First published in the Guardian, 3 December 2008.

An old friend was once memorably described as a sixties liberal with Catholic guilt – you can just imagine the internal contortions. I got the same impression of grinding gears while reading the International Energy Agency’s latest long term forecast, the World Energy Outlook 2008, published last month. In many respects the IEA’s analysis of threats to the oil supply is bloodcurdling, and yet the Agency maintains that global production can keep rising for at least two decades. The contrast is almost schizophrenic. The rich nations’ energy watchdog is clearly alarmed but seems afraid of its own bark.

The IEA’s annual forecast has become steadily darker in recent years, but this time the deterioration in its outlook is dramatic. Only a year ago the Agency was predicting that global oil production in 2030 would reach 116 million barrels per day, up from around 84 mb/d, but now it has slashed that to 106 mb/d.

At the same time the Agency has also doubled its oil price forecast. Last year it said the cost of crude would fall in the long term, but now it predicts an average of $100 per barrel until 2015 – despite the deepening recession – rising to $120 in real terms by 2030. It concludes that the era of cheap oil is over and that the recent extreme price volatility will continue.

If that sounds like good news for global warming at least – as officials prepare for UN climate talks in Poland next week – the IEA warns that its new ‘reference scenario’ would still mean a devastating 6°C rise in global temperatures.

One reason for the deeper pessimism about oil is a new analysis of the rate at which output of existing fields declines due to falling reservoir pressures – an inevitable feature of oil production. This number has always been difficult to estimate, but now the IEA has done a detailed study and concluded that the global average decline rate for fields that have already peaked is 6.7% per year, much higher than previous estimates and in spite of billions of dollars of remedial investment. That means in order to satisfy the IEA’s predicted demand growth of 10 mb/d day by 2015, the industry must build 30 mb/d of additional capacity. It is as if the oil industry is struggling up a large unstable sand dune, constantly slipping back, and forced to scramble three steps to make the distance of one.

The IEA says the challenge of raising oil production is made even harder by the recent collapse in the oil price from a record high in July of $147 per barrel to around $50, because many planned oil investments are now uneconomic. News of projects being delayed comes almost daily, creating the conditions for an even bigger price spike whenever the economy recovers. The report warns “there remains a real risk that underinvestment will cause an oil supply crunch [by 2015]”. This would pitch the world back into recession once again, with all the economic and social misery that implies.

But as alarming as it sounds, the IEA view is almost certainly far too sanguine. The Agency maintains its feared “supply crunch” could be avoided if only the industry would invest enough, and if OPEC, with three quarters of the world’s reserves, would only be reasonable. It insists there is no geological shortage of oil in view (“peak oil”), and that output should continue to grow to 106 mb/d in 2030, even though that would mean building new production capacity equivalent to six times that of Saudi Arabia today. Yet all this depends on a series of highly optimistic assumptions, buried in the report, which fundamentally undermine the IEA’s conclusions.

The first is that there is even the remotest chance the necessary investment will happen in time, now that projects are being delayed from America to the Middle East. It will take a sustained rise in the oil price before oil companies are confident enough to resuscitate these investments, by which time it will be too late to avoid another price spike. The IEA’s “real risk” of a supply crunch is more like a racing certainty.

The second assumption is that steep declines in non-OPEC oil fields will be offset by increases in “non-conventional” oil production such as the Canadian oil sands. This also looks unlikely. Oil sands projects are uneconomic at less than $80 per barrel, and several have recently been shelved. More importantly, they require vast amounts of water, and this is likely to limit output to about 3 mb/d, whereas the IEA is counting on twice that much by 2030. To be fair, the Agency’s forecasts for non-conventional production are so hedged around with caveats it hardly seems to believe them itself.

The third is that OPEC will ramp up its production, which the IEA says is crucial to satisfying demand “in the face of dwindling resources in most parts of the world and accelerating decline rates everywhere”. But if the rest of the world is running out, it makes perfect sense that OPEC members should want to husband their resources. The IEA fails to make a convincing case for the cartel to behave any differently.

More specifically the Agency assumes that Iraq will triple its output to 6.4 mb/d. The country almost certainly has the geological potential, but what it will actually be producing in 2030 is anybody’s guess.

Fourth is the assumption that OPEC’s oil reserves are anything like as big as they claim: 935 billion barrels. There have been severe doubts about this ever since the 1980s, when many members made huge upward revisions, without discovering any new oil, which most observers regard as largely bogus. The IEA has gone some way to deal with this by employing independent estimates which are somewhat lower than OPEC’s claims, but their numbers could still be some 250 billion barrels too high. PFC Energy, a Washington-based consultancy, has concluded that on a more prudent estimate of OPEC’s reserves, its output could peak by the middle of the next decade.

With so much apparently unjustified optimism in its model, the danger is that the IEA’s supply crunch turns out to be something even worse: peak oil – the geological limit of oil production – or as near as makes no difference. If the IEA were to moderate its assumptions, its outlook would come into line with the view of several major oil companies. Total has said the global output will never exceed 95 mb/d for a mixture of geological and geopolitical reasons, while Shell forecasts a plateau from the middle of the next decade.

The distinction may seem subtle, but the difference is crucial. One view allows for the resumption of economic growth, the other admits some kind of hard production ceiling that condemns us to alternating oil price spikes and recessions, until we liberate ourselves from oil dependency altogether.

So the question remains why the IEA persists in its view. Perhaps it is just the innate conservatism of an international bureaucracy funded by Western governments, or maybe the Agency fears a diplomatic rift with OPEC, or possibly it wants to avoid panic. Or maybe it hopes policymakers will read between the lines.

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