October 2009 Vol. 236 No. 10

Editor's Notebook

Editor's Notebook: Expert Advice

I doubt that there is anyone more knowledgeable about the petroleum industry than Dan Yergin, the Pulitzer Prize-winning author of “The Prize,” which has become the definitive history of the industry.

Yergin is updating his book and recently wrote an article for Foreign Policy magazine that offers some intriguing assertions during this time when so much attention is being focused on anything but oil as a fuel source.

Yergin notes several significant changes have occurred in the industry during the 20 years since he wrote “The Prize”: He refers to them as “the new age of oil.”

1) Oil is now a financial asset as well as a physical commodity. The massive increase in daily trading fed by a global network of instantaneous communications has led to price volatility that reached its peak on July 11, 2008 when West Texas Intermediate hit $147.27 a barrel before falling to $32.40 in just five months. The economic impact is enormous on hedgers, speculators and everyone in between. The impact of $4 a gallon gasoline on Detroit is a prime example. Planning future investments in oil and gas or renewables and alternatives has become a risky proposition. The politicians refer to this as “destructive volatility,” but acknowledge, albeit reluctantly, that there are no easy solutions, Yergin writes.

2) The cast of characters has changed significantly with the globalization of the oil business. Many oil companies have been swallowed up in the advent of “supermajors” such as ExxonMobil and Chevron, but even they are dwarfed by the development of the state-owned oil companies which today comprise 15 of the world’s largest oil companies, and along with governments, control more than 80 percent of global oil reserves. Oil traders now include pension funds, institutional money managers, endowments and hedge funds along with individual investors and day traders. This has led to a massive growth of oil speculators, Yergin says.

3) Rising demand in China , India and other emerging markets is a growing influence. Yergin notes that between 2000-2007, daily oil demand rose by 9.4 million barrels, 85 percent from emerging markets. That surge in oil demand driven by the economic growth in those markets was the real starting point for last year’s soaring prices. “When economic recovery takes hold again, what happens to oil demand in such emerging countries will be crucial,” Yergin says. China, he notes, can pay top dollar for access to existing and new oil sources while also making loans to oil-producing nations to ensure future supplies.

4) The issue of climate change has made carbon regulation a part of the future of oil, with renewed emphasis on reducing oil demand. Here, Yergin asks “how does that get done? How does the world at once meet both the challenge of climate change and the challenge of economic growth/steady expansion in the industrial economies and more dramatic growth in China, India and other emerging markets?” This needs to lead to an unprecedented emphasis on technology all across the energy spectrum. But can alternatives be found that will be competitive in massive scales?

Even with new efficiencies, global energy use will increase almost 50 percent from 2006 to 2030 with oil continuing to provide 30 percent or more of global energy in 2030, according to projections from the U.S. Department of Energy and the International Energy Agency.

On the positive side, Yergin says recent studies of the global resource base indicate there is enough oil to keep up with demand for decades to come, although many of the projects will be more complex and more expensive in addition to facing the standard “aboveground” risks and obstacles such as restricted access, taxes, civil conflict, geopolitics and uncertainties about demand.

Finally, Yergin suggests that flexibility and liquidity of markets is essential in balancing supply and demand and enabling consumers and producers to hedge their risks. The market remains the way, he says, to send signals to consumers and producers about how much oil to use and how much money to invest – or signals to would-be innovators about tomorrow’s opportunities.