Special Report: Peak Oil

Peak Oil and Commodity Pricing Fundamentals

Andrew McKillop explains how peak oil and peak natural gas will affect commodity pricing.

By Andrew McKillop
Published November 23, 2006

Contents

  1. Introduction
  2. Fundamental drivers
  3. Fundamental role of oil prices
  4. Near-term trends
  5. Oil price forecasting
  6. Commodity pricing
  7. The Food versus Fuel dilemma
  8. Investor Opportunities and the International Energy Transition Fund

Introduction

Peak Oil definitions vary, as indeed does the definition of "oil" (see my paper to AF237 "Oil and Gas Investing" conference), but public opinion, media and political sentiment, and business community perceptions are now clearly oriented to what is called "after oil". In fact, depending on the technical or financial definitions used, as I noted at the AF237 meeting, it is possible to affirm that we are at, near or even beyond "Peak Oil".

As for Peak Gas, however, this is an unknown subject. So-called abundant and cheap, that is, underpriced, gas supplies are imagined to be a quick fix solution to the grudgingly admitted reality of Peak Oil. In fact, the two are interdependent and interrelated.

Concerning both oil and downstream 'embodied energy' trading in the form of metals, minerals and agrocommodities, it is sure that traders and analysts have heavily anticipated "Peak Oil", at least insofar as this means structurally higher energy prices, and higher embodied energy prices.

Depending on the energy sources and quantities used in extracting or producing specific metals, minerals and agrocommodities, price rises for the final products in the last three to five years have often been unrelated to the real underlying energy price rise. Future scarcity has been brought into the present by customarily speculative, exuberant, irrational and under-informed market sentiment manipulation.

However, this does not remove, but merely confuses the structural trend towards higher energy prices, predicated and driven by Peak Oil. This will be surely and certainly reinforced by Peak Gas. The essentially incoherent but large popular and political movement for action against climate change, and protection of the environment, is intrinsically related to fossil energy consumption, in some energy sectors resulting in further and stronger demand growth - for example, gas pipeline construction and laying, windmill manufacture and installation, and nuclear power plant construction.

We can take Peak Oil to mean a structural trend towards less availability of cheaper liquid hydrocarbons in the economic system, with a knock-on effect on gas prices, coal prices, and electricity prices. Conversely, and en revanche we have a smile on the Cheshire Cat, for oil traders, in the form of now very sharp variations in the seasonal profile of world oil demand on an underlying base of highly 'robust' growth.

This increasingly creates oil price peaks, as in Summer 2006, while the seasonal troughs can create 'cheap oil windows' as during September, October, and most of November 2006.

Seasonal variations of world oil demand, which can attain at least two to two and a half million barrels per day (mbd) are, we can note, themselves linked to Peak Oil. These factors and trends can be analysed and forecast. Major causes of oil demand variation include 'just in time' buying, de-industrialisation in the 'mature' OECD economies, and also climate change - which itself is fundamentally linked to the burning of about 11 billion tons of carbon-based fossil fuels each year.

The basic role of oil prices in orienting commodity price trends should not need to be underlined, but ignorance of the energy economy, as opposed to the financial economy, creates both opportunities and risks for mainstream financial players without sufficient understanding of the energy economy.

In particular, we should address and analyse the energy costs, and roles of energy production, supply, utilisation before looking further up the 'inverted pyramid' of embodied energy represented by non-energy commodities.

Embodied energy trading is a concept, and name or bye-line for an investment and trading entity that I am promoting, and I invite expressions of interest for taking this further. The basic concepts driving this proposal are well evoked in the brief description of my presentation in the brochure to this meeting.

Fundamental Drivers

We are confronted by two major challenges for the world economy and society - climate change, and depletion impacts on world oil and world gas supplies. Both of these fundamental drivers entrain higher energy prices, and knock-on or downstream related price increases of most if not all hard and soft commodities.

This context and process can be called a challenge for society, when in fact consuming less is the real, and really simple solution, but it is surely an opportunity for financial and economic players able to understand, analyse and anticipate general increasing energy transparency, or energy linkage, of pricing throughout the world economy.

Energy inputs to energy industries: This process starts with energy itself. Energy is needed to produce and supply energy. The energy sector itself well exhibits the 'firewalls' or barriers, inconsistencies, national and regional exceptions, industry or regulatory exceptions, and so on that - when properly analysed - create many and large opportunities for intelligent and well-informed investors.

