Institutional investors warned about peak oil and climate change

Contributor PSJ writes:

The following is from the Peak Oil section of the CDP4 Report

“Peak oil” is a topic that has been given increased attention by the investment and political communities in recent years. Although FT500 companies were not explicitly asked in this (or any) year’s CDP questionnaire to comment on peak oil, we believe this topic to be of growing significance in the global carbon landscape and one worthy of continued analysis. While the relationship between peak oil and the growth of the global clean-tech sector remains uncertain, it is clear that concerns over peak oil are triggering energy alarm bells in the U.S and elsewhere.

Peak oil refers to the point at which aggregate global economic oil reserves reach an apex. From that point onward, the pool of oil available at viable acquisition costs to global consumers inclusive of all anticipated discoveries—will begin to decline at the margin.

We include below an insert from Mr.Winston H. Hickox, a senior member of the investment staff at CalPERS, the largest pension fund in the United States with over $211 billion in assets under management, illustrating some of the key implications of peak oil for the global investment community.

Peak Oil and its implications for Institutional Investors
concerned about Climate Change Risk

by Winston H. Hickox
Sr. Portfolio Manager
Environmental Initiatives
California Public Employees Retirement System

The world that lies ahead is highly likely to be significantly different as compared to the world we see in our rear-view mirrors. A changing climate will require different risk models, beginning with insurance companies and extending to the entire structure of our global economy. Energy pricing and the need to rethink our sources of energy will be equallysignificant as drivers of change in the global economy.

While climate change risks are rapidly becoming clearer and better understood by institutional investors, the implications of “peak oil,” yet another large-scale economic externality that requires better understanding by investors, is less well known to the institutional investor community.

The theory of “peak oil,” originally developed by American geophysicist Marion King Hubbert in 1956, uses extraction and depletion rates of oil in order to determine the “peak” of global oil production. Based on current information about known oil reserves, estimates of future discovery, growing oil demand, and available technology, the Association for the Study of Peak Oil and Gas (ASPO) predicts that global oil production will peak between 2010 and 2020.

While the precise point at which global oil production will peak is hotly debated and contested, few deny that the gap between annual global consumption and new global discoveries has widened dramatically over the past 25 years, such that the amount of oil we consume tends to be significantly greater than the amount we discover each year. 1991 was the last year the world discovered more oil than it consumed. In 2004, 30 billion barrels of oil were consumed worldwide, while only eight billion barrels of new oil reserves were discovered.

The implications of achieving peak oil are far from clear. On the one hand, a decline
in global oil production could dampen the world’s economic growth. On the other
hand, it is likely to make renewable energy sources more economically attractive.

Peak oil has other implications. As demand for oil continues to outpace the growth of supplies, the market signals that would normally be expected to give rise to solutions, will run head on into the rapidly evolving “carbon constrained” world that lies ahead.

Hence, the traditional outcome from the demand/supply imbalance will be unacceptable and unattainable, and players in the global marketplace will need to adjust. More specifically, simply finding more oil and burning more fossil fuel will not work.

The large scale meaning of this is that early bets by institutional investors in clean technology companies, and particularly “clean” and “alternative” energy enabling new technologies, will likely be handsomely rewarded.

It is precisely this kind of thinking that led CalPERS to move in 2005 to develop a CleanTech investment program in the Private Equity sector of its investment portfolio. Other institutional investors would be wise to consider following their lead.

Fiduciary duty requires that institutional investors make every effort to understand and quantify risk, as well as mitigate and find opportunity in its wake. Climate change and peak oil are extremely large-scale external forces bearing down on the global economy that plain and simply REQUIRE focused study followed by measured reaction on the part of investors.

Mr. Hickox is not alone in his warning. Stephen Wrobel, Chief Executive of Swiss-based asset management fund Diapason Commodities Management SA, told the Dow Jones European Commodity Investment conference in Frankfurt in June 2006 that global oil output could peak by 2010. UBS reported in a study in August 2006 that, “Over the long term, UBS believes that the peak in oil production is likely to occur in the mid- to late-2020s”.

While addressing the London Business School in March 2006, former U.S. President Bill Clinton said, “We may be at a point of peak oil production.” Former U.S. Vice President Al Gore, speaking on Larry King Live, went as far as saying, “We almost certainly are at or near what they call peak oil.”

A report for the U.S. Department of Energy written in February 2005 stated that, “The peaking of world oil production presents the U.S. and the world with an unprecedented risk management problem. As peaking is approached, liquid fuel prices and price volatility will increase dramatically, and, without timely mitigation, the economic, social, and political costs will be unprecedented. Viable mitigation options exist on both the supply and demand sides, but to have substantial impact, they must be initiated more than a decade in advance of peaking.”

However, many institutions have published reports that are skeptical of the peak oil thesis. For example, the International Energy Agency (IEA) addressed peak oil in its 2005 publication, “Resources to Reserves – Oil and Gas Technologies for the Energy Markets of the Future.” While the report concluded that there is no shortage of oil and gas in the ground, it also found that at least $5 trillion in investment will be needed in the next three decades to tap reserves. The report also recognizes that, “Neither private enterprises nor national companies necessarily have the incentive to assume the risk of tackling new types of resources such as oil sands or oil shales. Such players might choose, for example, to focus instead on maximizing returns from their investments in deepwater in a high oil-price environment.”

