Energy: The peak oil challenge
As the world stands on the brink of another recession, it is impossible to tell how deep it will be or how long it will last. Commentators are always confident that there will be an upturn and economic growth will return. This time, however, some are reminding people that past performance may not be indicative of future results, and there are claims that globalisation is unsustainable and growth economics is coming to an end.
If that is true, all the assumptions behind pension-fund investment must go out of the window and short-term business continuity looks doubtful as well. Surely this is just another scare story born of urban myth and put about by conspiracy theorists? After all, Malthus made similar predictions some two centuries ago, which have yet to be realised.
This time, a shortage of energy not food, at least initially, is expected to trigger economic disaster. This article will first explore the UK situation and then consider ‘peak oil’ — the point at which the maximum rate of global petroleum production is achieved — and global energy security.
Energy in the form of electricity is fundamental to the Western industrialised way of life. Electricity is not a source of energy in itself; it is a means of energy transmission. It is derived from the primary energy sources consumed by an economy: oil, gas, coal and nuclear. Natural gas is the largest component of primary energy in the UK. While 90% of natural gas comes from the North Sea, the reserves are rapidly decreasing and, in less than 10 years, the UK will be importing 80% of natural gas from Europe and increasingly from Russia. Up to 20% of natural gas will travel 7000 miles by refrigerated tanker from Qatar. Already over 60% of coal, another major fuel for electricity generation, is imported, mainly from Russia, South Africa and China.
A way of life
Apart from security of supply, the UK also has the problem of an ageing power generation and distribution infrastructure. Many of its power stations are reaching the end of their lives and while there are plans for replacements there are currently no new conventional or nuclear stations under construction. Indeed, Eon, which has plans for a new coal-fired station at Kingsnorth in Kent, recently asked the government to defer approval until its policy on clean coal technologies is clear.
Assuming there are no disruptions to fuel supplies in the short-term, there are still risks of unplanned cuts from the unreliability of older plants and the limitations of grid capacity in the face of a severe winter driving up peak demand. Unplanned power cuts are not only the cause of lost production and employee layoffs, but complex plants can suffer extensive damage from sudden power loss. Repairs or replacements may last several weeks. A sudden, or even very short, outage can cause damage to computers and data files.
A recent report (Mind the Gap — The black hole at the heart of the UK’s energy supply) by LogicaCMG estimates that there will be a gap of 5% in energy supply at peak demand by 2010, rising to 23% in 2015 and 32% in 2020. Predicted costs of the damage caused to the UK economy range from £8bn in the early years to nearly £200bn in 2020. How far these losses will be insurable is unclear.
Primary energy
From a global perspective, energy security rests on the availability of primary energy. Production of oil, gas and coal cannot keep up indefinitely with growing global demand. At some stage there must be a supply gap and a realisation that if energy supplies can no longer grow, then traditional economic growth must cease. An increasing number of commentators believe the situation is close to that point now. They believe that it is at ‘peak oil’, the point beyond which the current daily production of 88 million barrels cannot be exceeded.
The US reached peak oil production in 1970, the North Sea in 1999. All major oil fields throughout the world, with the exception of those in the Middle East, have reached their peak. The Middle Eastern fields have been in operation since the 1940s and still contain more than 60% of the world’s reserves. The exact quantity remains a state secret.
When the global peak is reached, the price of oil will rise because production will no longer keep pace with demand. From January to April 2008, oil rose from $100 (£51.27) to $120 a barrel, against a long-term trend of under $50. The weakness of the dollar and demand from emerging economies such as China and India drove the price up, even in the face of falling demand from a recession-hit US. There is already talk of the $200 barrel. More than a year ago, Matthew Simmons, chairman at Simmons and Company International, a bank serving the energy industry, said at least $300 a barrel would be closer to the mark. Until now, the fact that oil is finite has not been factored into the price.
