1 Introduction
Oil is the most globalised commodity and, arguably, the most critical commodity for the functioning of the world economy [
1]. It supplies most of the energy for transport, a significant proportion of heat and electricity, and it is the basis for the provision of chemicals, textiles and pharmaceuticals. It is also a critical input factor in the food supply chain; food security being linked to supplies of liquid fuel [
2].
Not surprisingly, energy security, and oil supply security in particular, are widely discussed [
3,
4]. In recent years, the discussion has focussed on whether there are enough oil resources left to meet the demand over the coming decades. In spite of the fact that the International Energy Agency, the energy watchdog of the OECD, warns of such potential shortages and even has an emergency response mechanism in place to mitigate short-term disruptions, many argue that the market will itself respond to these demands. The key argument is that, faced with increased demand, the price of the commodity will rise, which opens up previously uneconomic resources so that supply will increase. Supply and demand are simply regulated via the price—It is economics stupid! This is correct in some respect, but it is not the complete story.
In 2010, a common misperception about peak oil was dealt with. Neither petroleum nor fossil resources are getting scarce. It is conventional (crude) oil that is a limited resource and its production is currently plateauing, at about 64 million barrels per day (mbd) [
5]. Unconventional resources are filling the gap between crude supply and demand, now at 93 mbd. So, in essence, both sides of the argument have a point: There is indeed ample potential supply of fossil fuels, however, conventional oil, which is relatively cheap to recover, can no longer meet the demand. The conventional oil is so cheap because it is a relatively low density, low viscosity liquid and can be pumped out of the ground without the help of copious amounts of energy (see below).
High oil prices indeed make previously uneconomic resources marketable. The catch is that the extraction of other types of oil has many implications ranging from environmental to financial and geopolitical which will be explored in Sections 3 to 6. In Section 2, the status of global reserves of conventional oil will be first summarised.
2 A question of grade: conventional reserves vs. unconventional resources
When talking about oil, most people will think of a thick black liquid that is sold in barrels. While most of the oil produced now is indeed a black liquid priced by the barrel, hardly any one will ever see the inside of a barrel. This black liquid referred to as conventional oil, is the oil that is most accessible and least technically challenging to bring into production. It can, for instance, be produced by pumping water into wells as oil floats on water. In contrast, unconventional resources either cease to flow at surface temperatures and pressures or are submerged in sand or sediment, fairly described as tar sands or tight oil. These resources are, therefore, not readily recovered because the production is capital intensive and requires significant amounts of supplementary energy.
Conventional oil is unambiguously defined as oil that is less dense than water, i.e. above 10 in terms of API (American Petroleum Institute) gravity [
3], while some apply a stricter measure of 17.5 API [
6]. The former definition includes heavy oil (10–20 API), medium oil (20–30 API), light oil (above 30 API), and condensates. The data from reporting agencies do not distinguish between oil grades according to density, and commonly include a range of ‘conventional liquids’ including extra heavy oil (0–10 API), tar sands, tight as well as shale oils and natural gas liquids (NGLs). These reserves are referred to as unconventional oil resources and are excluded from the world conventional oil inventory.
Even if there were no other supply constraints, is there sufficient discovery of new conventional oil reserves to, at least potentially, meet the rising demand over the coming decades? To explore this, the amount of conventional oil reserves found worldwide since 1900 and was analyzed and compared to the amount of oil consumed each year [
3]. Figure 1 illustrates the flux in and out of the world’s oil inventory, i.e., the difference between the amount found and the amount consumed in each year. Therefore, positive values were given for years in which more oil was found than consumed and negative values for years in which more was consumed than discovered. As can be seen from Fig. 1, enormous amounts of conventional oil were found in the early part of the 20th century and these are the resources that have fueled the modern global economy. Since 1980, however, less oil has been discovered than consumed year by year with one exception, 2009, the year after the financial crisis that was characterized by a slump in oil demand. This clearly shows that more oil are consumed than are found year by year. The difference between the supply of conventional oil and the overall demand has to be filled using unconventional reserves, which has wide ranging implications (see Sections 3 to 5).
Murray and King in 2012 tackled the same problem in a different way by examining the conventional oil price as a function of production volume, as shown in Fig. 2 [
7]. This visualisation shows a striking change in the curve, analogous to a physical phase change, as production rose from 64 to 74 Mb per day. The price at 64 mbd was $15 per barrel (pb), in 1998, rising to $40 pb in 2005. Beyond this date, crude oil production ceased to rise, but the price rose and fluctuated between $40 pb and $140 pb. The behaviour up to 2005 was attributed to normal elastic supply-demand factors, but crude oil then plateaued, with the rapid price rise clearly attributable to demand exceeding conventional supply capacity, with marginal supplies being met from unconventional sources.