Impacts of the Kyoto Treaty will, on balance, add to these barriers and inconsistencies, resulting in the certainty of continued and large price variations for energy and embodied energy in the economy. The case of biofuels, some of which are highly oil-intensive, is another example of incoherence and inconsistencies in the constantly emerging and changing energy economy.

Primacy of the energy economy: To explain the basic significance of the energy economy, we can give one excellent example, which is electrification. Electrification was not only Lenin's favourite modernising slogan, but also a founding concept of the European Community and Union. It remains a constant goal of World Bank and regional bank funding for development.

Its role in the energy economy is usually ignored, at best misunderstood, but it is in fact a highly useful indicator. Study of electricity's role in the economy can improve forecasting of future energy demand trends, including oil, because electrification operates a 'ratchet effect' limiter of energy demand falls during economic downturns, and the opposite during upturns.

In brief, electrification of the economy sets a floor to non-electric energy demand compression in the downturn, and provides a springboard for growing demand of all forms of commercial energy in the upturn, including oil demand.

Relative to oil, electrification of the economy increases oil's hallowed "swing fuel role", both in the downturn and upturn. Full understanding of oil's "swing fuel" role in the economy immediately relativise and limit claims of "oil demand growth falling to zero" in a world economy growing at about 5.1 percent in real terms, according to the IMF and World Bank.

As noted, electrification is itself a leading energy demand trend indicator. Even in the sluggish, slow growing economies of the Eurozone, today, electricity demand growth is running at six to nine percent per annum (pa) in many countries, becoming intensely seasonal in demand variation, and generates fantastic - in fact, impossible - investment outlooks.

Electric power plant investment needs in the EU countries is projected by the European Commission at 1500 Billion Euros for the period 2007-2015. Such rates of power demand growth are imagined by political deciders to limit or constrain oil demand and the oil price, but the mid-term impact is very surely and very certainly the opposite.

Fundamental drivers: Peak Oil and Peak Gas: While Peak Oil is to some extent accepted, on de facto grounds at least, the sure and certain, geologically, technically and economically linked Peak Gas context is almost totally ignored. Simply because of Peak Oil, we can suggest, natural gas has been decreed and set as an unlimited resource with virtually no impact on the environment and no effect on climate change!

Yet even with extreme rates of gas demand growth, for example a minimum of 10 percent pa in all countries of Asia, we find that world oil demand continues to grow in 'robust' fashion. World electric power demand growth, as already noted, is running at around 9 percent pa, with coal far behind despite its giveaway price.

In other words, world gas demand, world oil demand, and world electricity demand all demonstrate the disconnect and de-linkage between a slow moving, depletion and investment capital constrained supply side, and the demand side where growth is running at 'Belle Epoque' rates. In addition, the positive feedback between oil, gas and electricity demand growth, and energy prices, is strong and supportive to world economic growth.

The supposed, mostly imagined, negative feedback - that is, price-induced energy demand growth contraction, and falling economic growth - is highly absent from the real world economy, as I have explained many times. A handy term for this is my term: Petro Keynesian Belle Epoque growth.

Forward price forecasting for oil, energy, and commodities will therefore and by necessity abandon the highly opaque and rumour-prone 'analysis' of supply, and concentrate on the real driver: demand. For oil, this will notably supercede and replace the atavistic 'analysis' of OPEC communiqués, and the periodic announcement of 'OPEC overproduction' when downward price speculation is attempted.

This 'overproduction' slogan is a hangover from the 1985-1999 Cheap Oil interval, and totally unrelated to real world trends. OPEC "surplus" production capacity is probably not even 1.25 mbd at this time, and probably less. World oil demand growth on a day average oil demand basis is running at about 2.2 mbd - 2.4 mbd each year.

Fundamental Role of Oil Prices

Despite pricing inconsistencies, we are today clearly at a point in time, both economy cyclic and economy structural, where energy transparency of pricing is increasing fast. This is shown by the almost formal, but highly fragile and speculative linkage, or 'barrel price indexation', of most hard and many soft commodities. To a certain extent, and increasingly this will penetrate into the services, where large but hidden energy subsidies currently exist. The communications industry, in particular, benefits from this opacity of pricing.

Through the period August to October 2006, downward price speculation on oil clipped about 20 USD/bbl (barrel) from traded oil prices. So-called 'informed' analysts, who had been forecasting an average barrel price around 75 USD/bbl for late 2006 (this price forecast was published by the European Central Bank's economists in June 2006) were quick to forecast 45 or 50 USD/bbl.

