Column: Oil Prices and Recession

by
Dale Allen Pfeiffer, FTW Contributing Editor for Energy

Isn't it nice to know the recession is over? Al Greenspan, George W. and big business are all patting themselves on the back and talking about how resilient our economy is. Some of them are even venturing to wonder if this little economic bump was really a recession at all. Sure, the recovery is somewhat anemic, but the worst is behind us, they say. Corporate Average Fuel Economy limits? Who needs them? Increase the percentage of electricity generated from renewable sources? Why bother? Don't worry about anything, folks. Just go out there and spend, spend, spend for your country.

Do people really buy this snake oil? I'm not one for polls, but in a recent Netscape poll, 62 percent of over 300,000 respondents said they did not believe the recession was over. Average folks are still feeling it in the pocketbook, in lack of job security, and in their stock portfolio. And once the 2001 tax returns come in, and people realize where last year's tax rebate came from, the dissatisfaction is bound to increase. And, if anyone hasn't noticed at the gas pumps, the price of oil is already on the increase.

So what has been going on over the last couple years, what is the deal with this "weak recovery," and what do we have to look forward to?

OIL PEAKED IN 2000

I won't claim oil was solely responsible for the recession. Among other major factors were the overvalued tech market, consumer debt, and the manipulation of currency values. However, it was the surge in oil prices from 2000 to early-2001 that originally plunged the world into recession.

Conventional oil production does appear to have peaked in the year 2000. As production could no longer keep up with demand, the price of oil began to climb. And soaring oil prices sparked inflation, sending a very susceptible economy into recession. Here in the U.S., this was reflected by higher prices at the pumps, but we have only to look at Europe to see how seriously this event affected others. "French fishermen blockaded the Channel Ports because their fuel costs had doubled, even though their fuel was already tax-free," wrote oil industry expert Colin J. Campbell. "The dispute spread rapidly to England and other countries. Schools were closed. Hospitals had red alerts because staff and patients could not reach them. Supermarkets started rationing bread. Trade and industry was seriously interrupted: the cost was huge." The recession was not just a phenomenon of the U.S. economy. It was felt around the whole world.

So why did oil prices dive over the past year, once the recession had begun? The answer to this is really quite simple. Rising oil prices brought on a recession, which in turn cut oil demand and reduced pressure on prices. In response, prices weakened to the point that OPEC was nearly in a panic. Oil producing countries had to straddle a tightrope between their own debts and decreasing production in order to hold prices steady.

In the U.S., the Federal Reserve Board made a record number of interest rate cuts in a desperate effort to bring inflation under control. And President Bush launched another major transfusion of money from the general public to the rich, with his tax rebate of last year and the further economic stimulus package he forced through Congress after 9-11.

But none of this seemed to make any difference. Nothing affected the recession until weak oil prices allowed the economy room to breathe again. And now that the weight on our chest has been eased, we are beginning to recover. Yet this recovery is very susceptible to disruption, and it is very possible that peak oil production will prevent us from ever making a full recovery.

From the chart below, courtesy of Campbell, we can see that we have produced almost half of the oil that is available. There remains only about 150 Gb (billion barrels) yet to be found, and we are consuming four barrels of oil for every one discovered. Because of this, we are depleting our oil inheritance at a rate of about two percent per year. From all of this we can deduce that conventional oil, which is the vast majority of the oil produced and consumed, has peaked.

Measurement / Measure
Produced-to-date / 873 Gb
Reserves / 928
Discovered-to-date / 1801
Yet-to-Find / 149
Yet-to-Produce / 1077
Ultimate recovery / 1950
Current consumption (2001) / 22 Gb/y
Current discovery rate / 6 Gb/y
Current depletion rate (ann. prod. as % of Yet-to-Produce) / 2%

For the last few years demand and production have been in a neck and neck horse race. Production had the lead until 2000, at which time production hit its limit and demand took the lead. In 2001 the recession curbed demand to the point that production bounded well ahead and the price sagged. This gave the economy a chance to gain its second wind, and now demand is ready to rebound and overtake production again. This horse race could last for a few years before production is crippled.

WHAT IS TO COME?

With Bush's oil wars, or as they are officially known, the "War on Terrorism," muddying up the pond, it is very difficult to say what lies ahead. However, we can be certain that oil production will eventually begin to decline, and the world will have to adjust. Despite all the variables that could enter into play, we can make some deductions about what lies ahead.

