Peak Oil primer

I drafted this article a few months ago for Carbon Retirement‘s newsletter, but simliar ‘peak oil primer’ articles were published around the same time by a couple of big publications and I decided not to publish it. In hindsight, I think this article is a bit more factual and have decided to post it here.

Through the Twentieth Century, we continuously increased the rate at which we drilled oil, but cheap, easily accessible oil may now be running out. This article looks at some of the debates around ‘peak oil’ and starts to explore how it could be relevant to people and businesses.

What is peak oil?

Peak oil is something that happens in all oil fields. The light, good quality oil rises to the top. It is cheap to extract and easy to refine. As the field empties, the remaining oil is thicker and stickier and more difficult to extract and refine. The finished product becomes more expensive to produce and production tails off.

If you add together fields that are at different stages in their lifecycles, you get a similar pattern, suggesting that peak oil also applies to regions. Here in Europe, for example, we are already well past the peak.

Oil production in OECD Europe

Source: Energy Watch Group 2007 - http://www.energywatchgroup.org/fileadmin/global/pdf/EWG_Oilreport_10-2007.pdf

What is less certain is whether oil production on a global level is going to peak any time soon, and how peak oil will affect economies, companies and communities.

What evidence is there for global peak oil?

There is agreement on one thing: there is still a lot of oil in the ground. The question is how much of it is accessible at a price we are prepared to pay. Much of it is deposited in places that are difficult to reach, or is controlled by unpredictable or hostile governments.

One important piece of evidence is the rate of new discoveries. A pattern is noticeable in countries where production has already peaked: the rate of new discoveries peaks a few decades before production peaks. In the US, discoveries peaked in the 1930s and production peaked in 1971. In the UK, discoveries peaked in 1975 and production in 1999. Global discoveries peaked in 1964.

A second piece of evidence concerns the recent oil price shock. Higher prices should stimulate more production if there are opportunities to develop new oil fields, but while the oil price increased from around $50 per barrel in early 2007 to around $145 in mid-2008, production hardly changed.

Thirdly, the average amount of energy required on average to get oil out the ground is increasing. According to Simon Ratcliffe of the Association for the Studies of Peak Oil and Gas, in the early Twentieth Century one unit of energy was required to produce oil containing 100 units of energy. In the 1970s, this ratio had declined to around 25:1. Today, some fields are only achieving 4:1.

There are many predictions of when global peak oil will occur. Some say it is happening now or even happened in the past few years. Others believe that production will continue to increase for several decades. The chart below shows a range of forecasts. The International Energy Agency (a forum for industrialised countries) has some of the most optimistic views.

Global oil production forecasts

Mbpd = million barrels per day CO + NGL = crude oil and natural gas liquids Source: The Oil Drum: http://www.theoildrum.com/node/5521

In August 2009 the IEA’s latest research showed that oil production is likely to be lower that previously thought. The forum’s chief economist told The Independent:

One day we will run out of oil … and we have to prepare ourselves for that day. The earlier we start, the better, because all of our economic and social system is based on oil, so to change from that will take a lot of time and a lot of money and we should take this issue very seriously.

The oil and gas companies are often optimistic about oil production. BP, a company that is investing in difficult oil deposits like tar sands in North America, believes that more sophisticated extraction technology will allow affordable oil to continue flowing for several decades. In a speech earlier this year (pdf), David Eyton, BP’s Head of Research and Technology, said:

There has been much debate about if and when we will reach ‘peak oil’. BP’s viewpoint is that there is no shortage of fossil fuels: we estimate that the world has already demonstrated the commercial viability of around 40 more years of conventional oil resources, 60 years of gas and 130 of coal at current consumption rates. Technology can extend all of these timelines well into the next century, in particular through the development of more unconventional resources. In our view, the more pressing challenge in the next decade is likely to be environmental — and more about the ‘peak carbon carrying capacity’ of our atmosphere than the availability of fossil fuels.