More recently, in June 2006, the U.S. Energy Information Administration (EIA) said that assuming a business-as-usual market environment, without disruptions such as war, terror, weather or geopolitics, and that all non-OPEC oil projects that showed a favorable rate of return on investment would be funded, peaking of world oil production would not be anticipated until after 2030.

The major oil companies have also spoken on the subject.

• Total SA, Europe’s third-largest oil company, expects global oil production to peak as soon as 2020.

• Jeroen Van der Veer, CEO of Royal Dutch Shell says, “My view is that ‘easy’ oil has probably passed its peak. But there are other reserves that are still a long way from their peak. In unconventional oil and gas – resources that are harder to tap – there are plenty
  of reserves.”

• Lord Brown, Chief Executive of BP, recently observed that, “the age of oil has seen its obituaries written so many times, and they’ve always turned out to be premature… We don’t have to be worried. There are still sufficient reserves out there.”
• An advert taken out in The Washington Post and New York Times in February 2006 by ExxonMobil stated that, “With abundant oil resources still available – and industry, governments and consumers doing their share – peak production is nowhere in sight.”
• Chevron-Texaco has set up a website (www.willyoujoinus.com) in which the company states quite simply that “the era of easy oil is over.” David O’Reilly, Chairman and CEO, Chevron Corp said of the subject, “Oil will peak – that is a geologic fact. But the new energy equation is not static. It is dynamic and variable.”

Even the U.S Army Corp of Engineers has covered the issue. “Peak oil is at hand with low availability growth for the next 5 to 10 years. Once worldwide petroleum production peaks, geopolitics and market economics will result in even more significant price increases and security risks.”

Peak oil has been extensively analyzed by numerous groups, think tanks and research houses. That the predictions for the date of peak oil varies so much simply highlights the need for deeper clarity of oil data, and also the fact that we will only know we have passed the peak when looking in the rear-view mirror.

Some of the reasons why there is a concern that global oil production will peak within the next decade are listed below:

• Oil production is in decline in 33 of the 48 largest oil producing countries. As more oil fields and countries fall into decline new discoveries will be needed to compensate but recent discovery trends do not suggest this will happen. Decline rates are quite steep, possiblyas a result of enhanced recovery technology creating a sharper peak. There are reports that Saudi Arabia is experiencing a decline rate of 5% to 12% a year, which would mean a considerable increase in annual production just to stay level.

• A bottom-up analysis of global oil supply by Chris Skrebowski, Editor of Petroleum Review concludes, “Oil production has the potential to expand for the rest of the decade but shortly thereafter production is more likely to decrease than increase.” A similar study by Cambridge Energy Research Associates concludes that there will be no “peak oil” problem before 2020, although this assessment has been challenged for not taking into account the decline in the existing production base. A study by the London based think-tank Chatham House, released in August 2006, sees a plateau of production after the 2010-2015 period. “In the future (say after 2010-15) the extent of depletion and the difficulties o finding new, large, low-cost reserves ill restrict the scope for a continuing rise in conventional oil production at prices similar to the 1986-2003 period (which fluctuated around $25 barrel (2004 dollars). The restricted scope for increase does not imply that the production levels cannot be maintained for many years, but oil production will reach a plateau.”
• Of the three largest oil fields in the world, Burgan (located in Kuwait) and Cantarell (located in Mexico) have peaked, while speculation continues that Ghawar (located in Saudi Arabia) will peak soon or has already peaked.
• There are concerns that the size of OPEC reserves has been exaggerated. The mid-80s saw a sudden increase in OPEC reserves, at a time when it was decided that OPEC production quotas would be partly dependent on proved reserve figures. This has been backed up by a recent report by Petroleum Intelligence Weekly that found that Kuwait’s reserves are less than half their claimed value.173 Two-thirds of the world’s claimed conventional reserves are in OPEC countries, and scenarios predicting a peak more than 10 years away assume that OPEC can substantially increase production from current levels. If the reserves have been overstated, then this casts doubt on the ability of OPEC to increase production.
• Discovery of conventional oil reserves peaked 40 years ago and has been in serious decline since then.
• 70% of daily oil supply now comes from oilfields “on production” for 30 years or more. 20% of global supply comes from 14 giant oilfields whose average age is over 50 years.

The information and debate about the peak of global oil production is constantly evolving as new data emerges. For more information visit:

The Association for the Study of Peak Oil and Gas (ASPO):
www.peakoil.net/

Oil Depletion Analysis Centre:
www.odac-info.org/

Peak Oil at Wikipedia:
en.wikipedia.org/wiki/Peak_oil

International Energy Agency:
www.iea.org/

Energy Information Administration:
www.eia.doe.gov/

Cambridge Energy Research Associates:
www.cera.com/home/

Organization of the Petroleum Exporting Countries:
www.opec.org/home/

Energy Bulletin:
www.energybulletin.net

Simmons & Company International:
www.simmonscointl.com/research.aspx?Type=researchspeeches

The Oil Drum:
www.theoildrum.com

The contents of this report may be used by anyone providing acknowledgement is given to Carbon Disclosure Project/Innovest.