First, world oil production peaked in 2000, but the give and take between production and demand may put off the decline of production for a few years. So it appears that we have entered what could be called the "oil plateau," a kind of limbo where we will alternate between stagnation and viability. From our perspective in the midst of things, this will hardly be perceived as a smooth plateau. We have entered a cyclic pattern of peaking production leading to a price surge, which results in recession, which then reduces demand, leading to production surplus and weakening oil prices. This will in turn permit an economic rebound and an increase in demand, bringing us back to peak production again. This cycle could continue for the next several years until the inevitable decline of production sets in. The only way out of this cycle is to hold back demand below the rate of production, and this is unlikely to happen in a free-market economy.

Outside of the Middle East, world production is already in decline. This means that the Middle East must increase production to make up for declines elsewhere simply to keep production where it is right now. Within the next few years, the Middle East will take control of world oil production. And probably by the year 2010, the world oil production curve will dovetail into the Middle Eastern production curve. There are reasons to doubt that the Persian Gulf states can rise to meet this demand. Many Middle Eastern countries are already pumping at maximum. As the importance of Middle Eastern oil grows, the entire world will be at the mercy of political and social instabilities in this region. And in any case, the Persian Gulf oil fields are aging, and their production is approaching peak as well.

The roller coaster ride should end by 2010, at which point we may begin to look back fondly on the years of cyclic recession. By this time we will slide out of the plateau into an irrevocable decline of oil production. We have the next several years to wean ourselves from oil and prepare. A century of conspicuous consumption must come to an end, and we must learn to be frugal. If we are not prepared, then the suffering will be great.

CAUTION ABOUT OIL DATA

There are reports that major oil discoveries are popping up all over the world, but none of these appear to be valid. Some of the reports are due to companies and governments attempting to put a spin on their assets in an effort to attract foreign investment. Whenever the claims are investigated, the size of the oil deposits decreases significantly. Two of the largest claims are the Arctic National Wildlife Refuge (ANWR) and the Caspian Sea reserves.

According to the U.S. Geological Survey (USGS), in the case of ANWR the most likely reserve estimate is in the neighborhood of 7.7 Gb, which is hardly enough oil to cover U.S. demand for six months.

As for the Caspian Sea reserves, these do truly represent a major find, equal to the North Sea fields. Their discovery is anomalous, due to the fact that the Caspian region only opened up to exploration after the dissolution of the former Soviet Union. Geologic studies of rock type and remote sensing data had long ago identified this as an area of interest, so the investigators rushed in just as soon as the iron curtain was raised.

However, this should in no way be taken as an indication that there are other major fields just waiting to be found. Scientific advances have done a great deal to explain where oil won't be found, and technological advances mainly serve the purpose of finding the small deposits which are still scattered about, and pumping the last few obtainable drops out of the fields that are in production.

There is also a great deal of confusion about the amount of oil contained in the Caspian fields. The most reliable figures place Caspian reserves on par with the North Sea oil fields -- 18 to 34 Gb of proven reserves, with a potential of maybe 50 Gb. While this is an impressive find, it is not enough to make a difference to the oil peak, but will only serve to help ameliorate the coming decline, and only if these Caspian reserves are fully brought on line in the next few years. Figures as high as 250 Gb are often bandied about, but they are meaningless. The U.S. Energy Information Administration (EIA) has stated that the Caspian region may yield as much as 235 Gb, but the EIA has admitted to doctoring its figures.

This is one of the major causes of disinformation regarding energy issues. The U.S. government relies on the EIA for all of its energy information. Yet the EIA, a division of the Department of Energy, has admitted that it reverse-engineers its studies. "These adjustments to the USGS and MMS estimates are based on non-technical considerations that support domestic supply growth to the levels necessary to meet projected demand levels," stated the EIA in a report titled, "Annual Energy Outlook 1998 with Projections to 2020." This means that the EIA first looks at projected figures for demand, then juggles reserve and production figures to meet demand!

Likewise, USGS reports can no longer be trusted either since the agency's about face in 2000. Prior to 2000, the USGS was talking about oil depletion and the cross-over event between demand and supply. In 2000, however, the agency published a rosy report stating there would be abundant oil for many decades. Geologists working for the USGS have stated off the record that they do not trust USGS oil data.

