Folks,

The IEA’s new report last week had some very stark warnings about the tight balance between oil supply and demand, and projected a possible shortfall of supply by 2010. The report generated a lot of buzz around the world so I felt like I had to comment on it. Here’s my take, for the Energy and Capital newsletter.

The IEA’S Come-to-Jesus Moment

2007-07-13

By Chris Nelder

Q: What’s the difference between an oil analyst and a used car salesman?

A: The used car salesman knows when he’s lying.

That’s a variation on the old joke about computer salesmen, but it can apply just as well to oil market analysts–such as the roughly 150 energy analysts and statisticians who work for the International Energy Association (IEA), the Paris-based agency that advises 26 OECD nations on energy.

On Monday this week, they had what I would consider a “come-to-Jesus moment,” walking before the whole world to the front of the tent, admitting their unworthiness and publicly confessing their sins.

The confession was in their bombshell “Medium Term Oil Market Report,” which looks at the global oil market over the next five years. And it was stark:

Despite four years of high oil prices, this report sees increasing market tightness beyond 2010 . . . It is possible that the supply crunch could be deferred–but not by much.

That was enough to set blogs and presses and email systems afire the world over. I was deluged with emails and phone calls about it. So I checked it out.

It’s a decent piece of work, 82 pages with lots of good charts and data. It was also a welcome break from the delusional projections that the IEA has made for its entire 30-year existence, consistently predicting that supply will magically meet whatever the demand was projected to be.

Because for the first time, the IEA admitted that they have some doubts about oil supply keeping up with demand.

Their chart really says it all:

Essentially, the report’s conclusions boil down to this:

1. Demand will rise at about the rate of 2.2% a year through 2012, primarily driven by the developing world’s consumption, which is rising three times as fast as in the OECD. Transportation fuels will be the largest source of demand, by far.
2. Non-OPEC production is expected to increase from 50 mbpd today to 52.5 mbpd by 2012, but the additional production will be mainly from unconventional sources such as natural gas liquids, tar sands production, extra heavy oil, coal-to-liquids, even biofuels.
3. OPEC spare capacity will increase slightly from 2.5 mbpd in 2007 to a high of 3.4 mbpd in 2009, then decline to just 1.5 mbpd (1.6% of demand) by 2012. Almost all of it will have to come from Saudi Arabia.
4. Depletion rates are worrisome: “Net oilfield decline rates average 4.6% annually for non-OPEC and 3.2% per year for OPEC crude. Aggregate levels mask much sharper declines in a 15-20% per annum range for mature producing areas and for many recent deepwater developments. All told, the forecast suggests the industry needs to generate 3.0 mb/d of new supply each year just to offset decline. Notwithstanding, above-ground supply risks are seen exceeding below-ground risks in the medium term.”
5. Rising project costs, shortages of labor and materials, and geopolitical problems will continue to plague world oil production, and conspire to create uncertainty and delay projects, so supply could fall short of demand by 2010. And shortages of natural gas are even more imminent.

As Steve Andrews of the Association for the Study of Peak Oil (ASPO) described the report on a CNBC appearance this week, we have a “three D problem”: demand, depletion, and delays.

I also hasten to point out that the ASPO’s estimate for global peak has been set at 2011 since March, having stood at 2010 since 2005. So I view this is a somewhat of a return to the fold of the truthful for the IEA.

The bottom line? IEA says that global demand will reach 95 mbpd by 2012, up from 86 mbpd today, but they don’t see how we can get there, and neither do observers I trust–people like T. Boone Pickens, Matthew Simmons and the geologists of the ASPO. We might not increase beyond where we already are, or we might manage to produce as much as 90-91 mbpd, but it’s not likely, and in any case we’ll probably be at the ultimate peak by 2010-2011.

Oh, and by the way, Simmons also said this week that there’s a “real risk” that gas pumps could run dry somewhere in this country this summer, due to our limited refining capacity (another factor mentioned in the IEA report).

It seems confirmed that we’ll have shortages starting now, with the big crunch–and skyrocketing oil prices–just two to four years from now.

Said Lawrence Eagles, head of the IEA’s oil industry and markets division: “The results of our analysis are quite strong. Either we need to have more supplies coming on stream or we need to have lower demand growth.”

The IEA even acknowledged the peak of non-OPEC conventional oil, although they couldn’t quite bring themselves to say it:

“The concept of peak oil production and its timing are emotive subjects which raise intense debate. Much rests on the definition of which segment of global oil production is deemed to be at or approaching peak. Certainly our forecast suggests that the non-OPEC, conventional crude component of global production appears, for now, to have reached an effective plateau, rather than a peak.”

You say potato . . .

Redefining conventional crude oil, by including sources like tar sands and coal-to-liquids, is really bending over backwards in order to call the top a “plateau” instead of a “peak.”

In the end, they seemed to really try to put a happy face on their otherwise dire report:

Finally, we note that focusing on non-OPEC crude alone is a rather selective way of considering the sustainability of global oil production. Peak or plateau production is frequently taken as shorthand for impending resource exhaustion. While hydrocarbon resources are finite, nonetheless issues of access to reserves, prevailing investment regime and availability of upstream infrastructure and capital seem greater barriers to medium-term growth than limits to the resource base itself.

But that’s a “dog ate my homework” quality apology. Crude production is an honest measure of its sustainability! And when you get to peak production, we know from experience that you’re near the halfway point of total production, so it really is an indicator of resource exhaustion. And the accessibility of reserves affects when you reach the peak, so that doesn’t explain away anything.

We currently have billions in oil-industry capital that can’t find any decent place to invest itself, even with oil prices in record territory and insatiable demand. If the market can’t produce oil now, when can it?

In fairness, they did temper that little rationalization by noting the “curious contrast” between higher cash return to energy company shareholders and “essentially unchanged exploration and production efforts.”

Above-ground factors, below-ground factors, who cares? When you’re falling from a cliff, does it matter if you leaped or were pushed off?

Let us not forget what IEA chief economist Fatih Birol said in an interview with French newspaper Le Monde just two weeks ago: “[I]f Iraqi production does not rise exponentially by 2015, we have a very big problem, even if Saudi Arabia fulfills all its promises. The numbers are very simple, there’s no need to be an expert.”

Many peak oil observers, including me, have been hard on the IEA in the past for their wildly optimistic projections. So we should take a moment now–and I do, despite my continued criticism–to acknowledge that they have finally owned up to reality and admitted the error of their past projections.

Perhaps they just didn’t know they were lying.

Until next time,

–Chris