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Oil change

Fighting global warming means reducing dependency on oil. But though supply is insecure, it remains plentiful. Keeping oil in the energy mix makes sense.

There is a vast, unexplored region where an estimated 30% of the world’s oil lies buried, yet only 2% of the world’s exploratory drilling is carried out there. Where is it? The answer is not Antarctica or under the Pacific, but the Middle East. Surprisingly, the world’s largest oil reservoir is under-exploited. Over the last 40 years, the number of wildcat wells drilled in the Middle East has plummeted, and today exploration is nearly zero. A number of reasons have contributed to the decline, from regional conflicts, two decades of low prices and the soaring cost of equipment.

Elsewhere around the globe, the picture is similar, with the additional constraint of tough environmental controls affecting exploration and drilling. A company leasing a drilling rig in the North Sea can expect to pay a 100% higher rate today than it would have paid a few years ago, and up to 400% more for a rig in the Gulf of Mexico. This inflation results principally from the surge in demand, mainly from fast-growing economies. How long can these needs be met? The Oil & Gas Journal estimates that the world’s proven oil reserves stand at some 1,293 billion barrels, revising earlier estimates upwards by approximately 14.8 million barrels. But prices, for both producer and consumer, remain high. In 2005, a barrel of crude averaged around $50, nearly four times the nominal price in 1998. Transportation is partly to blame, as oil is consumed p rincipally by that sector. Globally, primary oil consumption is around 35% of total primary energy consumption, and it will only decline slightly to 33% by 2030, according to World Energy Outlook 2006. Oil’s current contribution to global C02 emissions is 39%–of which the transport sector accounts for one-fifth. Add to this geopolitical uncertainties and it is little wonder governments are turning to biofuels as a way forward in developing a reliable energy mix.

The US Geological Survey estimates that the volume of undiscovered conventional resources is nearly 2,300 billion barrels. This is nearly twice the volume already produced (1,080 billion). And it is economically recoverable. Getting it out of the ground is the problem. Three-quarters of total industry investment goes “upstream,” which is to say production, of which 90% goes into fuel development, and only 10% into exploration. New technology would help, but industry is cautious, since companies understandably prefer to use tried and true methods when tackling expensive new projects. In the WEO 2006 “Reference Scenario”, about $164 bn per year will need to be invested between 2005 and 2030, most of it directed to production to maintain present capacity.

Even if massive investment for exploration is forthcoming, international companies face new hurdles. The unexplored basins around Greenland, in the Russian Arctic and deep-water Caspian are promising for large-scale investment, but their remoteness, harsh climates and lack of infrastructure means hefty capital investment. In the Middle East, Iraq is under-explored, but the current security risks are prohibitive. As pointed out in WEO 2006, oil and gas investments have surged in recent years, driven by rising materials, equipment and labour costs.

Energy security concerns and public suspicion of multinational energy corporations earning supernormal profits on the back of the price surge has led to renewed interest in nationalisation. Some countries restrict foreign investment, others, including in the OECD, forbid it entirely. Venezuela, Bolivia and Russia have put reserves back into state hands. The high price of oil has so far not enfeebled the global economy, which may be taken as a sign of good health as today’s robust marketplace now absorbs shocks of the kind that disrupted the oil industry in the 1970s and early 1990s. However, continued reliance on subsidies, notably in developing countries, cushions the consumer against price realities. This encourages waste. Subsidies also take government funds that could be diverted to research in alternative energy or to energy initiatives for poorer countries.

Diversification of energy sources finds its strongest supporters among countries with high import densities. If OECD countries adopted the alternative energy policies proposed in World Energy Outlook 2006 aimed at reducing dependence on imports and cutting greenhouse emissions, it could save up to $900 billion in oil imports by 2030. That is roughly the GDP of Canada.

Oil is still a remarkable energy source, with enormous energy density and efficiency. Its relative use will have to decline if we are to curb carbon emissions, but keeping it within the energy mix will make good economic sense for several years to come. And that means more wildcat drilling, too.

 References

IEA (2006), World Energy Outlook 2006, Paris. Visit www.worldenergyoutlook.org 

For further information on oil projections at the IEA, contact olivier.rech@iea.org and david.fyfe@iea.org 

©OECD Observer No 258/259, December 2006