Shell’s view is more conservative, but still shows a belief that technology will allow new sources of oil to be gainfully exploited (from the Peak Oil Task Force report):

The global supply of oil will flatten by 2015, in Shell’s view, and if the oil industry globally is to maintain hydrocarbons supply on this plateau, very heavy investment will be required in ultradeep water, pre-salt layers, tight gas, coal-bed methane, in the Canadian tar sands and other areas of unconventional oil production

Until we have clearly passed the peak there will be a range of views, and the oil and gas industry is likely to be at the optimistic end. Several people we spoke to in preparation of this article, including some ex-employees of oil and gas companies, felt that companies like Shell and BP tend to be optimistic about their future production to protect their share prices.

How might society be impacted?

A reduced oil supply will have a particular impact on transport because 99% of transport fuel is petroleum (BERR 2008) – a product of oil. Food will also be affected because fertilisers are made from oil and the global food supply chain relies on transport for moving food between continents.

Let’s think about what could go wrong. Trade will reduce as transport becomes more expensive, and countries and local communities will be forced to diversify to produce food and energy. With less total energy going into the global economy and less labour specialisation, economies will shrink.

More competition for resources will lead to military occupation of oil rich areas. Politics will become nationally focused as countries seek to secure their energy and food supplies.

People differ in their view of the severity of these changes. Nathan Hagens, an energy researcher at the University of Vermont, identified four views  of our future:

1. The ‘renewable energy’ contingent, who generally subscribe to the belief that solar based flows will eventually replace fossil fuels in a somewhat seamless transition and that Peak Oil is probably a good thing with respect to the environment;
2. The energy technologists, who believe that even in face of near term peak, that better drilling, seismic, and recovery techniques combined with increases in unconventional fuels will keep us roughly on a business as usual path. (BP falls into this group);
3. The End of Growth group – who think we have overshot resource limits (not just energy) and must generally powerdown to some cocktail of both more sustainable means and aspirations; and
4. The Dieoff Crowd – that some large proportion (possibly all) of humankind will perish due to biological tenets based on fact that we are akin to a plague species, our rapaciousness trumps our ingenuity and ability to plan for future…essentially humans are not smarter than yeast.

In some countries, local communities have begun to organise to increase their resilience to these changes. These movements are called Transition Towns. They seek to reduce their energy use, grow food locally and improve community links. In short – to break their reliance on global energy systems.

How is peak oil relevant to a business manager?

It’s tricky for a manager of a company that is not directly involved in energy to engage closely with peak oil. The debates are complex and technical, with different points of view. As a result, most people who think about peak oil are geologists or involved in the oil and gas industry, and sustainability managers are not usually engaged with the issue. Peak oil is in a similar place to climate change ten years ago – which was mainly a concern for campaigners and atmosphere scientists.

However, a decline in oil supply would have a big impact on every economic sector. Oliver Dudok van Heel, a sustainability expert, believes that “some carbon intensive businesses will not survive. If a business model is based on liquid fossil fuels being available at a low price, they will have to change the way they operate. Overall, economies are likely to grow less and possibly shrink.”

As a business manager, you need to think about the resilience of your business model. Here are five questions to start you off.

• How sensitive is your business to higher energy prices? What would be the impact on profitability of a long term increase in the price of oil?
• How reliant on oil are your customers? Do their businesses depend on transport, for example? If their businesses suffer, yours will suffer too.
• Are there commercial opportunities in a more limited energy scenario? Even if the economy shrinks, some businesses will be successful if they can help local communities to diversify and meet their immediate needs.
• Are there ways that your business can support local food and energy production?
• What are other organisations in your sector doing about peak oil?

Is carbon still following oil?

In January I looked at European oil and carbon prices to show how they were reacting to the economic recession. Today I had another look at these two markets to see what’s happened over the past six months.

The graph below (click to expand) shows the December 2009 EUA contract (from ECX) and the Europe Brent spot price (from the Energy Information Adminstration, converted in Euros using currency data from OAndA). The prices have been indexed to January 2007. Historically, carbon has largely followed oil.

In 2009 the trend seems unclear. While daily trading news is full of headlines like “carbon nudges higher on strong energy complex”, carbon seems have recovered less than oil. In January 2009, the nominal prices of oil and carbon were both around 70% of January 2007. At the end of last week, oil was at 110%, while carbon was at 80%.

Performance of EUAs vs crude oil

I don’t have any clear commentary to offer just now. Glancing at the graph, it looks like carbon has fallen behind oil by about three weeks, but that doesn’t feel like a very plausible theory. I’d be interested to hear any thoughts.