In fact, the speculative goal, and likely US Republican party goal of taking and talking down traded oil prices to around 55 USD/barrel, a price level we can note the ECB's economists, in June 2006, indicated as the 'preferable price', is almost certainly unattainable. World oil demand is too strong to permit any return to cheap oil. World demand is growing at around 2.25 percent to 2.75 percent pa and world oil import demand is growing at well above that trend rate, but world oil supply is growing, at best, at less than 1.5 percent on a net-of-depletion basis.

Peak Oil and Peak Gas impacts: To be sure, the so-called Kyoto imperative in ratifying countries and in the real world is essentially to slightly reduce oil demand, while massively increasing gas consumption to satisfy extremely strong electricity demand growth worldwide. While Peak Oil is accepted by media and politicians to the extent that 'After Oil' is now a buzzword phrase, the reality of Peak Gas is artfully hidden from the eyes of the consumer masses, and wilfully ignored by the decider masses.

This will not prevent the arrival of Peak Gas within at most 10 to 12 years, starting with a sharp reduction in Russian gas production and exports. Further, the climate change impacts of methane (natural gas) losses in production - at least equal to nine percent of world total gas production - yet another unwelcome fact that is carefully hidden from 'environment conscious' citizen consumers, make it urgent not only to constrain and limit oil demand, but also to rationalise gas demand.

I have addressed this double challenge of Energy Transition featuring the rational utilisation of declining, environment-unfriendly fossil fuels, and worldwide development of renewables for many years, in fact for decades, of course with no serious uptake or suite.

Energy economy basics: Because Peak Oil and Peak Gas are interlinked, we should therefore not at all be surprised if 'expensive' oil tends to drag up gas prices, rather than underpriced and 'abundant' gas dragging down oil prices, as is hoped or imagined by many deciders. Study of energy cross elasticities within the energy economy, for example, and the supported non-energy economy, requires analysis of the oil dependence and oil intensity of the energy industries.

This basic dependence needs to be understood to appreciate the fundamental role of oil prices in the energy economy, and the non-energy economy. Oil is the key element, the grease in the works of industrial society, if not the deus ex machina.

Oil, gas, coal and electricity prices are fundamentally interdependent and interconnected, despite 'firewalls' and barriers, because of the shared and related infrastructures underpinning any and all commercial energy supply and consumption systems. Analysis of this interdependence is useful for intelligent, or at least profitable trading of downstream, energy-rich commodities.

The fundamental role of oil prices, usually the apex or fulcrum of the pyramid-setting price trends, with downstream hierarchies similar to the trophic levels of ecosystem food webs, needs to be underlined. Producing or extracting coal, gas, electricity or oil themselves require often large, and constant inputs of oil.

The inverse - that is, oil production dependence on gas, coal or electricity - does not apply or is usually very much weaker. The energy industry dependence on oil can be explained by transport needs, and industrial equipment needs of the productive infrastructures.

Further down, or up the energy economy pyramid, whether we conceptualize it as normal or inverted, we have the utilisation infrastructures, that is energy-dependent functions of the non-energy economy. These are called is simple production and consumption structures and processes, by regular economists.

Depending on our analytic approach, taking account or not taking account of successive infrastructure hierarchies, each with often massive embodied energy input, called capital investment by regular economists, we can estimate the total oil demand of the energy industries. Excluding electricity production from oil, we obtain a figure of around 6 mbd oil input to the energy industries in 2006, growing at about 7.5 percent pa.

Non-oil energy inputs to the energy industries are vastly lower, for example coal energy utilised in the gas or oil industries, or gas energy in the construction and industrial operation of electric power plants (not their consumption of gas or coal to generate electricity), simply proving the slogan: "oil is the lifeblood of industrial civilization".

Oil and nuclear power: We can take a simple example, very timely for those so concerned about climate change they roll their eyes and messianically proclaim an urgent need to 'massively construct' nuclear power plants, almost anywhere and everywhere.

Nuclear power, whether civil or military, fundamentally depends on mined uranium. This is a depleting fossil energy resource needing extraction, crushing, separation, upgrading, transport to point of use (the nuclear power plant, civil or military), and transport of used nuclear wastes, and their storage, away from the 'clean, cheap and safe' nuclear power plant.

All personnel operating the plant, and services consumed by the plant will need transport or delivery, and of course prior production, and disposal after use where physical goods are concerned. In sum and overall, the nuclear power industry is totally dependent on oil energy, and not the reverse.

Without upstream embodied oil energy, and parallel oil energy supply and consumption, the autonomy of supposedly "oil free" nuclear power plants would be zero. The oil industry can exist without nuclear power. The nuclear power industry cannot exist without oil.

