The oil crisis and its impact on Sri Lanka

The world has now used up more than half of the recoverable oil reserves discovered since 1859. It took 50 years more for oil and gas to displace coal as the fuel of choice. Current oil production is ~85 million barrels per day (Mbd) and there is general consensus that the oil industry has probably reached a production peak. With current recoverable reserves standing at ~1065 billion barrels (Bb), there are another 36 to 40 years of oil reserves left in the rocks. Oil, which takes millions of years to be produced in the rocks by some of the most complicated chemical reactions known, would have been exhausted in just 200 years since its first discovery. Today, the world consumes 4 barrels of oil for every new barrel discovered and the shortfalls will not be filled with any new discoveries in the coming years. This is the unfolding oil crisis. Similarly, the gas reserves will last for about 60 years.

Oil accounts for more than 50 per cent of the World’s energy requirements; oil and gas together supply almost 70 per cent. About 65 per cent of the oil is used for transportation. A major crisis in the supply of these commodities can drastically affect the price and bring industrial societies to a standstill. Supply problems have everything to do with rising demand (increasing at 3 per cent / year), global and regional events and now production peaks. Oil is a highly versatile fluid. It burns more cleanly and could be transported by pipelines, ship, rail or road. Yet, about half the energy produced is lost in distribution, wastage, inefficient usage and now in pilferage. There is no other single source of energy in the horizon to replace oil.

World oil reserves- how much and where?
The Arabian-Persian Gulf region contains about 70 per cent of the reserves. The Organization of Petroleum Exporting Countries (OPEC) accounts for 80 per cent; OECD countries 10 per cent and the rest are independent producers. Of the 700 odd known petroleum basins, about 95 % of the oil is in 50 basins and 75% in only 10 basins. There has been a marked decline in the annual rate of additions to the world reserves since 1970. The new oil basins being discovered in the Central Asian-Caspian Sea region and elsewhere would not alter the existing overall picture of either reserves or distributions. The cost of finding a new oilfield is calculated in billions of dollars. It takes 7 to 20 years to see a return on upfront investments required for hydrocarbon exploration.

Peak oil scenarios
World oil production peaks when half of the proven reserves are extracted. Even if global oil consumption remains steady, worldwide oil production would go into absolute decline by around 2036. But consumption keeps going up, increasing from 60 mb/d in 1985 to 69 mb/d in 1995 to 85 mb/d in 2005. Calculations by the world’s top experts indicate peak oil dates of between 2005 and 2010.

Around 37 of the 51 oil producing countries are in decline, having passed the mid-point of reserves years ago. All non-OPEC production is now at a maximum of its resource limits. Even in the OPEC, resource limits will force production declines within the next 5-10 years. Remaining supplies will be consumed much faster due to increasing demands of the industrial world. The prediction by experts is that world production could be down to about half of 85 mb/d by 2030. With a 3 per cent increase in annual global demand (mainly from China and India), the supply side will be stretched to the limits.

Oil prices
In January 2004, the price was U$ 33/b. It reached a maximum of U$ 77/b in August 2006. Historically, the price of oil has not increased too much in real terms if inflation is taken into account. In the post 1945 era, the median and adjusted world price of crude was U$ 17/b at 2004 base prices. Since 1869, the world prices adjusted for inflation have averaged only U$19.40/b. Actually we have had it very cheap for a very long time. In the 1950’s the price of petrol in Sri Lanka was around Rs. 0.50 per litre! There is a high hidden cost to cheap oil. This is the military protection of supplies, which is estimated to cost about U$ 100 billion per year to ensure the free flow of oil from oil-rich unstable regions and hence is subsidized to the consumer. The real cost could be as high as U$ 1.5-2/litre. The artificially low prices of oil and gas over the past years gave them a competitive market advantage and prevented development of alternate energy mixes. Today, the oil market is dominated by OPEC and the major oil companies, both of whom are making unprecedented profits due to the soaring prices. Thankfully, oil is traded in U$ dollars. If OPEC decides to shift to say the stronger euro currency, the global economy will be subjected to unpredictable upheavals and outcomes.

U$ 75/b would cause severe problems if the world economy was in recession. However, if growth can be sustained at about 4 to 5 per cent per annum, the global economy should be able to cope if strong conservation measures are in place to prevent wastage, inefficiency and profligacy. Economists can advise whether it is better to have oil at U$75/b with a 5 per cent growth rate or oil at U$ 55/b with 2 to 3 per cent growth (assuming interest rates remain low and steady). High oil prices, low growth and high interest rates sets off chain reactions with high inflation, high manufacturing costs, weakening currencies, expensive consumer products, high current account deficits (CAD) and debt repayments and the inevitable recessions. High energy costs account for over 50 per cent of CADs of many nations (World Bank). Sri Lanka’s oil import bill for 2006 will be over US$2 billion (20 per cent of total imports). Three of the last four global recessions were caused by high oil prices. Since the 1970s, the world is now experiencing the long expected “third oil shock” and it could last for a very long time.

The current high price is due to the surging demand from India, China, Russia, Brazil and Korea etc. (close to 3 billion population) as they annually shift large sections of their populations into the burgeoning middle-classes who want to drive cars, build better houses, run air-conditioners, gadgetry, holiday abroad, computers, TVs, DVDs, CDs, cell phones and all other paraphernalia of conspicuous consumption. All of these “needs” have great implications for total energy consumption. Here we are talking of 300-400 million people of the new middle-class. For the next 25 years at most, vehicles will have to run on some form of refined oil. By this time China and India will have more cars than the USA; Brazil and Russia more than Japan and we may be heading for a billion automobile scenario. What price oil then? Are these rational expectations? This is perhaps the very first time that a soaring oil price has been caused by surging demand rather than some forced or contrived political event. Already, there is a shift to natural gas, but the global peak in gas production will also come within 20 years.