Europe: irrationally inefficient

McKinsey published a report today (pdf) today that shows how all our energy and carbon targets can be met through productivity improvements alone (i.e. our energy supply does not need altering). And even better – unlike most GHG abatement technologies, all energy productivity improvements are reported to have a positive NPV.

Improving energy productivity involves things like energy efficient buildings and recovering heat from industrial processes.

The chart below from McKinsey’s report shows just how important energy productivity is. When we compare with CCS, which has the potential to deliver 3% of Germany’s GHG abatement potential and according to most industry estimates requires a carbon price of EUR 40 – 75 to be commercially viable, it seems obvious that our obsession with clean coal being necessary to deliver safe levels of emissions is misplaced.

So why isn’t the market delivering these improvements? Even with no carbon price, energy productivity makes economic sense. According to McKinsey, most productivity gains are dispersed among consumers who have insufficient capital and information to make the right investments. Product standards are the only way to address these barriers.

It feels like there’s something missing to me – it just seems like too big a market failure. I’m afraid I don’t have an answer right now but will mull it over.

Energy 2020: Closing remarks

There were two things I heard consistently today:

1. The support of the public is essential – both to get the right planning and policy decisions and because individuals are directly responsible for a large part of the UK’s carbon footprint. In some cases, the speakers seemed to have a point that individuals don’t have enough information to make a judgement about what is in their best interest. Average homeowners are not in a position to calculate the impact of microgenerators on their energy bills and the value of their home, for example. But I’d say that most people do have sufficient information about their energy costs and act quite rationally. The issue is that their demand is inelastic. When fuel prices go up, people continue driving. This is why cap-and-trade (either upstream, like the EU ETS, or downstream, like the personal carbon trading scheme being designed by the RSA) is an attractive mechanism: the price at which people are prepared to change is discovered. If people had carbon rations they would start taking note of their meters.
2. The planning process is jamming up the whole renewable industry and needs to be reformed. Everyone was politely horrified with the UK’s planning and it seems an obvoius place to start if the UK is to achieve its target.

Thanks to the RSA for inviting me to blog at this important Summit. I’d encourage you to take a look through the Energy 2020 Action Plan.

Energy 2020: Resource availability

Sir Ben Gill, Hawkhills Consultancy. Where is the resource going to come from? 3 places:

1. Virgin materials – there is an enormous untapped resource from forests. The most wooded area of the UK is the south-east, and these woods could provide woodchips for biomass plants. Energy crops still have high potential – for biomass energy and transport biofuels. Virgin materials also could be used much more extensively in construction and manufacturing.
2. Non-virgin materials – many things thought of as waste are useful resources. Up to 10m tonnes of timber are being put into landfill each year – this could easily be turned into energy. Energy from manure and the organic elements of packaging and other types of waste can be extracted through combustion, digestion etc. Food from wasteful processing, homes and supermarkets has a lot of embedded energy.
3. Other renewable sources – waves, tidal power, rivers etc. are abundant in the UK.

Energy 2020: Major infrastructure

Stephen Balint, RES. The UK has good natural resources and could even exceed the 2020 target, but revision of the UK’s infrastructure is a prerequisite.

The planning process must be driven by the renewable energy strategy. Many applications have been stuck for 6-7 year. Public buy-in is critical to making these plans work and is key to planning decisions.

The National Grid is not delivering for new renewable generation – there is a long queue for connection.

The price-cap regulation for energy is stifling investment. Ofgem needs to prioritise sustainability. These changes will affect consumers – but in the long term, the switch to renewable energy will reduce consumers’ exposure to volatile energy markets.

The 2020 targets are only a milestone and plans must look beyond this (other speakers echo this).

Energy 2020: Consumers and Waste Energy

Phillip Sellwood, Energy Saving Trust. Consumers are key – transport and domestic sources are 45% of our current CO2 emissions – but we’re spending 25% of our time looking at them. Without consumer support, real progress will impossible.

Consumer action means modifying day-to-day behaviour: choosing energy efficient products, how and when we travel, the source of energy we use, our use of water and how we deal with waste. It doesn’t mean radically different lifestyles.

Consumers are vital across all the sectors being discussed in this summit. Transport in particular needs tackling urgently. If everyone chooses the most efficient car, individual carbon footprints would go down by 25%.