We find that oil, because of its low transport and storage costs, its low cost and simple point-of-use technologies, its high embodied energy (around ten kWh/kilogram), is far more basic and far more widely used in industrial infrastructures than coal, gas, or electricity.

Storage proof: OECD country members of the IEA strategic oil stock program undertake to store oil equivalent to about 90 days average consumption. No such stockage exists for coal. Gas storage, little developed except in a few European countries and USA-Canada, is essentially costly, complex and suffers very high loss rates.

We find, in fact, that gas "storage" exists in the form of in transit gas pipeline "stocks", often very slow moving on a miles-per-day basis, and dependent on very large gas and oil energy subsidies for transport. Electricity stockage, except in the form of pumped water, is technically impossible explaining why a combination of seasonal demand variation, fast demand growth, and underinvestment can lead to massive brownouts and blackouts in interconnected, interdependent regional or continental electric power supply systems.

Oil storage, conversely, exists and certain types of oil storage are called 'strategic'. No such storage exists for other commercial energy. When we examine oil dependence of warfare, we can note that US and UK troops, and suppletive forces estimated at about 48 000 pistoleros and mercenaries in Iraq, take about 300 000 barrels per day, that is around two barrels per day per person, or 730 barrels per year on average.

World oil demand is 4.8 barrels per year per person, on average.

Energy economy analysis and commodity price forecasting: Examination of the energy pyramids underpinning the metals, minerals and agrocommodities consumed and used by what are erroneously called 'postindustrial' societies of the OECD countries, and increasingly used by the industrialising, emerging nonOECD consumer economies and societies, allows much better and more precise mapping and forecasting of commodity price setting factors.

Taking the so-called 'postindustrial' societies of the OECD group, their average oil intensity (average oil consumption per person) runs at around seven to 25 barrels/year. Their average natural gas intensity runs at around 4.5 to 14 barrels oil equivalent/year. Many 'post-industrial' OECD countries have a highly advantageous energy subsidy in the form of energy intense (high embodied energy) merchandise trade imports, covered or partly covered by low energy but high value service exports. This results in yet higher real energy intensities of their 'postindustrial' societies.

World average oil and natural gas intensities per person are about 4.8 barrels/capita/year for oil, and about 2.75 boe/capita/year for natural gas. Both are growing, fast in the case of natural gas.

Petro Keynesian economic growth: This approach allows us to appreciate the 'quantum leap' or geometric growth of energy demand, and embodied energy demand, already occurring in the two emerging supergiant nonOECD economies, China and India. One part of this process, precisely, is increasing embodied energy in the economy, in the form of energy intensive infrastructures.

In the previous period of Belle Epoque economic growth, what can be called pre-Petro but surely Keynesian growth during the 'Trente Glorieuses', the OECD countries, whose annual oil consumptions typically increased by four to seven percent, acted as locomotives for the rest of the world economy, outside "Communist Areas", of course.

Today, perhaps more subtly, the OECD economies, notably the USA, are not only locomotives, but also wagons in the process of what we can call 'Petro Keynesian Belle Epoque' growth. In other words, growth of economic output and related energy infrastructure and capital goods spending in the Chinese and Indian economies (and in other emerging economies), will tend to limit downturns in the OECD economy.

This, in turn, will surely reinforce oil and energy demand growth at the global or world level. This, in turn again, will tend to reduce and limit the width or duration of 'cheap oil windows', until and unless severe economic recession ensues - probably through the self-administered poison of 'robust' interest rate hikes in the old world OECD countries, because of inflation fear and eroding monetary value.

Forecasting oil prices: The approach of Peak Oil, howsoever defined, will surely reinforce the two major trends for oil prices, that is increasing volatility and increasing peak prices during seasonal peaks of demand. In turn, this will also affect and sometimes govern downstream embodied energy prices, that is hard and soft commodity prices, but with large and variable differentials and time delays or linkages. Forecasting these slits and windows will surely pay dividends to those knowing how to analyse the energy economy.

Near Term Oil Price Trends

Through Sept-Oct-early Nov 2006, very likely encouraged and incited by US Republican party leaders unsuccessfully engineering 'damage limitation' attempts for the US midterm elections, by temporarily delivering cheaper gasoline and gasoil to consumer-voters, traded oil prices were clipped about 20 USD/bbl from their Summer highs of around 78 USD/bbl.

