Oil Spin

Ignore the optimists. Peak oil is real.

Last week, four of the world's most outspoken oil aficionados waded into the controversy of peak oil, publishing articles packed with myth and distortion. This "Gang of Four" all claimed the issue was silly, moot, or simply a myth.  The four pieces were Pulitzer Prize-winning author Daniel Yergin's seven-page article in Foreign Policy, energy analyst Michael Lynch's three column op-ed in the New York Times, analyst Edward Morse's essay in Foreign Affairs, and scholar Amy Jaffe's paper published by the Baker Institute at Rice University.

Here is a quick synopsis of the views expressed by all four writers:

1. Oil will remain an extremely important part of the world's economy throughout the next century as its main base of users  shifts from prosperous countries to the teeming mass of humanity in Asia that previously used only tiny amounts.

2. Oil markets are now far more transparent and far more liquid given the fact that existing oil contracts allow investors to trade three to five times more oil than the world uses every day. This transparency will flood capital into oil markets, keeping the price low which, in turn, will encourage even greater demand.

3. The world's endowment of oil has never been so large, despite 150 years of constant oil use coupled with the fact that the world now consumes more than 85 million barrels of oil daily. This "fact" is why all four authors took aim at the Peak Oil worry-warts who they feel are intent on trying to convince the world that it is running out of oil.

4. The emergence of spectacular new technology will enable the supply of oil to flow far easier than ever. And, this new technology boom is just getting started. Over time, it will improve by leaps and bounds.

Thus, these four global oil authorities mused that oil, celebrating its 150th birthday last week, has never been in better shape. How terrific the world's outlook would be if these four myths had even a touch of reality! Sadly, if one ignores opinion and simply adheres to a body of well-documented -- if ugly -- facts, it quickly becomes clear that these four assertions are utterly without substance.

First, alarming data from the International Energy Agency and the U.S. Department of Energy shows that the flow of global crude oil peaked in 2005 and is now sliding steadily. The world will never "run out of oil," but its flow is in decline. There may still be ample oil reserves left in the ground when oil flows fall to half of today's use. But these remaining reserves are all either very low-quality heavy oil, which is difficult to process, or tainted with toxic elements that make it hard to refine into usable petroleum products.

It would be comforting if some vast new oil frontier existed that would recreate the 20th century's oil miracle, but almost five decades have now elapsed since the last great super-giant oil fields were discovered and the last frontier basins were found.

Second, while global oil demand is growing far beyond what can easily be supplied, countries like China and India are still in relative economic infancy and their per-capita oil use is tiny when compared to the prosperous OECD countries. Demand is insatiable, but oil use can only match oil supply -- this is an irrefutable law of nature.

It is true that a steadily increasing number of financial players now bet on the price of oil. These speculators created the highest volatility that oil prices have ever experienced.  The Gang of Four seems to think this is good for oil markets, but as a seasoned investment banker to the energy industry, I believe this volatility is a cancer that will ultimately destroy it. It shouldn't have been surprising that oil prices plummeted from $121 a barrel on Sept. 22 to a low of $31 a barrel on Dec. 22. It happened because hedge funds decided to short the oil contract. But the Gang saw this as normal price changes as folks realized the oil bubble had burst, although this doesn't sufficiently explain the size of the price swing that occurred.

When oil prices sunk to $31 a barrel, the oil industry was no longer financially viable, despite the fact that major oil-company CEOs considered this price "fair" only a year or two earlier.

All four oil experts made the same general argument, though stated in slightly different terms.  None of them had any hard data on existing oil reserves to share with their readers because no hard data is available, only firm beliefs.

The final topic the Gang discussed was the rapid advances in oilfield technology. Sadly, this is the greatest myth of all. I spent four decades as an investment banker to the global oil-service industry, which collectively invented all of this technology. The concept that there are new innovations in this area is false.

In fact, the seeds of this so-called technological revolution -- the ability to exploit oil from deep water or drill horizontally -- were first developed 40 years ago. I personally raised a great deal of the venture capital that helped implement some of the most important technical advances in the industry. Our firm, through advising on mergers, consolidations, reorganizations, and bankruptcies, helped save the oil-service companies that created these great technological advances that help us find and commercially exploit oil and gas.

None of this technology is new -- in fact, it is now quite mature. Sadly, there are few new ideas in the oilfield pipeline to replace advances that were made decades ago.

In my view, while Yergin, Lynch, Morse, and Jaffe, are articulate in their theories, none seem to have any strong sense of the brutally grim reality of today's oil markets. The facts speak for themselves: Oil flows have peaked, technology is now mature, the people running the industry are far too old, and few top-notch graduates are interested in embarking on a career in such a volatile field.

Even oil's much-touted 150th anniversary is a myth. You can read about an oil flame burning next to Babylon in the Old Testament. This was oil flaring from Kirkuk, which later became the first super-giant oilfield found in the Middle East in the late 1920s.