Conventional oil reserves are unevenly spread around the world, which means that most nations have, since 2005, been importing oil at very high prices (up to $160 pb), and this has sent trade balances into deficit in many countries, including countries of the EU, the USA and India. These negative trade balances have created large fiscal deficits and consequently significant foreign debt. This debt has been a key factor in the slow recovery of most advanced economies since the crisis of 2007 to 2008. Emerging markets dependent on oil imports, most notably India, have also suffered from high oil prices. However, the second half of 2014 was a game-changing year for oil prices and thus for both oil-importers and exporters.
3 A question of fiscal prudence: oil importers vs. oil exporters
What happened to oil prices in 2014 went against almost all forecasts. They dropped, and they dropped significantly. Between June 2014 and December 2014, the price for London-traded Brent crude oil dropped by more than 50% (Fig. 3). This has significant geo-political and geo-economic ramifications. In short, it has turned the tide. Although prices did not fallen to the pre-2005 levels (Fig. 2), it was taking pressure off the oil importers in both developed and emerging markets that relied on steady, secure and affordable oil imports. It could act as a cut in taxes in all oil importing countries and might trigger the long-awaited economic recovery. Moreover, many conventional oil exporters benefited significantly from high oil prices over the past years, since production costs did not rise in line with prices. One response would be to cut supplies in the hope that prices would rise, but OPEC was clearly not using this option. Oil exporters depended heavily on oil revenues, having developed economies that were so heavily reliant on this one export commodity. For example, in the Russian Federation, energy accounted for 25% of GDP, 70% of exports, and 50% of federal revenues.
Oil exporting countries are, therefore, closely examining the so-called fiscal break-even price of their oil exports, the price at which they are able to balance their fiscal budget. Most of the countries, however, have to go through fiscal tightening in order to avoid significant foreign debt [
8]. For some countries, as with Russia, currency depreciations counteract the decrease in oil prices, which brings some relief.
Why did the high oil price, sustained above $100 pb since 2008, collapse in the matter of a few months? Blanchard and Arezki, of the International Monetary Fund (IMF), analysed the case and argued that both supply and demand factors played a role [
9]. A slowing global economy and the consequent reduced demand for oil contributed about 20% to 30 % to the price drop. However, metal prices, which typically react to global macroeconomic activity even more than oil prices, also decreased but substantially less so. This observation suggests that factors specific to the oil market, especially supply factors, have played an important role in the observed drop in oil prices.
According to them, the evidence points to a number of supply-side factors that contributed to an increase in oil production, such as the unexpectedly fast recovery of Libyan oil production in September as well as Iraqi production that remained stable in spite of domestic unrest. The major factor, however, was the publicly announced decision of Saudi Arabia, the dominating force within OPEC, not to counter the steadily increasing supply of oil by reducing its production. This as well as the November 2014 decision by OPEC to maintain their collective production ceiling of 30 mbd in spite of the perceived excess in oil supply has induced a bear market. This market has brought the price of oil closer to what may be a new ‘market equilibrium,’ estimated to be between $50 pb and $70 pb [7]. However, this notion is difficult to justify. Production costs, even of conventional oil, are highly variable, and strongly dependent on political factors, including $500 billion p.a. oil subsidies in many oil producing countries, and the operations of the OPEC cartel.
Another factor that is widely believed to have contributed to the observed fall in oil prices is the increased production of unconventional oil and gas in the US. The production of US unconventional oil in 2014 catered for 4% of global oil demand or roughly a quarter of US oil demand. In total, 75% of US oil consumption has been provided by domestic production this year, and, therefore, the effect on the global market has to be expected. It is obvious that domestic production and low prices not only have economic but also geo-political ramifications, as discussed below.
The next critical question that has to be asked is “what has triggered the resurrection of American domestic oil production?” Definitely, the fracking technology has played a crucial role and ultimately is the enabler of this effect, as has already been outlined (vide supra). Nevertheless, money has played a crucial role, as well.
After the financial crisis that has paralyzed the global economy in 2007, interest rates in many countries were decreased by Central Banks to historic lows. The availability of “cheap money” due to these low interest rates as well as strategic energy security concerns (vide infra) and a chase for profitable investments by a sector that had just lost its glamour were the crucial support for this transformation. Oil production in North Dakota, for instance, has increased five-fold in 5 years [
10] from 218 bpd in 2009 to 1087 bdp in 2014, a transformation fuelled by low-interest financing.