Energy 2020: Transport

Brian Robinson, IMechE. (Note energy use by transport is included in the 15% target.) The main contribution that transport can make is through demand reduction. The government’s focus should be on the road vehicle fleet – the fuel consumption hasn’t gone down since the mid 90’s (“a national disgrace”). There is also a role for demand reduction in freight.

Investment is required for a modal shift, especially in freight. We could be using boats to transport goods round the country to much better effect, for example. These networks don’t exist so investment is required.

Biofuels are also an important area of development. Growth will be driven in part by the long term price of oil. They have been unfairly demonised – some are sustainable and they have an important role to play. 10% biofuels in transport is attainable.

Consumers must demand efficient cars – manufacturers will move fast to block legislation but even faster to meet their customers’ wishes.

Energy 2020: Central and local government

Andrew Cooper, REA. Local government is a big sector with a lot of potential for better energy management, but there are a range of barriers to it delivering energy efficiency. Councils are quite siloed and the departments often don’t feel they have control over the energy they use. Many large councils will be under the Carbon Reduction Commitment, but they have a poor understanding of what carbon is and their exposure to the mechanisms. The way investment decisions are made often only take account of the revenue impact of the project and exclude the environmental impacts. They’re limited by funding constraints (especially districts). Building control is not well enforced (perhaps the fault of building regulations rather than councils). There’s a lack of knowledge, skills and political will.

So with all that doom and gloom, what can they do?

A whole range of things, from free cavity insulation (Kirklees) to CHP (Southampton). There is a big overall potential – local authorities have a huge estate and broad channels to communicate with local communities, but they need direction from central government.

Energy 2020 – Bulk Energy Production

Gaynor Hartnell, REA. Bulk energy is unique in that is has been considered (at least the electricity side – less the heat side) in detail and we know the issues. The big issue is obvious: we have large, electricity only plants rather than heat and power plants integrated with the build environment.

Key issues for renewables are:

• Getting quick access to the National Grid – renewable generators must be connected when they need to be connected
• Getting planning permission – Merton (a required to include microgeneration with new developments) is a good development but much more is required
• Getting the right incentives in place. The Renewables Obligation should be seen as a temporary thing – the end game is for the economy to deliver clean energy

Energy 2020: National Action Plan

Ian Arbon, Engineered Solutions. Energy 2020 is a vision for how the UK can meet its commitment to supply 15% of all energy (heat, transport and electricity) from renewable sources by 2020. That’s a big jump – currently less that 2% of energy is supplied from renewable sources, a figure that is not growing at any great pace. We are well behind the rest of Europe in implementation.

BERR’s UK Renewable Energy Strategy Consultation is called a “good strategy but difficult to implement”. The worst outcome would be for the strategy to remain “just words”, and the Energy 2020 Manifesto will go a long way to meeting it.

The Manifesto follows the energy hierarchy – conservation is most important, followed by efficiency and then generation. If followed, Ian believes the UK can exceed its European renewables target.
The Action Plan is available from today on the RSA website (pdf) for review and comment.

RSA Energy 2020 Summit

The RSA is holding its second high profile sustainable energy summit on Monday, titled Energy 2020. The debate will focus on how the UK can deliver on energy efficiency and the European renewables target. Given the gulf between current policies and the UK’s target to generate 15% of energy from renewable sources by 2020, the summit will be focusing on an area that requires urgent attention.

If you can’t be there, don’t worry – I’ll be reporting live from the event on In Balance.

Policy Exchange on CCS

Policy Exchange has published a report arguing that carbon capture and storage (CCS) is essential to meeting our emission reduction targets. The report explores various ways that the government could support CCS.

If there is a strategic case for CCS the mechanism that I believe to make most sense is:

5. Government underwrites the EU-ETS minimum base price.
This involves a risk for Government, to provide baseline funds of €30 to 60/ton CO2 if the EU-ETS market remains low. It is not clear how the Government recoups its money, except by waiting to sell EU-A at a high price some years later, or by cross-subsidy from the new Phase 3 Auction revenue.

