Gas could burst Peak Oil theorists' bubble

Despite the appealing logic of the hypothesis that crude prices will inexorably rise as known reserves diminish, some experts believe it is flawed.

Analysts ponder whether some of the old forecasts for oil prices are about to be vindicated, or whether the current volatility will run its course.

As much an art as a science, oil price forecasting is a major preoccupation for many energy consultants. But whose forecast is the most reliable? After all, fortunes hang on the answer. Yet when looking ahead more than four years, almost all oil price forecasts over the past 40 years have been wrong, according to Dr Ole Gunnar Austvik, the head of research at Lillehammer University College in Norway.

As it turns out, the flawed forecasts all predicted upwards price trends, whereas inflation-adjusted oil prices actually fell for two decades from the early 1980s. It was only over the past decade that a seven-year price rally challenged that. A related question, now that oil prices have crashed and partially rebounded, is whether some of the old forecasts are about to be vindicated, or whether the current period of price volatility will run its course, eventually leaving crude lower.

The perennial popularity of forecasts projecting crude prices rising indefinitely reflects the intuitive appeal of the "Peak Oil" theory, which predicts that global oil production will reach a maximum rate and then inexorably decline. Everyone can grasp the seductively simple hypothesis, which encapsulates deep-rooted insecurities over energy supply. Surely everyone must understand that oil is a geologically scarce resource that must one day run out.

To many who see the writing on the wall, it appears that peak production must be fast approaching, if it has not already occurred. Nor does it take much economic training to surmise that the price of a commodity should normally increase if its supply falls and demand rises. So why do some articulate, highly experienced petroleum economists, among them The National newspaper business columnist Robin Mills, take issue with the Peak Oil theory?

The usual argument levelled against the prediction that world oil production is about to enter a period of terminal decline is that the theory fails to take into account technology's way of increasing known reserves of oil and decreasing extraction and processing costs. Such is the current popular bias in favour of Peak Oil, however, that sceptics are sometimes accused of nursing hidden agendas to protect vested interests.

Big Oil and governments, the argument goes, do not want the public to think the world is about to run out of oil because such subversive ideas could promote civil unrest and cause investors to dump oil producers' stock. That is not to say that all Peak Oil proponents act selflessly. Some make handsome livings peddling investment advice. There are solid reasons, in any event, to question the assumption that falling oil production would force crude prices higher over the long term.

Dr Austvik has put his finger on one of them: the problem with the rising price hypothesis is that it should come into play only if there are no alternatives to oil. If energy alternatives exist, as they do in most sectors of the economy, then another price model should take over. The "Hotelling rule", named after the late US mathematician Harold Hotelling, states that the price of an exhaustible commodity should converge towards the price of a substitute resource.

This implies that the oil price volatility we have recently experienced could represent the start of a series of decreasing price oscillations that may settle at a new equilibrium point. That price would depend on the nature of the backup energy supply, and there is no shortage of candidates in various regional markets and industrial sectors. They include renewable energy resources such as wind and sunlight, the other usual suspects for electricity generation, such as coal and nuclear energy, as well as biofuels. But the most likely substitute fuel in most circumstances is plentiful, cleaner burning natural gas.

If the imminence of peak oil production is questionable, the same goes in spades for global gas output. From shale gas in North America to big new discoveries off the coasts of Venezuela and Israel, the recent appraisal of a huge Turkmen gasfield, new Australasian, Russian and Yemeni liquefied natural gas (LNG) projects and initiatives to reduce gas flaring in Nigeria, Russia and Iraq, it has never been clearer that the world is floating on a party balloon of gas.

Ironically, the more geologists search for oil, the more they usually find gas. Consequently, gas prices have fallen in markets where the commodity trades freely. Not so long ago, gas produced from oilfields was considered a nuisance, and it was burned as waste. Now gas is a valued commodity for heating, power generation, the production of petrochemicals and fertiliser, for pushing more oil out of the ground, and even for conversion into synthetic crude oil and for use in some diesel engines.

Like oil, it can now be shipped around the world in tankers as well as moved through pipelines. If global warming continues, LNG tankers may soon ship gas from the Arctic. Because of its infrastructure requirements, however, gas has most often been sold under long-term contracts linked to crude prices. In future, if Dr Austvik is right, crude markets may follow international gas prices. That may not be welcome news for most Gulf oil producers. The era of cheap gas is probably far from over; and if there is one fuel more subject to price volatility than oil, it has historically been gas.

@Email:[e-mail]