In another five years, oil could be close to U$ 120/b; but what if it doubles again in two years? All what we can hope for is a steady rise in the price over time and not a sharp shock of doubling prices. For sure, the era of cheap oil is finally over. Governments, oil companies and society must now think of other energy options seriously. In the short term, conservation is the best option and additional source of energy as it gives some of us some breathing space to develop alternate strategies. It is wise not to believe in what the oil producers and oil companies say on this issue – that oil reserves are ample for current consumption for the coming decades. Governments must do all it can to ensure energy security and sustainable growth. Any realistic economic planning must assume that in another 5 years the oil price will be around U$120 / b.

Geopolitics of oil
In the scenario described above, it would be natural for consumer countries to look at energy security in the longer term. This is where the concept of globalization comes in. Globalization is the operational mechanism to gain early access to resources, which is a perfectly legitimate exercise in a global market economy. China, India, Japan, USA etc are already jockeying for position to get a share of new production from Africa and Central Asia. In April 2006, the Chinese Prime Minister visited Nigeria and promised to invest up to U$ 4 billion in the oil industry there; it is already buying oil from Sudan. Africa was traditionally dominated by the western oil giants. Last year the China National Oil Company made a U$ 18 billion bid for the US oil company UNOCAL, which was disallowed by the US Congress. India is to invest in the Ivory Coast and the Japanese Prime Minister’s recent state visit to central Asia was to discuss oil investments and supplies. Knowing that resource limits will force production declines in the next 5-10 years, the energy hungry rich and powerful nations are already jockeying for position to get a piece of the action. China alone will require 99 mb/d by 2031 if it sustains a growth rate of 8-10 per cent. Such volumes will never be available and such growth rates near impossible due to obvious production/supply constraints. Add India and others to the equation and there will be resource wars in the making.

About a fifth of the World’s oil has to go through several “choke points” like the Straits of Hormuz in the Arabian-Persian Gulf, the Bab al-Mandeb (Yemen) at the entrance to the Red Sea and the Straits of Malacca. Any disruption at these points will create severe problems and skyrocket prices. Recently, Iran, which accounts for 4 mb/d, has been in the news over the nuclear issue (it controls the Hormuz passage). There have been attacks on tankers in the Red Sea and piracy in the Malacca Straits.

The view of some economists is that the market will solve the energy shortages. Accordingly, the present crisis will produce an economic stimulus, which will discover new resources and invent new technologies that would maintain market equilibrium and that regulations, which curtail economic growth are to be avoided. They do not explain how growth can be sustained with a shrinking energy base. Technology only provides the infrastructure to run the oil/gas based industries. With a fast depleting hydrocarbon base, there is just not enough time to shift our entire transportation and industrial network to a single alternative energy source. Oil and gas enabled us to operate highly complex systems on enormous scales. Nothing can replace them in time or scale. Most renewables and alternate fuels (winds, waves, solar, nuclear, biofuels, etc) are presently very marginal and also require lot of energy and the existing oil platform for future development. The non-conventional oil sector (oil shale and tar sands, coal gas etc) is still very far off. Fuel-cells are only a form of energy storage.

Petroleum prospects in Sri Lanka
There have been numerous statements by government spokespersons over the past few years that significant oil deposits have been discovered in Sri Lanka and that we are very close to producing our first oil and should be in a position to face the emerging oil crisis. I was somewhat taken aback and surprised at this news. With my limited knowledge of the oil basins in Sri Lanka and the current state of exploration development, we are nowhere near to seeing the first barrel of oil reach the surface. A new Petroleum Act has been drafted and passed by parliament. However, the Regulations required to operate this Act is still not in place. This will take at least two years. As far as I am aware, the Ceylon Petroleum Corporation has not called for any expressions of interest from potential investors or exploration companies. CPC has to sort out a dispute with TPG- NOPEC, which is in possession of all 2-D seismic data. This data is a pre-requisite before the sea bed is leased out to the various companies for more advanced exploration. It is possible for governments to reserve exploration blocks on a state to state basis based on extraneous or political considerations. Exploration and production companies coming to Sri Lanka will depend very much on the prevailing political and security situation in the country, a level operating field and the nature of the agreements with the CPC.

In oil exploration investors will have to take all risks. The Sri Lankan contribution and colateral will be the potential oil deposits only. The large financial input required will be borne by the investors. Actual drilling for oil will depend on the exploration results. If the reserve estimates indicate that insufficient oil is present in the reservoirs, any further work could be abandoned. If a decision is made to go ahead with drilling and subsequent production, then negotiations for a production sharing agreement between the CPC and the foreign government or companies will commence.

The critical mass of petroleum geologists, geophysicists, reservoir, civil, mechanical and production engineers required for the entire operation is currently not available in Sri Lanka and most likely will be brought in by the oil companies. An enormous infrastructure needs to be put in place. This is also colateral by the investors. Normally, the whole process takes six to eight years and billions of dollars. So what is in it for Sri Lanka? This depends on how we negotiate exploration, drilling and production sharing agreements and oil royalties. It is imperative that we set up a competent negotiating team for the purpose, which will get the best deal for the country. With all the unwanted interferences, changing governments and policies and inevitable delays it will take more than 10 years before the first oil reaches the surface. Sri Lanka will continue to bear the high oil import bills for many more years.

The writer was Professor of Geological Sciences at the Universities of Kuwait and Oman, both oil-rich countries, and taught Petroleum Geology for many years. He was involved in the preparation of the Mines and Minerals Act of Sri Lanka, 1992.