I would argue that the base price be set by auction. The CCS developer that offers the lowest base price would be given by Ofgem the difference between that price and the EUA price for each tonne of CO2 it avoids. This approach is economically similar to the feed-in tariff that Policy Exchange favours but is more likely to determine an appropriate subsidy. Unlike Policy Exchange’s other preferred option – allocating one or two free EUAs to plants for each tonne of CO2 they capture – it maintains the environmental integrity of the EU ETS (see this post for more on multiple EUA allocation).

The government would risk depressing the EUA price by subsidising CCS and thereby inflating the subsidy it would pay for further CCS generation – but this cost would also be borne in the feed-in tariff model. The reduction in the EUA price would filter through to the wholesale energy market, making the feed-in tariff represent a larger subsidy.

The real question is whether there is a strategic case for CCS. New CCS will not create net emission reductions in the short term (unless CCS remains unrecognised in Phase 3 of the EU ETS), so it should only be supported if it is considered integral to decarbonisation in the long term. As Policy Exchange points out, it looks like we will be dependent on coal for decades to come. Perhaps our resources should be concentrated on reducing our dependence.

Renewables – what incentive is there to build back-up capacity?

E.ON is arguing that Britain will need lots of fossil fuels for a long time in the future, even if we hit our 15 per cent renewable energy generation by 2020 target (which will mean 30 – 40 per cent renewable electricity generation). Gas is a particularly good partner for renewables because it can be switched on and off quickly and balance out the volatility of renewable generation.

E.ON has a fair question about this: what incentive is there to build back-up capacity?

“If we are to meet the European target, we need to back that up with fossil fuel generation that can be turned on quickly when the wind does not blow,” explained a spokesman for the company. “But the issue is who pays for that. If we spend half a billion pounds on a gas-fired power station that is not turned on very often, we need to look seriously at how that investment is rewarded.”

Renewables generally have low marginal generation costs, so fossil fuels will lose when there is lots of electricity being generated by the new wind farms (assuming they ever get built).

Funding CCS through proceeds from government EUA auctions

Many people think that proceeds from EUA auctions should be hypothecated (ringfenced) and spent on projects that reduce emissions, rather than going into general government funds. The CBI believes that EUA proceeds should be used to fund carbon capture and storage demonstration plants.

Given that coal power stations are within the EU ETS, any reduction in emissions achieved through CCS will allow the coal industry to sell EUAs (or buy fewer), so there would be no net reduction in emissions from CCS specifically (assuming that EUAs are scarce). Public support for CCS would allow other industries within the EU ETS to release more carbon dioxide into the atmosphere and depress the EUA price. It would amount to a subsidy to the coal industry, which, given the rosy outlook for coal over the next few decades, does not seem sensible.

Pragmatically, though, CCS is felt to be necessary for meeting overall emission targets and it is unlikely that the coal industry would do it alone. If governments go ahead and provide funding – whether from EUA proceeds or otherwise – they should build in provisions to reclaim and cancel EUAs matching the avoided emissions from the power stations.

A different option would be to offer auction proceeds as debt finance for CCS (or any long term project that reduces emissions within the EU ETS) and allow the project owners to sell any surplus EUAs. This would encourage industries within the EU ETS to take on riskier, long term reduction projects.

(Or just use the money as grants outside the EU ETS, of course.)

Just for reference – Green NGOs are sceptical about CCS – see see WWF and Greenpeace – pdf.

In Balance makes bold accusation that IEA chief economist doesn’t understand demand elasticity

The IEA’s chief economist yesterday warned that cap-and-trade policy alone will not deliver the cuts in emissions desired by the EU. His concern is that energy consumption is inelastic – people may simply pay a higher carbon price rather than consuming less energy.

He is right, of course, that that the EU ETS alone is not sufficient. It only covers around 40% of the EU’s emissions, it must take more care of leakage (industries relocating beyond the EU and continuing to produce the same level of emissions) and it is unlikely to create a business case for long term investments like carbon capture and storage.

But demand elasticity is not a serious concern for the emissions within a cap-and-trade scheme. With cap-and-trade you effectively auction off a fixed number of rights to release GHGs into the atmosphere. If everyone is very reluctant to change their carbon intensive habits the price would be very high. No type of consumption is completely inelastic and the scheme discovers the price at which people are prepared to change.