A WORD ABOUT ABIOTIC OIL

There is some speculation that oil is abiotic in origin -- generally asserting that oil is formed from magma instead of an organic origin. These ideas are really groundless. All unrefined oil carries microscopic evidence of the organisms from which it was formed. These organisms can be traced through the fossil record to specific time periods when quantities of oil were formed.

Likewise, there are two primal energy forces operating on this planet, and all forms of energy descend from one of these two. The first is the internal form of energy heating the Earth's interior. This primal energy comes from radioactive decay and from the heat energy originally generated during accretion of the planet some 4.6 billion years ago. There are no known mechanisms for transferring this internal energy into any secondary energy source. And the chemistry of magma does not compare to the chemistry of hydrocarbons. Magma is lacking in carbon compounds, and hydrocarbons are lacking in silicates. If hydrocarbons were generated from magma, then you would expect to see some closer kinship in their chemistry.

The second primal energy source is light and heat generated by our sun. It is the sun's energy that powers all energy processes on the Earth's surface, and which provides the very energy for life itself. Photosynthesis is the miraculous process by which the sun's energy is converted into forms available to the life processes of living matter. Following biological, geological and chemical processes, a line can be drawn from photosynthesis to the formation of hydrocarbon deposits. Likewise, both living matter and hydrocarbons are carbon based.

Finally, because oil generation is in part a geological process, it proceeds at an extremely slow rate from our human perspective. Geological processes take place over a different frame of time than human events. It is for this reason that when geologists say that the San Andreas fault is due for a powerful earthquake, they mean any time in the next million years -- probably less. Geological processes move exceedingly slow.

After organic matter has accumulated on the sea floor, it must be buried by the process of deposition. In geological time, in order for this matter to be a likely prospect for hydrocarbon generation, the rate of deposition must be quick. Here is an experiment you can conduct to get an idea how slow the rates of deposition are. Place a small stone on the bottom of a motionless pond. Take another stone of about the same size and place it at the mouth of a small stream, a stream where the current is not so great that it will sweep the stone away. Check both of these stones yearly until they have been buried by deposition. You might see the stone at the mouth of the stream covered over within a few years, but it is unlikely that you will see the stone in the pond buried within your lifetime.

It is a simple geological fact that the oil we are using up at an alarming rate today will not be replaced within our lifetime -- or within many lifetimes. That is why hydrocarbons are called non-renewable resources. Capped wells may appear to refill after a few years, but they are not regenerating. It is simply an effect of oil slowly migrating through pore spaces from areas of high pressure to the low-pressure area of the drill hole. If this oil is drawn out, it will take even longer for the hole to refill again. Oil is a non-renewable resource generated and deposited under special biological and geological conditions.

THE PROOF IS IN THE PUDDING

If oil has a rosy future, one where there will be plenty of oil to pump, then what is the industry doing to prepare for that future? The major oil companies and other related industries have been merging and shedding staff. Likewise, they are buying their own stock. These are the moves of an industry preparing to downsize. On top of this, the major companies are not investing in new refining capacity. It has been over a decade since there was any talk of building new refineries. These are signs that the oil companies know there are no major investment opportunities left. As Colin Campbell notes, "Their past is worth more than their future -- and they know it."

And now, while claiming that the rest of us should increase our consumption for the good of the economy, and while claiming that conservation and renewable energy are not as important as increasing oil and gas production, developing nuclear power and burning coal, George W. Bush and Dick Cheney have been busy renovating their own households. George W.'s new home in Texas is fueled by solar power and features a 25,000-gallon cistern that collects house wastewater and rainwater for reuse in irrigation. His house will also utilize a geothermal heating and cooling system that uses 25 percent of the electricity of traditional systems. Water at a constant 67 degrees is piped up from a source 300 feet below ground and channeled through the house for cooling in the summer and heating in the winter. Similarly, the Cheney vice presidential house is equipped with state of the art energy conservation devices installed by Al Gore.

Who said, "Let them eat cake?"

[Ed. Note: For an in-depth scientific look at the oil peak and the economy, read Colin J. Campbell's excellent article, "Peak Oil: an Outlook on Crude Oil Depletion," revised February 2002. http://www.mbendi.co.za/indy/oilg/p0070.htm]