However, the case is more complex as interest rates have affected not only oil supply and consequently oil price, but also exchange rates. Since the early 2000’s, economists have observed a clear negative correlation between the dollar value and oil prices, i.e. an increase in oil price is associated with a decrease in dollar value. The European Central Bank has analyzed the correlation using time-series regression and concluded that a 10% increase in the price of oil leads to a depreciation of the US dollar effective exchange rate by 0.28%, whilst a weakening of the US dollar of 1% causes oil prices to rise by 0.73% [
11]. Although statistically significant estimates for the link between exchange rates and oil prices were found, a variance decomposition showed that the economic relevance of exchange rate movements in explaining overall fluctuations in oil prices was limited, which was consequently also true for the reverse effect. The Czech Central Bank has come to a very similar conclusion in a study that compares the price of Brent Crude with the dollar-euro exchange rate [
12]: Since 2002, the gradually rising price of oil has been accompanied by a depreciation of the dollar. This trend peaked in 2008, when the effective exchange rate of the dollar was weakened to a historical low in March (close to USD 1.6 to the euro) and the average monthly price of Brent oil then reached an all-time high in July. Recently, the reverse effect could be observed, i.e. the appreciation of the US dollar in combination with the decline in oil prices. A possible explanation is that the US dollar functions as the valuation currency in the international oil trade, and consequently a strong dollar has a downward pressure on the oil price.
Goldman’s Sachs Commodities Leader Jeff Currie, however, sees different effects. In “The New Oil Order” [
13] he writes that from the early 2000’s to the global financial crisis, increasing oil imports has seen a widening US current account deficit. It puts depreciation pressure on the dollar and appreciation pressure on oil producer’s currencies, which, in turn, puts further widening pressure on the current account deficit causing additional dollar weakness. However, Currie also claims that during the post-crisis financial market normalization, the drop in oil imports has dramatically reduced the correlation between oil and the US dollar, to around 0% (i.e. is uncorrelated) today from historical highs near 60% in 2008/2009. This means that although oil prices have recently dropped as the dollar has surged, one trend does not explain the other, according to the investment bank’s analysis.
We believe that due to the stabilization of the US economy and the consequent appreciation of the dollar, the US market is, again, becoming a relatively safe option for international investments especially in the bond market. The inflow of foreign capital therefore pushes the nominal effective exchange rate of the US dollar to historic highs which, as concluded by the ECB, pushes the dollar price of oil to nominal lows. The causality of this will certainly be analyzed by economists over the coming years.
Will prices stay at current levels for the time being? Yes and no: according to the IEA, oil inventories have reached their highest levels in two years and, therefore, price increases are likely. But by how much will prices increase? The futures market suggests that by 2019 the barrel should recover to roughly $73 – we will see if the futures market is a good indicator here. Unfortunately, past predictions do not provide much confidence. However, with production efficiency improvements due to technological advancements, it is possible that production costs for unconventional oil will decrease, which will be offset against production cost increases as ‘easy’ fracking resources diminish. It is, therefore, likely that unconventional resource will remain part of the resource mix over the coming three decades. The longer term future will depend on global demand, set to rise with increased consumption predicted for the Asia Pacific region, and with the ability of conventional oil production to keep pace with demand. In the short term, it is likely that prices will stay well below the $100 mark.
This is in line with our own predictions in 2010 [
5] and we reprint the updated graph below (Fig. 4). While conventional oil production is already at a plateau, (dark and light blue), unconventional resource production (green) will have to close the gap between supply and demand. This is a major problem: The energy used in the mining and refinement of these resource is significantly higher than that of conventional resources and consequently, the greenhouse gas (GHG) emissions generated by combustion of these fuels is higher. Globally, there is an agreement to manage GHG to keep the temperature rise due to global warming to<2°C above pre-industrial times [
2,
5,
14]
4 A question of sustainability: energy security vs. climate security
Energy must be invested to produce a resource. Oil has to be pumped out of the ground or removed from shale by fracture cracking (fracking), and the crude product has to be transported to the refinery where it is converted to various fuels (gasoline, diesel, kerosene etc.) and chemicals which, then, have to be transported to the point of demand. Each of these steps has an energy cost, and the amount of energy that has to be invested to make fuel out of a certain reserve in the ground critically depends on the quality of the reserve.