Media, even financial media such as 'Goldman Sachs' publications, of course focused this 'sensational' political hanky panky, but what was entirely ignored is the fact that falling oil prices in September to Nov 2006 were enabled by seasonal trends. Falling oil prices are only possible when there is falling demand, if the supply context is essentially rigid, always behind demand, and even in fact showing signs of rigor mortis.

Talk of 'OPEC overproduction' is surely one of the most atavistic-possible things any so-called analyst could say, similar to proclaiming that whale oil supplies will soon bounce up and solve streetlighting problems in the world's major cities.

The real situation can be summarised as follows:

The above statements can be verified - they are not Delphic utterances by oil price "experts" interpreting OPEC communiqués to earn their daily free meal - providing realistic and operational trading strategies for players who prefer facts rather than rumour-mongering.

Simply due to the 'cheap oil window' of Sept-Nov 2006, many or most large oil consumer entities, including national purchasing entities, will have built above average stocks - this 'hypothesis' being easy to verify within the limits of upcoming period, but essentially opaque and easily manipulated, oil storage and inventory data.

Conversely, comparing oil storage trends, capacities, products/crude ratios, and policies of the recent period (last three years), and long-term trends previous to 1990-1995, we are confronted with sharply reducing total volumes, worldwide.

Thus we can say that the recent 'cheap oil window', which was unable to drive prices even to 55 USD/bbl, will flatten the coming winter peak, but not by large and durable amounts. By the Feb-Mar 2007 period world daily demand can easily attain 87.5 mbd, and more (all liquids).

Detailed demand profiles by country, and products/crude ratios, will of course set the pricing scene - demand dominated - enabling prices to easily re-attain the Summer 2006 highs, with a small premium for US dollar value erosion, due to the Bush team losing the midterm elections.

The summary presented by myself at the AF237 meeting (November 3) can be shown again:

Summary of Key Estimates And Forecasts

The term 'operating peak year' can be briefly explained: through Jun 2007-Jun 2008 it is not certain, but surely possible that a combination of depletion losses, slow capacity additions, high and very volatile oil prices, Kyoto Treaty-linked action, and other factors, can lead to total world oil extraction and production not exceeding 32 Billion barrels.

Such is the nature of increasingly tertiary-dependent oil extraction and production, and the cost and complexity of these technologies, that any setback to world oil production, whether demand driven or supply driven, can lead to long-term inability to climb, or more precisely crawl back up to daily average production rates around 89 or 90 mbd on an all liquids base.

Conventional or 'classic hydrocarbon liquids' oil production is now below 66 mbd and stagnant since 2000, or even 1996-1998, we can note. Claims by oil price experts of the self-declared variety such as Matt Simmons or Osama bin Laden, that oil prices can rise to 144 USD/bbl for the last, and 250 USD/bbl for the first, can be treated as grandstanding of the type indulged in by persons who have no knowledge whatsoever of the energy economy. Prices above $99.99 USD/bbl will surely, and quite quickly generate negative financial and monetary feedback, resulting in a fall of world oil demand.

Oil Price Forecasting

The major real world determinant of oil prices is demand overhang. Through the 1986-1999 Cheap Oil interval the favourite slogan of so-called oil price "experts" was supply overhang. Today we have demand overhang. In other words, there is structurally high, even incompressible world oil demand growth, but unrelated and weak supply growth, mostly "unconventional" oil, such as condensates and NGL.

The related "gas bulge", or window, is entirely logical for any person with the slightest knowledge of petroleum geology and the world oil industry. Even using world oil capacity depletion estimates made by Exxon Mobil Exploration, of about 2.5 mbd-per-year, increasing to 3 - 3.25 mbd-per-year by 2010-2015, we are confronted by a theoretical need of the world oil supply system to deliver a total of about 5 mbd-per-year of new or expanded capacity, that is about 2.3 mbd/year of consumption growth plus 2.5 mbd/year of depletion losses. This is already impossible, and will become even more so.

Until and unless the mirage of "demand destruction" actually presents itself, therefore, pressure will remain on oil prices which, at 55 USD/bbl, are considerably underpriced.

60 USD/bbl is already a new datum or "resistance threshold". We should also note the USD-oil price functional relationship: high oil prices tend to bolster the world value of the US dollar, always welcome for an overpriced money with nowhere to go but down. The chance of energy "demand destruction" in the Chinese and Indian economies, due to 'overpriced oil', can be gauged on the basis of combined foreign exchange reserves of China and India standing at about 1550 Billion USD at this time. Their capacity to pay for 'overpriced oil', can easily be calculated.

