity and knowledge of the oil market could accomplish in a situation where oil production was peaking in such important producing regions as the North Sea, and new large discoveries of reserves were NOT taking place.

Then, in 2003-04, the escalating oil demand of China and India gave OPEC its opportunity, and they took advantage of it. What about speculation? In the diagram, in the background to the price movements from 1991 to the beginning of the new century, there was plenty of speculation, with smart speculators registering excellent incomes and bonuses; but from 2003 speculators -- or traders as they prefer to be called -- did not have to be particularly smart. What they had to do to make serious money was to recognize that demand was outrunning supply, and one of the reasons for this is OPEC and its agenda becoming the determining factor on the supply side of the oil market, which they still are!

Unlike the situation when I wrote my oil book, the futures market now occupies a pivotal role in the pricing of oil (for reasons that cannot be discussed in this short note), but if the actions of speculators or traders or dealers in physical oil have not been validated by fundamentals, a price movement of the steepness shown in the diagram could not possibly have happened! Some algebra might be useful here, but it will be excluded because neither algebra nor anything else can convince the new chorus of hard-line populists who are resolutely determined to blame 'Wall Street' for the present macroeconomic meltdown, as well as the failure of the oil price to collapse as a result.

In my textbooks (2007, 2000) I might have said that there still remains a great deal to be explained about the oil market, but as far as I am concerned that is no longer the case. To use a favourite expression of President Richard Nixon, it is all perfectly clear. Given the likely future demand, oil is scarce, and that commodity will become scarcer as the global motoring population increases!

As for the prediction of Len Gould at the beginning of the present contribution, large or small wars for energy materials are something that definitely could happen, but when possible it would be best if they were avoided, since they are extremely expensive. Alan Greenspan may have been correct in attributing the Iraq war to oil, since after the fall of Bagdad the only building in that city receiving maximum protection appeared to be the oil ministry, however it must have occurred to him (and others) that it would have been more economical to finance very large investments in the oil and tar sands of Northern Alberta than to continue to prosecute a war for years after it was won. Moreover, there are some large Iraqi oil fields that are ripe for exploitation, in that they contain large quantities of easily accessible oil, and apparently Big Oil has been welcomed back into Iraq for the first time since oil assets were nationalized in the early seventies.

Perhaps I should confess my belief that things have played out so that Iraq will remain a staunch member of OPEC, and abide by its quotas. The reason I believe this is that it makes both economic and political sense. The IEA now says that non-OPEC production -- which is about 60% of total crude output -- will peak this year, but they cannot accept a global peak of crude by 2030. This is not just wrong, but in terms of secondary school mathematics ignorant -- although the brilliant energy analyst Gregor MacDonald confines his judgement to "silly", and provides some numerical evidence that non-OPEC production has already peaked (2010). Moreover, when on the subject of economic sense, it might be wise to remember that the key variable for the oil importing countries is not production in the OPEC countries and elsewhere, but exports from those sources. Consumption in the oil exporting countries is set to rise almost everywhere, and this could mean a stagnation of exports even if output in those countries increased.

Something else that I would like readers of this contribution to ponder, is that a larger production from that unfortunate country than the one realized today, whether it was or was not related to almost any conceivable output quota for oil that OPEC would have assigned Iraq, might have sufficed to avoid the disastrous macroeconomic events of the past (and coming) two years.

References

Banks, Ferdinand E. (2008).'The sum of many hopes and fears about the energy resources of the Middle East'. Lecture given at the Ecole Normale Superieure (Paris), May 20, 2008

______ (2007). The Political Economy of World Energy: An Introductory Textbook. London and Singapore: World Scientific.

______(2000). Energy Economics: A Modern Introduction. Boston and Dordrecht: Kluwer Academic.

______ (1980). The Political Economy of Oil. Lexington and Toronto: D.C. Heath.

Chenery, Hollis B. and Paul G.Clarke (1962). Interindustry Economics. New York: Wiley

Cohen, David (2009). 'Mr Market gets it wrong again'. 321 Energy.

MacDonald, Gregor (2010). 'Officially, peak non-OPEC in 2010. Really? Seeking Alpha (January 15).

Eltony, Mohamed Nagy (2009). Oil dependence and economic development: the tale of Kuwait. Geopolitics of Energy (May).

Greenspan, Alan (2008). The Age of Turbulence. London and New York: Penguin Books.

Kubursi, A.A. (1984) 'Industrialisation: a Ruhr without water'. In Prospects for the World Oil Industry, edited by Tim Niblock and Richard Lawless. London and Sydney: Croom Helm.

Subcommittee on International Economic Policy (of the United States Senate), (1979). 'The future of Saudi Arabian oil production.' (April)