Although the fundamentals of energy supply and demand still underpin the long-term future of the oil and gas industry, the pace of change in the energy scene has been accelerating, Edward Chow, senior fellow of energy and national security at the Center for Strategic and International Studies, a Washington, D.C., think tank, observed to the Alaska World Affairs Council on May 11. This rapid change and the resulting uncertainty creates difficulties for an industry that needs to invest in projects that may take 10 to 15 years to pay off, Chow said.
“We don’t know where all of this is actually leading,” Chow said. “The most obvious indicator of that (rapid change) is price volatility in the oil and gas market.”
Things that used to take decades to work through now seem to happen in days or even hours, he said. The price of oil more than doubled between the summer of 2007 and the summer of 2008, hitting a peak of $147 before crashing back to $32 and then climbing back up again.
“Last year, 2011, was the highest average price in the history of the petroleum industry,” Chow said.
Chow said that there is probably now a $20 risk premium factored into the oil price, reflecting oil traders’ concerns over possible supply disruption because of issues such as the Libya uprising last year and the Iranian situation this year.
And at the moment market psychology has taken over from supply and demand fundamentals in oil futures trading, Chow said.
“People are speculating on sentiment, as opposed to speculating on supply and demand. It’s no longer strictly a hedging phenomenon,” he said.
At the same time, oil demand is sluggish to respond to price changes — people do not immediately change their cars when prices go up. And it takes the oil industry a long time to respond to high prices because of the lead time involved in bringing new oilfield projects to fruition.
Debunking peak oil
However, the high oil prices have brought to light the weakness of a theory that the world is about to pass an unsustainable peak in oil supplies. New oil and gas resources have magically appeared in improbable locations such as Uganda, offshore Mozambique and the eastern Mediterranean, Chow said.
“The other thing that we’ve learned in the last few years … is the peak oil theory is bunk,” he said.
It turns out that the availability of oil and gas supplies is determined by people’s imagination, their ability to harness innovative technology and by the amount of investment that people are willing to risk, and not so much by geology, he said.
Nothing perhaps illustrates this phenomenon better than the spectacular resurgence of North American natural gas production as a consequence of new technologies for shale gas development.
“If you had told me five or seven years ago that the United States would be producing more gas than Russia I would have thought you were crazy,” Chow said.
High gas prices at around $13 per million British thermal units originally drove the shale gas revolution, but as North American gas prices have dropped, now to around $2, the shale gas technologies have improved and become cheaper.
There are large disparities in the price of natural gas and liquefied natural gas, or LNG, around the world. Gas is currently worth $16 to $18 per million British thermal unit in Japan and $8 to $10 in Europe, Chow said. But with the United States moving into a position where it can export LNG and with regional gas markets becoming increasingly linked by the global LNG trade, in the next 10 to 15 years the international gas market will probably converge, becoming more like the globally connected oil market, rather than be dominated by gas supply contracts indexed to the price of oil, Chow said.
Meantime there is such a price premium in the northeast Asian gas market that someone is going to capture that market before the window of opportunity in that market closes.
“There is a window of opportunity for Alaska gas, perhaps in Asia, but it is not an infinitely wide window of opportunity,” Chow said. “You need to move quickly in order to seize that opportunity.”
In a few years Australia will be exporting more LNG than Qatar, world-class discoveries in Africa will go into the LNG market and China is talking about producing more gas, including shale gas. If the shale gas revolution can be replicated internationally, then the Chinese will do it, Chow said.
But Chow cautioned against the state taking on the business risk involved in a project such as bringing Alaska gas to market. In a free market investors need to take the risks, with government providing the appropriate conditions to encourage investment, Chow said.
Despite the renaissance in the U.S. oil and gas industry, Chow said that the continuing high level of U.S. dependence on oil makes him less optimistic about the situation than some observers. The 4.9 million barrels of oil spilled into the Gulf of Mexico from BP’s Macondo well is equivalent to six hours of U.S. oil consumption every day, Chow said.
“We have 4 percent of the world’s population and we consume more than 20 percent of the world’s oil,” he said.
And, although the U.S. has plenty of domestic coal, hydropower, nuclear energy and natural gas, the country has to import substantial volumes of oil. The world as a whole consumes 8 million to 9 million barrels of oil per day, Chow commented while also questioning the sustainability of the continuing rise of this consumption rate.
“It’s oil where the vulnerability is,” Chow said.
The preponderance of oil consumed in the U.S. goes as liquid fuels into the tanks of private vehicles — there are 240 million passenger vehicles registered in the country, Chow said. The U.S. needs to transform its energy usage, with a different transportation system and a rethink on issues such country living and the need to commute to work. But such a transformation would take decades to bring about.
“In order to do this we need a national dialogue about the challenges that are involved, an honest dialogue, not one that is marked only by slogans,” Chow said.
That will take brave politicians who are willing to talk about these issues in a serious way, he said.
Chow said that he personally favors a major hike in the federal gasoline tax — by at least 50 cents or perhaps by a dollar or more — as a means of dampening oil demand. A price signal such as this is a better means of guiding consumer and producer behavior than government mandates or regulations, he said. And the regressive aspects of a gasoline tax — the way in which it would hit the poorer members of society harder than those better off — could be offset by tax rebates, say on the social security tax, for the working poor.
Right now high oil prices are producing a surplus economic rent that is going to oil producers such as Russia and Venezuela, rather than to the United States. Directing that economic rent into the U.S. through the gasoline tax could help reduce the federal deficit and reduce concerns about the viability of programs such as social security, while at the same time achieving a public policy objective, Chow said.
However, no one who favors higher gasoline taxes will be elected into office, he admitted.
But, Chow said, it is a role of think tanks such as his to ask the sometimes uncomfortable questions that people need to address, even if that means saying unpopular things.
“If we are going to wander foolishly into an unsustainable path, at least some of us are raising the alarm bell,” he said.