If you earned $1 million a year, life wouldn’t be bad, especially if you had only earned $300,000 a year some 36 months previously. Suppose that in order to carry on earning $1 million a year, you had to invest $20,000 each annum. You would agree and do it, in order to preserve the healthy profits you were pulling in.
Suppose that someone came up to you and asked you to invest $60,000 a year instead of $20,000. They say it would help them out. Then they told you as a result you would only earn $500,000 a year. What would you say? You would politely ask them to insert their head in a painful and probably physically impossible place.
But this is exactly what the consuming nations such as the U.S., the European nations, and Japan are asking of countries that produce oil, such as the OPEC nations and Russia. They are saying, “Produce more to make us more profitable and yourselves less profitable.” It is not going to wash.
For some time now, countries like the UK, in the form of new prime minister Gordon Brown, have extolled OPEC to produce more oil - more oil that countries like the UK cannot refine and turn into diesel or gasoline. In the main, politicians like Brown or President George W. Bush have demanded this of OPEC, but only in order to protect themselves from the heat of public opinion.
Now we are being told by the International Energy Agency’s chief economist Fatih Birol that unless Iraq produces something in the order of 6 million barrels per day by 2015, we are going to have some difficult times. Why Iraq? Why not Russia or Saudi Arabia? In fact, Iraq seems the least likely place to hit a trebling of extraction rates within eight years. Perhaps it is because Iraq is one of the few places that could actually make money from producing more oil, even if oil fell back to $50 per barrel.
Nevertheless, what this means is that the idea of “peak oil” is not just one of geology. Rather it is symptomatic of a fiscal culture, both in business and geo-politics, that profits from low margins and tightness of supply and demand. If you flood a market with product X you will see margins fall. If you keep supply demand tight you will see margins increase, even if costs have to rise.
Everybody in the energy complex sees advantage in high oil prices, except the poor countries with no oil production and the poor people in rich countries with no means to avoid the hikes in cost. As long as you have a stake in the game, keeping the balance right works.
Of course this in turn ends up inflating costs, sacking costly workers (the experienced older ones) and lowering safety standards. This makes getting projects to completion even trickier than normal. The result being that supply and demand stay tight and the price stays high, which in turn inflates the value of your reserves – if you are a producer – and makes you even richer. As the oil and gas price stays high, it also allows you – as a producer again – to invest in the next generation of renewables without destroying your own value.
To destabilise things even more some consuming countries like the U.S. and the UK are talking about investing in other forms of energy such as biofuels. This means producers have even less incentive to carry on investing and producing more oil.
What this means is not that we have reached the halfway point in consuming the world’s hydrocarbons, instead what it means is that market economics will create a peak in output whenever it occurs. Profits create peaks.