To gauge the benefits for society of a certain energy provision process, the net energy gain, or energy balance, has to be assessed. Odum and Hall have conducted studies on the energy balance of energy provision, and introduced the term “energy returned on investment” (EROI) [
15]. The EROI is given as
In the case of conventional resources such as the light oil produced in the US early last century or the oil that is produced in Saudi Arabia today, little energy is invested to get a high-energy product. The EROI of these products can be as high as 100, providing 100 times the energy invested. However, for unconventional resources, the EROI is significantly lower. Murphy and Hall gauge that shale oil, for instance, has an EROI of as little as 5 GJ/GJ [
16]. Take tar sands as another example. For the production of oil equivalent to a barrel containing 6.12 GJ, 1.26 GJ have to be invested, and the energy balance of tar sand is therefore roughly 4.8 GJ/GJ [
17]. This compares to 10 GJ/GJ for oil imported to the US from the Middle East or Venezuela [
18]. All this is roughly a factor of 20 lower than early conventional oil. Consequently, the energy benefits from these resources are significantly lower than the benefits from conventional oil. The benefits are diminishing.
Moreover, the energy invested in the production process has an equivalent in emissions (unless the energy is itself sustainably produced, without GHG emissions) and, therefore, unconventional resources cause an increased environmental externality due to their increased carbon footprint. Figure 5 illustrates the different greenhouse gas emission impact of liquid fuels derived from different feedstock—the emissions per amount of energy provided increase with decreasing quality of the resource.
Figure 5 therefore demonstrates that in closing the widening gap between the supply of easy oil and global oil demand with liquid fuels made from feedstock such as gas, coal, tar sands or tight/shale oil, we will increase global greenhouse gas emissions even more than anticipated and counteract other decarbonisation endeavours. In effect, an “environmental credit card” is being used to meet an entrenched but unsustainable desire to continue to base economic development, or recovery, on maintaining a mode of providing energy for transport which is not suited to the 21st century.
Are unconventional resources always bad for the environment, because they provide less energy and cause more emissions? Not always. For example, in the US where shale gas is crowding coal, an even worse polluter, out of the resource mix and therefore results in overall localemissions savings [
19]. China is at present looking for advanced fracking technology in order to produce its more challenging shale gas reserves. Since China is heavily reliant on coal for electricity production, also here a crowding out of coal by shale gas may be environmentally beneficial. Moreover, given China’s appalling air quality, which is to a great extent due to coal-fired power plants, substitution of coal by clean-burning gas is likely to provide co-benefits for public health.
Even Europe, which is committed to a pathway to reduce emissions of GHGs by at least 40% by 2030, and by 80% by 2050, is now pushing for fracking technology to produce domestic reserves. As gas is a good back-up for intermittent renewables such as wind or solar, now commonplace in Europe, this could also mean that renewables will be further developed. However, the renewed interest in European unconventional is also likely to be driven by geo-political factors as explained in Section 5.
5 A question of power: political tensions vs. energy sufficiency
Europe is currently dependent on Russian fuel imports, especially gas. The energy policy of Europe is based on the progressive development and deployment of renewables, usually intermittent renewables such as wind and solar. In order to ensure steady supply, gas-fired power plants serve as back-up due to the current absence of economic power storage facilities. This, in combination with the Nordstream pipeline that delivers Russian gas through the Baltic Sea, has made the EU (particularly Germany) reliant on Russian supplies. In the light of the recent tensions between the West and Russia, the EU is seeking to diversify its gas supply, which is a further motivation for tapping into domestic shale reserves. Moreover, additional LNG terminals are available and could take up the surplus production created by the US shale-gas boom. This should make Russia nervous.
But it is not just Russia, US unconventional oil and gas output has offset shortages induced by sanctions against Iran, and this may have brought the Iranians back into negotiations on their nuclear programme. They may be experiencing a weakening of their negotiating status due to the newly added supplies of oil and gas.
The decision of OPEC to maintain their collective production ceiling of 30 million barrels a day demands further examination. This move is likely to be strategic: excess supply will keep oil prices low for the time being and since production costs in OPEC states are lower than production costs for unconventional resources in North America, some of the unconventional fields could go out of business. This could induce a rebound of the oil price and shift power back to the OPEC states. This is, however, a double-edged sword as higher prices will return the oil fracking business to the market place. Alternatively, the OPEC strategy may be to retain prices at a level low enough to drive unconventional supplies out of business for an intermediate period. Current political instabilities in the Middle East, including Sunni and Shia tensions, may be a significant factor in supporting this decision.
The US could counter OPEC’s chess move by keeping their fracking fields in production through import or pricing controls: domestic production is a strategic imperative for the US as it eases balance of payment issues and keeps the budget off the fiscal cliff.