Exuberant free market forces: We are therefore focussed on the 'end of Peak Oil' and the 'start of Peak Gas', a period we can figure at 2009 to 2015, assuming no coherent and coordinated international moves, similar to the Kyoto Treaty process and targeting the very urgent need of International Energy Transition, very notably setting up an 'International Oil & Gas Agency' with powers to set volume supplies, and prices of traded oil and gas.

This period, if left to 'unfettered market forces' will be a classic, late Victorian style orgy of speculative boom-bust cycles in energy sector trading and financing, and energy related financing.

Assuming this is the case, traders and players in energy commodity markets will find some utility in coherent and fact-based, rather than rumour-based crystal ball reading, methods for mapping pressure points in the world energy economy and downstream, embodied energy commodity production and supply system. Upstream, as already noted several times, the primal role of oil prices is underlined.

Forecasting in a context of extreme volatility: We are confronted by ever rising seasonal variation in oil demand, as well as electricity demand. The only rational method for mapping these trends is as follows:

This demand-side analysis is now the only rational method for oil price trend forecasting. Supply-side forecasting, always highly heuristic and rumour-oriented, is now only an extension of chartism, or the imaginative drawing of lines on cobbled-together graphs. Fact based demand analysis of the energy economy will always supply superior predictive capacity.

Window for traders: in theory at least upside and downside price movements on any market, for any financial instrument or support, should be entirely neutral for traders. Be this as it may, T Boone Pickens and others (but surely not Amaranth in Canada) like to play upside price booms, enabling myself to propose an upside window for oil prices in the range of 25 - 30 USD/bbl from present prices, in the period of about Dec 2006-Mar 2007.

Apart from weather trends (degree days, singularities), the main determinants of full, or only partial realisation of this upside window are volumes of stock build during the 'cheap oil window' of Sept-Nov 2006, economic growth trends in USA, Europe, Japan and China-India, and the so-called 'geopolitical risk' element, able to be talked up, or down, by about 10 - 20 USD/bbl.

Claims by Saudi Arabia that it could or might raise oil production to "new summits" can be treated as essentially motivated by fears that the Oil Age needs stretching through supply of cheap oil - a Saudi and US strategy of the 1980s, but now totally inoperative and impossible for simple geological and technical reasons.

The impact and timing of "gas shock" will be very important for oil price trend forecasting and forward analysis. It is little known, but sure and certain that Gas Shock is a lot closer than finance journalists like to imagine, when or if they they think about 'abundant and cheap' world gas supplies, building the Gas Bridge to the Future, at least in their imagination.

Russian net gas export downturns, not at all due to political 'blackmail' but perhaps presented as such for face saving reasons, are possible by well before 2010. The precise relationship and nature of oil and gas pricing will become a lot clearer, and more indexed, in the next two or three years.

Under any hypothesis, the possibility of world traded gas prices falling, as they did in Summer 2006, to 3 USD/Million BTU (equivalent to oil at under 18 USD/bbl) will rapidly diminish. For 2006-2007 we can suggest that even 7 - 8 USD/Million BTU is cheap and unsustainably low.

COMMODITY PRICE FORECASTING

Here again the approach can be transparent and fact-based, rather than based on supply-side chicken bone analysis and the savouring of rumours. What is required is cycle energy auditing, proceeding with a separation of of processes and flows generated by the supply chain, and continuing to detailed analysis of the user cycle.

Schematically we have:

Extraction/production -> Upgrading/processing -> Further processing -> Distribution -> Consumption/Use -> Disposal -> Recovery/reutilisation

This analytic framework applies to any metal, mineral or agrocommodity and offers fact-based, rational data for further price trend analysis. Our interest is to obtain transparent energy auditing of all phases in the Consumption Utilisation Cycle (CUC), that is production-use-disposal. This can be measured in kWh, kgs oil equivalent, kgs coal equiv, MJ, etc. Treatment of upstream embodied and overhead energy in production infrastructures and equipment presents the biggest problem for producing transparent data.

Several non-energy and policy-related factors can be identified as likely playing a role in emerging commodity pricing frameworks in the short-term and mid-term future. These include:

We can note that these trends, in whole or in part, are already predicated by some aspects of Kyoto Treaty application in ratifying countries.

The biofuels "revolution": We can note, see below, that the so-called "biofuels revolution"often incorporating very large energy subsidies to biofuels production, and large if hidden financial and economic subsidies to biofuels production and utilisation, will have major impacts on soft commodities.

