Peak Oil and NZ’s Flawed Oil Pricing Assumptions

PowerLess NZ Response to NZ’s MED Oil Pricing Assumptions and Scenarios.
23 March 2006

The purpose of New Zealand’s Ministry of Economic Development (MED) is to provide advice and co-ordination to both public and private business sectors that stimulates sustainable economic development.

It is therefore incumbent upon MED, given its capacity to influence significant private and public decision making, that it provides balanced, considered and transparent information that is as accurate as possible. Advice from the department is likely to influence if not drive public investment in infrastructure amongst other things.

Late last year the MED published an Oil Pricing Assumptions and Scenarios paper and it re-iterated these assumptions in a workshop presentation on 21 March 2006. PowerLess NZ wishes to raise serious concerns about the MED’s oil pricing assumptions.

The oil price assumptions form the basis for oil related impact assessments using the MED’s Energy Supply and Demand Equilibrium Model known as SADEM. This model informs policy makers in the development of New Zealand’s energy and environmental policy. Current oil price assumptions and scenarios are to be used in the next Government published Energy Outlook. According to the previous Energy Outlook produced in October 2003 the MED assumed oil prices to be “rising from US$20/bbl in 2004 to US$25/bbl by 2020 and constant thereafter”.

The fact that the MED got this so wrong suggests the method by which they come up with oil price assumptions demands attention.

The opening discussion in the Oil Price Assumptions report dismisses the impact of oil prices as “not too important”, and as “mostly impacting transport”.

The impact of oil prices may be “not too important” to some things in life, but in regard to economic development particularly decision making in regard to transportation infrastructure, the price is clearly all important. Furthermore the price of oil has wide reaching implications for a great many industries least not agriculture New Zealand’s greatest export earner.

Further into the report the MED argue “both theory and empirical evidence suggests that oil futures markets are probably the best source of future oil price projections.”

Clearly this is not the case. At the time of the release of the last Energy Outlook by the MED, October 2003 NYMEX sweet crude was trading at US$30.40 (already US$10 higher than the Energy Outlook assumptions) and 2-3 year delivery contracts were trading significantly lower than the 2003 October price. Oil futures markets particularly several years out are a no better predictor of oil spot prices than any random guess might be.

Another factor in influencing MED’s oil pricing assumptions is “to look at what the best-known industry analysts are saying”. The best-known analysts according to the MED report turns out to be the International Energy Agency (IEA) and industry consulting firms.

Largely discredited by independent analysts the IEA project the price of crude to be between US$21 to US$48 in 2030 (in 2003 US dollars).

The thrust of the IEA argument is that new technologies, increased investment, and significant finds of very very large yet to be discovered oil reserves will overcome any production inflection. The IEA estimate the total necessary investment to be in the vicinity of $5 trillion US.

Of course this figure begs the question, can private industry be relied upon to invest in research and technologies that are yet to be shown to directly benefit themselves?

PowerLess NZ argue there are a great many factors not considered by the MED in its oil price assumptions. Most important is the fast approaching global peak in oil production and existing depletion statistics.

Existing Depletion.
According to BP’s Statistical Review of World Energy figures OECD and Non-OPEC (excluding the former Soviet Union) oil is in decline and depleting (representing the change over the 2003-2004 period) by -1.5% per annum.

UK and the North Sea are depleting at the extraordinary rate of 10% per annum and expected to continue depleting at around 7-8%, oil production falling to less than half it’s current present level by 2010. The US has been in decline since the early 1970s.

Kuwait and Mexico have recently admitted production falloffs indicating that their very large reserves are in decline. Mexico is responsible for over 4% of the current worldwide production and Kuwait over 3%.

Note that Mexicos production decline may be slightly offset by the significant Noxal oil field discovery, however putting Noxal in perspective in regard to global production, if the field turns out to be as large as expected it would only supply around 3 months of global oil consumption over it’s entire life span.

The OPEC nations increased production by over 7% during the 2003-2004 period however in recent reports OPEC has admitted it is pumping at maximum capacity. It is increasingly unlikely that the OPEC nations, particularly Saudi Arabia can sustain production increases of this magnitude.

We are approaching the time where all new production in those regions that can increase their output will only stand to offset the depletion in those regions that are in decline. This will be exacerbated by global demand growth - currently running at about 3%. Standing still is the first stage of falling behind, as demand exceeds supply, even if that supply is flat, substantial price increases will ensue. After this period of peak or plateaued production, we enter the stage where the total amount of oil produced each year will be less than the previous.

The MED’s strategies for developing oil price assumptions are lazy and woefully inadequate and should therefore not be used to inform public or private decision-making. Any oil pricing assumptions and scenarios must take into consideration the impact of peak oil including current depletion and demand growth statistics, and in a wider context on relevant mitigation and adaptation strategies.

Steve McKinlay
PowerLess NZ

ENDS

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