OPEC countries as well as Russia are now orienting their fossil fuel business towards the growing markets in the Eastern Hemisphere, a logic reaction to increased production in North America as well as energy efficiency and renewable energy endeavors in Europe. However, just like the US, China and India are looking into developing their more challenging, unconventional resources to increase energy security and shift trade balances. Rapid advances in fracking technology could soon enable Asian resources, which are geologically more difficult to produce, to add to the diversified fossil fuel mix. In such a scenario, some countries could lose their relevance in the international arena and could react with drastic measures.
In short, the geopolitical impact of the surge in US oil production due to fracking of tight oil is already in play. The tide has not just turned economically, but also politically. But, strategically, it is imperative to respond to the new energy politics by integrating our responses to work for economics, politics and the environment.
6 A question of choice: short-term vs. long-term sustainability
Unconventional resources of gas do buy time to complete our decarbonisation endeavors without running into resource shortages. But the use of these novel resources must be guided and incentivized so that they act as a transitional and not a long-term fuel. First, we have to internalize the environmental externality of greenhouse gas emission. It does not really matter if this is done via regulation, obligation, a carbon tax or a carbon price, but government intervention is needed [
20]. The Environment Protection Agency in the US is setting a maximum amount of CO
2 that can be emitted per kJ of power produced by a power station. This could incentivize either carbon capture and storage installation for coal-fired power stations, or substitution with renewable and/or gas-fired power sources. It is important to note that renewable costs have been dramatically reduced over the past decade, largely driven by the market created by feed-in tariffs in the EU. Smart grids and energy storage facilities will need to be incentivized through publically funded research to enable these transformational technologies to competitively enter the market. In 2012, we published a compendium that outlines how both the energy and the transport sectors can be restructured to conserve remaining easy oil supplies as a precious future resource [
2]. This restructuring ranges from alternative fuels to modal substitutions, novel drive-trains and advanced transport management. Since that volume was published, the first commercial second generation bio-refinery has come into operation, the Granbio refinery in North East Brazil. This plant creates 22 million liters of liquid fuel per annum for transport from cellulosic, leafy material [
21] which is a by-product of nearby sugar cane plantations. Biogas produced as a by-product in the process itself is used to provide all the energy needed to run the refinery, the baling and transport of the stalks and leafy material after the harvesting of the cane itself for sugar production, with surplus biogas put into the market. The overall production and use of the fuel is negative in CO
2 emissions, since the CO
2 used in plant growth offsets the CO
2 produced in combustion. The product is also commercially competitive even at current oil prices. The roll-out of 2nd generation bio-refineries in conjunction with food farms can be anticipated over the coming decades [
22]. Moreover, car sharing and bike schemes are now commonplace in big cities, taxis are often powered by a hybrid electric drive train and full-electric vehicles. Europe, especially the UK, is investing and upgrading its railway system to make it faster and more convenient.
A combination of all this could lead to a sustainable economic system that reduces demand for oil, therefore conserving oil supplies for essential uses, and eventually removing oil as a major source of political instability. We should make sure that we do not trade off long-term environmental and energy security for perceived short-term economic gain.
7 Conclusions
We are not running out of oil, but we have reached a plateau in easy, inexpensive conventional oil production, which will be followed by a fall in production [
23]. Cheap conventional oil has over the past century been the mainstay, globally, of primary energy for transport and for the chemical and pharmaceutical industries [
24]. Novel unconventional oil reserves are abundant, but are more costly to produce, provide less net energy and cause more GHG emissions. This runs counter to the accepted global agreement to reduce emissions, if the gap between rising demand for oil and the supply of conventional oil is met with these high-emission resources. We have to internalise the externality of greenhouse gas emissions so that highly polluting resources such as coal are replaced by renewables, energy efficiency measures, and advanced biofuels. Pricing and regulation will be critical to balance short-term, inertial responses to energy security and pricing with long-term climate and environmental security.
At the moment, very strong political and economic forces [
25] support the utilisation of unconventional oil recovery. In fact, these resources help turn the tide and oil exporters are now politically significantly weakened due to the increased energy sufficiency of the West. This restructuring of the geo-political balance towards indigenous primary energy supplies, solar, wind, hydropower, geothermal, tidal, wave, etc. as locally appropriate, coupled with energy storage facility and smart grid development, is likely to reduce the fiscal burden of current energy import prices for most developed, emerging and least developed economies and also aid the resolution of conflict in key parts of the world.
Unconventional gas resources can be used as an interim measure to buy time to restructure our energy and transport systems, hopefully reducing demand for oil so that that the remaining crude oil reserves can be used as an essential resource for future generations. Achieving this will require policy interventions and significant political will.
Higher Education Press and Springer-Verlag Berlin Heidelberg
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