The Food Versus Fuel Dilemma

The "finger in the leaking dyke" syndrome is well shown by even the quickest analysis of real potentials for "biofuels" coming to the rescue of fossil energy-based industrial, or 'postindustrial' societies. In terms of volume and net energy yield we can say that biofuels have the potential of one little figure in a well breached dyke with a tsunamai on the other side.

This is already recognised by defenders of the "biofuels route", who now claim that GM crops must come to the rescue of biofuels, through producing go-anywhere, rapid growing miracle plants yielding high amounts of oils and/or cellulose without requiring heavy and energy-intensive irrigation and fertiliser inputs, nor pesticides.

Choices available: Vegetable oil utilised for biodiesel production - a relatively simple and relatively low energy process of transesterification based on adding methyl alcohol in the presence of potash catalyst - appears the most rational and productive biofuels route, if tropical, higher yield oleaginous plant sources are utilised for vegetable oil supply.

As we shall see, major agro-industrial countries in the OECD prefer to utilise higher latitude, one annual crop plant sources for biodiesel production, for example the French rapeseed biodiesel programme. In general terms, one ton of vegetable oil will need about 100 kgs of methyl alcohol and 5 kgs of potassium oxide catalyst to yield about 1000 litres of biodiesel motor fueland about 100 kgs of glycerin sideproduct.

The energy content and engine performance of biodiesel, used in about 20/80 fuel mixtures with mineral gasoil (diesel fuel) is very close to 100 percent gasoil, fossil origin fuel. The great problem with vegetable oil biodiesel, as for bioethanol (fuel alcohol), is volume requirement to achieve serious subsitution of current massive utilisation rates of fossil fuels.

Vegetable oils able to be used for producing biodiesel include coconut oil, palm oil, jatropha oil, soya, sunflower and other oils, particularly rapeseed oil in higher latitudes. Few of these can achieve better than 4000 litres per hectare per year on a gross yield basis, and about 2750 - 3500 litres on a net basis. The higher latitude oil bearing agrocommodity crops, particularly rapeseed, are unable to yield better than about 2000 litres per hectare per year, before deduction of fossil or other energy inputs for farm machinery and processing.

Impossible targets: World oil consumption is running at about 5040 Billion litres per year, of which around 600 Billion litres is road transport gasoil diesel fuel, and another 600 Billion litres/year is motor gasoline. Taking only the diesel fuel, substituting this volume with biodiesel fuel would require about 1 Billion hectares to be dedicated to crop production including vegetable oil for operating farm machinery needed to produce the crops.

In addition, we should note, world consumption of gasoil is growing at well above 5 percent/year, requiring constant growing acreages to be dedicated, in theory, to this theoretical salvation for fossil energy based society.

The Dionysian solution - alcohol fuel: On first impression and superficially it appears that bioethanol production - in Brazil and based on sugarcane, the fastest growing sugar yielding commercial food crop - could or might produce serious amounts of motor fuel on a worldwide base.

We can note, as shown in the Presentation, that Brazil in 2005 dedicated about 55 percent of its total sugarcane crop, of around 209 Million tons, to fuel ethanol production, producing about 15 Billion litres of fuel ethanol with a fuel value, and gasoline substitution capability of about 12 Bn litres of gasoline.

This should be compared to the 600 Bn litres of motor gasoline consumed each year, growing like gasoil demand at about 5 percent/year. In simple terms, for those unable to do the complex mathematics, world gasoline demand increased about 30 Bn litres in 2005; this was 2.5 times the total production of Brazilian bioethanol. Media and TV treatment of the Brazilian 'miracle' surely avoid to present these simple facts, and disinform uncritical consumers of TV hype with slogans such as "Brazil could become another Saudi Arabia".

The moral dilemma and environmental limits: For sure these tiresome details are kept out of the flowing euphoria regarding the 'Biofuels Revolution', but even today we have about 900 Million persons worldwide suffering acute or chronic malnutrition: working to keep cars fed while people starve is surely a joyous challenge for true grit modern marketeers but is unlikely to win hearts and minds in the producer countries chosen as new energy plantation colonies for the motoring elites.

More seriously, because plantation agroindustrial production is widely accepted by ruling elites in low latitude, low income countries, the environmental implications of "second generation" biofuel crops, that is non-food GM plants occupying specially cleared, previously spared lands, likely presents the biggest danger from mass biofuels production, including accelerated erosion and loss of biodiversity.

Under almost any hypotheseis, the potential for Brazil perhaps becoming another Chad in oil export potential (about 250 000 barrels/day exports) is surely more likely than it becoming another Saudi Arabia (about 8.75 mbd net exports).

