Throwing the Long Ball

There has been a recent barrage of articles and books regarding the future of the oil and gas industry. This preoccupation with the long-term view says less about the future than it does about the current state of the energy industry.

Speculation about the future of oil and gas is as old as the oil and gas industry. There are those who believe the end of the resource is in sight. And there are those who believe new technology and entrepreneurial spirit guarantees that oil and gas are going to be around for a long, long time.

Those arguments have existed since shortly after the Drake well was discovered in 1859. Though the particulars of the arguments may be different today--the most recent concept debates when the world will reach peak global productive capacity--the discussion continues and, as always, remains unresolved.

Witness the many articles--and books--on the future of oil and gas that have cropped up in the last couple of years. M King Hubbert enthusiasts have found solace in Kenneth Deffeyes: Hubbert's Peak: The Impending World Oil Shortage. Scholarly journals have presented some intriguing efforts. For example, Foreign Affairs carried an extended piece last summer on how the U.S. should enact an energy policy that generates less reliance on oil--particularly Middle Eastern oil. What made the article notable was the political diversity of its co-authors, who are former members of the Bush (Senior) and Clinton administrations.

Nor have business and trade publications been absent from the growing volume of copy. Two weeks ago, The Economist acknowledged the 30th anniversary of the Arab oil embargo with a cover proclaiming: "The End of the Oil Age." This infatuation with the future was also evident at the Society of Petroleum Engineers annual technical conference in Denver last month, with a panel discussion on myths and realities of future oil production.

In the early 1990s, the volume of copy focusing on the future of the oil and gas business was much lower. Between 1982 and 1994, no one really cared about the future of oil--or gas--because the main problem facing the energy industry was overcapacity. World productive capacity greatly exceeded demand for oil.

With the evolution to oil and gas commoditization after the 1970s, excess capacity resulted in low-cost production and an emphasis on cost reduction through technology and manufacturing types of efficiencies encapsulated in the term "just-in-time" inventory. The overriding consensus was that new technology guaranteed low energy prices, a concept epitomized in another, somewhat infamous, cover on The Economist proclaiming: "Drowning in Oil." The March 1999 article argued that technology and greater efficiency meant that crude prices above $10 were destined for the dust heap of history.

Oil prices doubled by the end of 1999 and have been strong ever since, thanks to new cohesion among OPEC member nations.

Ironically, the renaissance in articles that the industry has seen lately dates to this era in the late 1990s when it became apparent to some that the energy supply/demand lines were about to cross. This surfaced initially as the Simmons Thesis, named for Matthew Simmons, the erudite CEO of the Houston investment banking firm Simmons and Company International. The Simmons Thesis argued that the world's growing demand for oil was outpacing the energy industry's ability to supply hydrocarbons. The situation was exaggerated because of the enormous decline in industry infrastructure through decades of underinvestment.

Basically, oil and gas industry capital expenditures had been growing at an annual rate of 10 percent since 1990 while production grew by less than 1 percent. Reserves increased at only 1.1 percent per year. The convergence of these lines eventually meant disaster.

It was in this atmosphere that the first resurgence of the "Back to the Future" articles surfaced, typically as a rebirth of interest in the Hubbert Curve model. M. King Hubbert, formerly a Shell Oil Company geophysicist, had done a number of statistical studies in the 1950s on oil discoveries, reserves, and production, all of which led him to project that the United States would reach peak oil production about 1970. His theory, enshrined as a bell-shaped curve, gained instant credence when U.S. oil production rolled over the peak within a year of Dr. Hubbert's forecast.

King Hubbert died in 1989. But a group of devotees expanded on his concepts and began applying the theory to global oil production. This surfaced as a series of articles by Colin Campbell and other Hubbert enthusiasts that appeared in the Scientific American and other journals as the 1990s came to a close. The theme was sobering. The peak for conventional oil production was likely to take place in the first decade of the 21st century, ostensibly between 2003 and 2010.

The message was quite simple. The world--particularly the United States--had a narrowing window of time to begin weaning itself from reliance on oil.

Imminent peak proponents managed to upstage colleagues who had different ideas. In 2000, the U.S. Energy Information Administration speculated global peak production was more likely to be one-third higher than present daily consumption--and likely to occur around 2037, though it could happen as late as the 22nd century.

Ultimately the exact peak is unknowable, and probably will be for years after it passes. There are two variables that make prediction hard. The first is infrastructure, or the industry's ability to find, produce, and transport raw material from source to consumer. This is primarily a function of price.

The second is the unpredictable role of technology.

Shorter-term, non-OPEC oil production is expected to increase from places like Mexico, Russia, and eventually Iraq. This production gain will be roughly equal to growing demand as the global economy recovers. However, it will serve as a short-term bridge to the future. But the reality of petroleum is inescapable. Eventually global petroleum supplies concentrate in the Middle East, which sits atop two-thirds of global oil reserves.

And that is what makes the most recent articles of interest. Most perceive the inevitable concentration of petroleum reserves in the Middle East as ultimately dangerous. The mantra behind many of the articles is contained in the recommendation that the U.S. and the developed world need to reduce reliance on petroleum long before petroleum supplies run out. The argument today is that technology is in the earliest stages of an era that will for the first time offer the potential for a nondisruptive transition to a future of lower consumption from areas of geopolitical risk.

It is largely a matter of political will to start down that pathway--something always easier said than done.