Carbon capture and storage needs a kick start, but not through double crediting

Chris Davies, a Lib Dem MEP, is pushing the EC to adopt a directive that would require all coal power plants built from now on to have carbon capture and storage by 2030.

He recognises that the market alone will not deliver CCS and public support will be required. The EU budget is locked down to 2013 and he thinks member states are unlikely to pay.

He supports a “double credit system” within the EU ETS. This means that each tonne of captured carbon dioxide is not counted as an emission and the power plant is allocated an additional allowance (or even two). The allowance has a market value and can be sold or used by another of the company’s power plants.

This type of intervention might make sense if there were fears of non-compliance and unenforceability in Phase 2 of the EU ETS, but there are not. If double crediting is sufficient to get CCS off the ground, it will cause a net increase in emissions and a reduction in the allowance price as the additional allowances are sold or used.

Other types of public support (such as a direct subsidy) for CCS would be likely to reduce the allowance price too, but they wouldn’t increase emissions – rather they would move reductions into coal from other sectors.

Coal generation accounts for an estimated 24% of European greenhouse gas emissions. This proportion will increase over the next 20 years. A successful double-credit scheme could more than wipe out the reductions that will be made in the EU ETS.

Feed-in tariffs defeated: not such a bad thing

The government got a bit of kicking on Wednesday night when 33 Labour MPs voted for feed-in tariffs to be included in the Energy Bill. The government did not want the amendment, and in the end, it got its way and feed-in tariffs were left out.

The amendment would have required energy suppliers to buy renewable electricity from homeowners and businesses at fixed, long term premium prices. The UK’s level of renewable generation is miserably low and many think (e.g. FoE – pdf) that a FIT is essential if the UK is to stand any chance of meeting its EU target of 15% renewable energy generation by 2020 (the proposed directive is at this pdf and is supported by the UK).

There is not much doubt that a FIT would increase microgeneration. But is it a good way to reduce emissions? Questions that need answering include: how will the new capacity work with core electricity supply? What are the capital emissions associated with manufacture and installation? What is the likely cost to energy consumers per tonne of GHGs avoided?

Because FITs are an intervention based on a type of solution (small scale renewables) rather than outcomes (lower emissions), questions like this must be addressed.

Windfall profits to power generators do not mean that the Emission Trading Scheme is not working

The WWF and Point Carbon published a report (pdf) earlier this week estimating that power generators in Germany, the UK, Spain, Italy, and Poland will make a windfall profit between 23 and 71 billion Euros in Phase 2 of the EU ETS.

The windfall is made when power generators pass the market value of freely allocated allowances onto their customers. They do this because the allowances have an opportunity cost: once the allowances have been allocated, one option open to the power companies is to shut down or scale back their trading and sell the surplus. Customers must pay the generators the value of the credits to persuade them not to do so.

Point Carbon is probably right about the windfall – the calculations look as good as any – and WWF is right to feel that the windfall is unmerited. Environmental Capital calls it a “cautionary tale about how not to fight climate change” and that it “undermines the fight to curb emissions”.

Actually, the windfall problem does not damage the environmental integrity of Phase 2 – the cap remains the same. The problem is around who the cost imposed on carbon ends up with. The government is probably the best we can hope for, which is where the money will go when allowances are auctioned.

One way out of the windfall profit problem while credits are still freely allocated would be to impose a fine on companies that reduce their trading activities. The fine would be based on an estimate of the market value of EUAs that would have been required to cover the reduced trading.

Government seems unsure whether it wants a domestic renewable industry or not

The UK supports an EU target that will require it to generate 15 per cent of its energy (which is likely to mean 30-40 per cent of its electricity) from renewables by 2020. The UK has a low baseline of renewable generation and the target will be stretching and expensive – which is why the government has been trying to open loopholes.

According to The Guardian, the government is pushing for carbon capture and British developments in other (cheaper and less regulated) countries to count toward the target.

This is a pretty silly suggestion. The EU wants the target because a) renewables are thought to be a key part of the European response to climate change and b) the renewables industry is not considered capable of getting on its feet with an outcome based mechanism (i.e. one that is based on lower emissions rather than the type of solution) alone. The target is a type of command and control, which has been used because European governments are sure that we need significant renewable generation within Europe, even if the market won’t deliver it.

Allowing non-European or non-renewable generation to count toward it does not make sense.