The world is awash in oil.

This might come as a surprise in an era that saw the price of oil near $150 a barrel less than two years ago. It’s the law of supply and demand, we are told. Too much – and growing – demand, and limited and declining supply. The oil world has reached or will soon reach its peak, at which point production will decline inevitably to zero, and the end of the Oil Age will be upon us.

The end of the Oil Age will, undoubtedly, come some day, but it won’t be in my lifetime. It probably won’t even be in this century. The problems of supply and demand are real, but they need a bit of explanation.

Demand is definitely growing.

Even though global demand will undergo a tightening in the coming months due to the shock of oil prices and an overall slackening economy, on a long term basis, it is increasing inexorably. Once this downturn is over, the wealthy nations will go back to work and the emerging nations will ramp up use once again. Global energy use has grown every year for the last two decades and more, and will likely grow in 12 (or 10 or 11 or 13) of the next 15. The current contraction will be temporary, whether it lasts for 6 months or for 60.

Oil supply is a slippery thing.

As noted above, there is a strong and growing belief in the world of the Peak Oil theory. The problem with Peak Oil is that nobody knows how much oil there is in the world, so it is impossible to know where the peak is. People have been confidently predicting an approaching peak for decades, and, not only have they been wrong, but each year global proven reserves have actually increased over the previous year. According to the BP Statistical Review for 2008, “reserves have grown 107.8 billion barrels since 2001 and 168.5 billion barrels, or 14%, over the last decade.” A good example of the uncertainty of oil reserves is the nation of Iraq. As shown in the table below, Iraq has the world’s third largest proven reserves at an estimated 115 billion barrels. However, due to decades of war and poor governance, Iraq is the most under-explored nation in the Persian Gulf region. As a means of comparison, the Energy Information Administration points out that, while the state of Texas has over 1 million oil wells, there are just 2,000 wells in Iraq. With further exploration, Iraqi reserves will certainly increase. To what extent is just guesswork, but the US Geological Survey expects another 100 billion barrels, and Iraqi government officials think they will ultimately find over 300 billion or even 350 billion barrels, dwarfing even the vast Saudi fields. Similarly, estimates of Russian oil reserves range from a low of 60 billion barrels to a high of over 200 billion. Recently, Brazil announced the discovery of a large oil field in the deep Atlantic coastal waters that some analysts predict will be as big or bigger than the big Alaskan discovery decades ago. In all likelihood, there are fields as large or larger in the waters off the American coasts, but current law bans exploration there (and exploitation of them even if they were discovered).

Having oil and getting it are two different problems

So, if there is all that oil out there, why are we hearing about supply problems? The answer is there are many answers. First, because having a massive supply and bringing it to market are two entirely different things. Going back to the example of Iraq – although petrogeologists are certain that vast quantities of oil are there to be discovered, the nation is simply too chaotic and violent to do any exploration. Russia, although it has made a comeback in recent years, still suffers from dysfunctional governance. Brazil’s offshore fields will take enormous effort to bring to market – the national petroleum company Petrobras has leased 80% of the available offshore fleet in the entire world, and that still won’t be enough (that lack of capacity is why, even if the US changes its offshore oil policy, it still won’t be able to fully exploit the resource for years, or even decades).

The problem of Political Peaking

A second reason is a phenomenon called “Political Peaking.” Petro-states, that is, nations whose economic base is completely or even largely based on selling oil, have a vested interest in understating their proven reserves. Creating the impression of limited supply increases the market price of their oil and, as night follows day, of their overall economy. Some will argue that large oil companies are in cahoots with the petro-states in this game, but there is a counter-argument that oil companies, in order to attract investors and to assure shareholders, have to demonstrate that they have access to as large a portion of the world’s reserves as possible, which works against their interests in understating supply.

The Rise of the Speculators

A third reason is that oil itself is used to satisfy two types of demand. First, as most of us think of it, oil is a commodity. This is how I have been treating it in this article. However, oil is also an investment instrument. Investors purchase oil futures, which is a bet that the global price of oil is going to increase over time, depending on the length of the futures contract purchased. While the price of oil has been increasing steadily for the last few years, the recent explosion of prices has come directly on the heels of the worldwide credit crisis. Many banks, investment houses, and hedge funds were heavily invested in mortgage securities, whose value has plummeted in the last year, placing many institutions in precarious positions. Indeed, some have already failed. Many of those remaining have turned their investments toward commodities in general and to oil in particular. Now they, too, have in interest in seeing the price of oil increase. Every dollar increase in the price of crude is an increase in the value of their futures contracts and a narrowing of their losses (at least on paper) on mortgage securities. So, when an energy analyst from Goldman Sachs predicts that oil will reach $200 per barrel, we have to remember that he has a vested interest in doing everything he can to see that it reaches that price – including pumping up the price with frightening, if baseless, predictions.

This is not to say, however, that speculation is the cause of increasing prices. It is but one factor in many. The perception of limited and increasingly scarce supply is another, and the reality of limits on production is a third.

But, really the world is awash in oil

British Petroleum’s current estimate of worldwide reserves 1.238 trillion barrels, with worldwide demand currently around 85 million barrels per day (that is a 1.1% increase from 2006 to 2007, although the United States – the world’s largest user, showed a 0.1% decrease). If current demand held steady, and estimates of reserves were complete and correct, then the world would run completely out of oil in about 40 years. If estimates of reserves are off by 50%, meaning there are actually 1.8 trillion barrels, then we have roughly 60 years. Of course, the fact is demand is increasing yearly, so the amount of time left in the petroleum age would shrink with increased use. However, even a 50% estimate is probably too low. The US Geological Survey, using statistical modeling based on the history and frequency of new oil finds, projects a total value of worldwide reserves to be about 3.338 trillion barrels, about 3 times the current estimates. The USGS model works on three possibilities. At the low end, they predict that there is a 95% probability that there at least 2.793 trillion barrels that will ultimately be recovered, while at the high end, there is a 5% chance that there will be 3.947 trillion barrels or more. Using these numbers, and assuming moderate growth in global demand, the Energy Information Administration estimates the year for peak oil production to be around 2040.

After the peak, a crash or a slope?

Most models of Peak Oil see production as a bell shaped curve, which means that there will not be a crash after the peak is reached, but rather a gentle decline. In other words, in the year 2072, thirty two years after the peak, the world will be producing as much petroleum as it is today, thirty two years before the peak. In the intervening decades, we can expect technological developments on many fronts – alternative energy sources that will do some of the jobs that petroleum does today, additives and supplements that will increase the efficiency of petroleum products, advancements in refining that will allow the generation of more gasoline from a barrel of crude (half a century ago, a 42 barrel of crude produced 11 gallons of gas; today, that same barrel produces 21 gallons of gas). Additionally, there are other, non-conventional sources of gas that will become available.

CTL

The technology for producing gasoline from coal, called coal-to-liquid or CTL, has existed for nearly a century, but it has usually been far more expensive than simply refining crude oil. As prices increase, however, CTL becomes more viable. If all the known coal reserves in the world were converted to CTL fuels, it would be the equivalent of just under 3 trillion barrels of oil. The United States alone, which controls 27% of the world coal reserves, would be able to distill 800 billion barrels – more than 3 times the proven reserves of crude in all of Saudi Arabia.

Tar Sands

Another estimated 2.3 trillion barrels

Heavy Oil

Additional 1.3 trillion barrels

Shale Oil

Estimated 800 billion barrels in the US alone

Total non-conventional fossil fuels

about 7.3 trillion barrels, which, when added to the estimates of current conventional reserves brings the total world reserves to well over 10 trillion barrels.