Oil is essential for pharmaceuticals, fertilisers, plastics and pesticides. As oil becomes more expensive there will be price pressures on food, healthcare and transportation. The initial reaction to this is that it has all been heard before and there must be undiscovered reserves that will satisfy demand at least for the rest of this generation, by which time technology will have found a solution. Brazil has recently announced a vast new oilfield; Russia, Canada and the US are squabbling over the ownership of oil and gas beneath the Arctic Ocean; and Canada’s tar sands contain more hydrocarbon than has been used since the start of the petroleum age. If there’s a problem with oil, there are still huge coal deposits, more nuclear power stations can be built, crops can be grown for biofuel, hydrogen can be used that burns with no emissions apart from pure water, or a whole range of renewable technologies, from wind and solar to waves and tides, can be exploited.
The size of the new Brazilian oilfield has been inconsistently reported as five billion, eight billion or 33 billion barrels, although the operating companies are back-tracking until more drilling has been completed. If we assume that 33 billion is the correct figure, at 88 million barrels global consumption per day, the field will provide enough for one year. We will need to find a similar field every year, just to keep up with current demand.
Sub-sea arctic oil, tar sands, biofuels and hydrogen are all subject to the same constraint — the energy-in to energy-out ratio. In economic terms, if prices for any commodity rise high enough, we will eventually justify extracting it from almost anywhere. This is not true of energy. There is no point in expending the energy equivalent of one barrel of oil to extract one barrel of oil — or less. Subsidies have distorted the market so that some biofuels contain less energy than it takes to produce them. Already oil companies classify some remote oil and gas fields as ‘stranded assets’ because they need more energy to exploit them than they yield. Apart from the environmental issues surrounding Arctic oil and tar sands, it is doubtful whether the energy produced will exceed the energy used. As for hydrogen, the energy required to isolate, store and distribute it is far greater than the energy it contains.
Coal, nuclear and renewables
At opposite ends of the pollution scale, these sources principally produce electricity — 40% from coal in the UK, 21% from nuclear and 8% from renewables. Even if all these could be expanded to compensate for declining oil and gas, the electricity grid would need to be upgraded and 30 million cars would have to be replaced with electric cars. In addition, gas central heating will have to be scrapped.
If these predictions are true, peak oil will reverse globalisation and change investment assumptions for ever. The decline of oil means not only that personal mobility will be dramatically reduced, but that lifestyles will be fundamentally changed.
There is no education campaign to prepare the public for the coming oil shock. The effects will probably be felt gradually, first as an economic recession. As recession slides into depression, people will suspect a conspiracy and seek scapegoats. The government is already being petitioned about VAT on fuel and about oil company profits. Violence may erupt against governments, the oil companies or anyone else seen to be responsible, as many people remain in denial.
Gradually a reorganisation of society will occur. Local communities will have to become self-sufficient because it will be too expensive to ship food and other goods in from distant countries, and too expensive to travel more than a walking or cycling distance to work, school or to the supermarket. International trade will decline and whole industries based on transport and travel will disappear.
The technology will remain, and as long as the electricity can be gained from another source, people will still web-surf and shop online. They will also spend more time at home, with their families and among the community. If these predictions are true, these changes will occur not within 20 to 50 years but within the next 10. The world will be on the threshold of the post-industrial revolution — the greatest challenge of our lives.
Anthony Day is a speaker, writer and consultant on sustainable business – energy, climate and resources. He is a member of The Actuarial Profession’s Environmental Research Group.
Environmental Research Group
The purpose of the Environmental Research Group is to identify and research areas in which actuaries can become, or will need to become, involved in environmental issues.
The Climate Change Working Party (CCWP) is a related group set up specifically to look at the effects of climate change on actuarial work. Both groups comprise members from all fields of actuarial practice, as well as a number of nonmember experts, such as insurers, accountants and scientists. Due to the reorganisation of the Profession, both groups will become member interest groups.
Any members who wish to participate should contact Audrey Cosens at audrey.cosens@actuaries.org.uk. Please also visit the CCWP’s website at http://climatechange.pbwiki.com.