Oil has been a miracle resource for ages but has never been well understood. For more than a century, myths about oil kept the real facts buried in a fog of bad information. Until the world's oil producers allow third-party audits of the flow rates of the world's largest oil fields, which they have so far been reluctant to do, it is impossible to know just how dire a situation we are in. I believe that such an audit would prove peak oil, but it is certainly irresponsible to make optimistic projections without hard data.

Once this transparency is attained, we can debate true facts and end flow of myths that led so many well-intentioned people into so many bad decisions about the future of oil.



Saving Ghana from Itself

In the September/October issue of Foreign Policy, Moisés Naím asks if there's any way oil-rich countries can avoid the resource curse. Ghana, the newest member of the oil-producing club, has a good shot. Maybe.

When Barack Obama picked just one country to visit on his maiden voyage to Africa as U.S. president, it was no surprise he chose Ghana. The West African country of some 22 million people has been a peaceful democracy for nearly two decades. Its economy has grown steadily since the early 1980s while the number of Ghanaians living in poverty has plummeted. Ghana has mostly contained the fraud and theft that rots other economies and avoided the maladies affecting so many of its neighbors.

But Ghana's greatest test is yet to come. A major offshore oil project will soon produce about 200,000 barrels of crude per day, delivering a windfall of profits. Gold and cocoa exports, the driving forces of the economy for more than a century, will both be surpassed by oil almost immediately.

The worry is that oil will do to Ghana what it has done in too many other places: destroy its economy and poison its politics. A library's worth of studies have linked natural resources to conflict, authoritarianism, corruption, and high poverty -- directly threatening the very things cited as evidence of Ghana's economic and political progress. "Unlocking the secret of what enable[s] ... poor countries to successfully lift the resource curse can spare millions," writes editor in chief of Foreign Policy, Moíses Naím. And luckily, Ghana still has another year or so to build its defenses. But as Naím points out, nobody has yet figured out how, exactly, a country can successfully stave off the worst of oil's ills.

For Ghana, Nigeria's experience looms especially large. The country earned more than $200 billion from its huge oil reserves between 1970 and 1999, but over that time, the average Nigerian grew poorer. Rather than develop the country and build a future, oil created a politics obsessed with dividing spoils. Other than what not to do, Ghana doesn't have much to learn from Nigeria.

Another neighbor, Chad, is also a failed experiment in resource management, exposing the pitfalls of expecting a national oil savings account to do the trick on its own. As part a massive pipeline loan from the World Bank, Chad agreed in 2001 to pay oil proceeds into a Citibank account in London meant to fund social services such as healthcare and education. But once the pipeline was built, there was nothing to stop the government from simply reneging on the deal. And, in 2008, it did.

Successful natural resource exporters such as Norway, Chile, and Botswana each have something, by accident of history or just good luck, that Nigeria and Chad lack: a powerful political bloc with an interest in holding the government accountable for responsible resource management.

So what should an oil-bonanza country do if, like Ghana, it lacks any such constituency? It should do what Alaska did: Give the oil revenue straight to its people. After a major corruption scandal in the U.S. state in the 1970s, Anchorage created an oil-revenue fund and, starting in 1982, paid dividends to citizens as a deliberate check on abusive state power. Last year, every Alaskan got a check for $3,269 in the mail.

What works in chilly Anchorage might work in tropical Accra, too. What better way for the country to generate intense public scrutiny overnight than give every citizen a direct claim on oil cash? And once the payouts are established, what politician would dare risk the wrath of voters by scrapping them?

There's an added bonus for a country like Ghana, where average annual incomes are still under $500: putting cash directly in the hands of very poor people. Rather than waiting for the money to trickle down through inefficient public services, people could choose how to spend their oil bonus straight away. Based on current projections, every citizen could receive about $85 per year by 2013 -- not enough to make them quit their jobs, but enough to give a real boost to poor families.

Some may worry that this would deprive the government of the funds it needs to build schools and roads. But Ghana's government already collects a healthy 24 percent of GDP in revenue. And receipts would grow with the handouts, since Ghana already has consumption taxes in place. Some portion could still be set aside as national savings, and rules could be enacted to smooth payments over multiple years, mitigating concerns about volatility.

The most critical question will be finding a fair and practical way to distribute the money. New technology can help. Biometric cards or mobile phones could easily be adapted as a means of accounting and delivery. Mobiles are already a popular means for money transfer, and people without phones could either use a prepaid airtime card to received funds or even use a portion of their first oil check to purchase a low-cost handset.

Ghana can save itself from the oil curse by simply handing over the cash directly to citizens. This may sound like a radical proposal, but given what havoc oil has wreaked on other places, the riskier path is in fact the most judicious one.