Energy-food renewable-sustainable technologies: These in fact exist. One of the least known and most attractive is OTEC-Ocean Thermal Energy Conversion, or production of electricity from thermal gradients in surface-deep ocean profiles, in tropical regions of the planet.

Intrinsic to this technology is pumping of water from extreme depths, up to and beyond three km depth (the same at which oil is produced offshore Angola and in the GoM-Gulf of Mexico, for example). This brings deep ocean nutrients to the surface, reproducing natural upwelling intense densities of fish, crustaceans and the microorganisms on which they depend.

OTEC "energy islands" of the type already developed for offshore oil installations, and for tourism development, could be large producers and exporters of high protein fish foods, as well as completely energy autonomous. Possible related development would include methane gas and bioethanol production, for certain export status of energy products, as well as high value fish protein.

Investor Opportunities and the International Energy Transition Fund

IET Background: The IET Fund results from a simple observation : on the one hand world oil demand and consumption will necessarily start declining as total output peaks and then declines ; on the other hand, for a variety of reasons and causes including Kyoto Treaty obligations in ratifying countries, consumer resistance to high energy, habitat, transport and food prices, citizen and community concern for the environment, growing alarm on climate change, and through evolving and emerging lifestyle choices, there is a large unsatisfied market for the products and services focused by this proposal.

This proposal was developed by myself in response to two of the most frequent questions posed concerning 'Energy Transition':

  1. What will Energy Transition do to the economic and business environment?
  2. What are the economic and business opportunities arising from Energy Transition?

After Oil: The term 'After Oil' has higher media coverage and impact than the supposedly technocratic, specialty term 'Energy Transition'. Certainly since early 2006, media and public opinion, and increasing numbers of political parties and deciders in the OECD urban industrial, or 'postindustrial' economies and societies utilise the term 'After Oil'.

'After Oil' is of course rarely defined, but despite being subjected to media overkill and disinformation is now a widely-used variable geometry catch-all idea - with growing political, associative, financial, economic and business angles.

My proposed IET Fund addresses the fast-emerging market opportunities generated by After Oil. These are concentrated in the following sectors, all of them urban-dominated or urban-oriented:

Low Cost: It is obligatory, for market success, to understand and act on the prime mover of consumer and collective perceptions, needs and desires generating the 'market clusters' listed above.

This is the high perceived cost and related decreasing supply security of current energy, habitat, transport and food supplies and services in the large, mature urban markets of the OECD countries, and increasingly in nonOECD countries.

This generates one very clear strategic goal of all and any investments to be considered by the IET Fund: Low cost, localised solutions to perceived cost and supply security concerns regarding energy, habitat, transport and food supplies in OECD country urban areas.

Successful start up, operation and growth of Fund vehicles will depend on this criteria cluster being satisfied. We only have to check, for example, the slow and unsure market penetration of organic and biological foodstuffs, and "green cars" or energy efficient vehicles, to understand this constraint: consumers and users find the current and small market offer too expensive, as well as uncertain, not user friendly, and so on.

Investment Criteria: To be sure, other selection and operation criteria will also be used in operating the Fund, and particularly the specificity of market potentials and supply opportunities by city, region and country.

One strategy which will be favoured by the Fund can be termed 'commercial-associative', that is tapping into and complementing associative, NGO, political party and community action in favour of renewable energy, environment protection, 'natural' or organic foods, sustainable habitat and urbanism, and so on.

Short-term Future Action: Several immediate, and short-term forward investor opportunities are available, and described in short briefs which are available on request. Depending on investor support, and progress with selected 'early day' investor opportunities notably in the domains of ecohabitat, sustainable or green tourism, and green urbanism, I place full-scale constitution and operation of the IET Fund on a forward timescale of three to six months from end-2006.

You are invited to partner with me, or support development of the IET Fund in any way you want, my personal ambitions in this area being to fully demonstrate the self-reinforcing growth potentials of this cluster of concepts.

Andrew McKillop is a writer and consultant on oil and energy economics. Since 1975 he has worked in energy, economic and scientific organizations in Europe, Asia, the Middle East, and North America. These include the Canada Science Council, the ILO, European Commission, Organization of Arab Petroleum Exporting Countries, the UN Economic and Social Commission for Asia and South Pacific, and the World Bank. He is a founding member of the Asian chapter of the International Association of Energy Economics. He is also the editor, with Sheila Newman, of The Final Energy Crisis (Pluto Press, 2005).

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