Report on the risks and impacts of a potential future decline in oil production

Report on the risks and impacts of a potential future decline in oil production 1 June 2009

There is a vocal group of analysts/scientists who believe that the peak in global oil production is going to happen “soon” – though views range on whether this means the peak is imminent or will occur in a few years. The attached report summarizes the main outputs of an internal project undertaken in 2007 by then BERR officials on the issues surrounding peak oil. Who and what is this report for?

Content Executive Summary What is peak oil and what do others say? Oil in the UK Economy Alternative Technologies Scenarios of peak oil and their impacts Conclusions Bibliography 3 Content

4 Why did we engage in a peak oil project? • Why does peak oil concern us? • Our current view is that a permanent decline in global oil production – i.e. peak oil – is unlikely to take place before 2020. However, if it were to happen, the consequences for economic prosperity and security are likely to be serious, with: • Impacts on UK security of oil supply • Impacts on the prices for other fossil fuels such as gas and coal • Disruption of the UK economy especially the transport sector • Long term macroeconomic impacts (GDP, inflation etc) and impact on prices of other goods • Possible impacts on our climate change goals • Possible geopolitical implications • The lead-times for Governments and economic systems to adjust to peak oil could be several years or even decades – with a potentially painful transition time. Therefore, it is prudent to more thoroughly explore the issues surrounding peak oil in the context of longer-term risk management. • What methodology was used? • Literature review of existing evidence • Interview programme with key stakeholders and experts • Scenarios workshop(s) mapping out possible paths and patterns • for supply & demand growth • Implications workshop(s) debating the impact of peak oil on price, • demand, supply, technology development, GDP, security, etc. • Policy option workshop(s) and steering group meetings • What were our objectives? • To understand the facts and uncertainties surrounding • the peak oil debate • To improve government communication on the subject • To provide high level policy recommendations to • address peak oil’s impacts on the UK • To show which of our key policies already address • issues surrounding peak oil When was the project undertaken? The project was started in May 2007 and ran until November 2007. In order to disseminate outcomes of the project more widely this report, based on the earlier work, was prepared. What happened since the end of the project? The 2008 World Energy Outlook warned of investment shortfalls and rising depletion rates of existing fields. The current recession raises questions on how the recession will impact on investment in the oil industry and the likeliness of a future supply crunch.

What were the key conclusions of the project? 5 • Domestic policies that increase our resilience to peak oil… • Investment in alternative technologies and renewable fuels for transport (i.e. biofuels and electric vehicles) and heating (through among others the Renewable Energy Strategy, the Heat and Energy Saving Strategy and support for research into new technologies) • Pursuit and legislation on higher energy efficiency standards (for example new car CO2 standards in the transport sector) • Regular monitoring and reporting on energy supply, demand, price and other market developments • Maximise production from maturing provinces, especially UKCS • Conclusions on peak oil… • It is not possible to predict with any accuracy exactly when or why oil production will peak; • While reserves are plentiful existing fields are maturing and the rate of investment in new production is being slowed down (by bottlenecks, the credit crunch and geo-politics). Alternative technologies to oil in transport will take a long time to develop and deploy at large scale. • The implications of tight oil markets and a decline in total production would be higher and more volatile prices • The UK economy would be initially relatively robust to higher prices; overall, the UK is relatively more immune than most other countries. • However, if peak oil happened before 2015, this would have significant negative economic consequences for some of the main importers of UK goods and services resulting in a negative impact on the UK economy in the longer term. However… Policies relating to oil consumption in the transport sector, particularly road and air travel, should continue to be monitored closely, as this sector would probably be most exposed to rising and volatile prices in the event of peak oil. Security and diversity of supply are even more important in the transport sector, as oil cannot be substituted in the short term (or even the medium-long run) without significant investment, large technological improvements and/or alternative fuels. Economically viable and readily available alternative and renewable technologies are an essential policy area if we are to increase the resilience and flexibility of UK businesses and consumers to high and volatile oil prices. The UK’s move to a low carbon economy and climate change policies are consistent with these conclusions.

Content Executive Summary What is peak oil and what do others say? Oil in the UK Economy Alternative Technologies Scenarios of peak oil and their impacts Conclusions Bibliography 6

7 Defining the Debate ‘Peak Oil’ refers to oil production reaching an all-time high and the subsequent decline in production volumes. Thus, after the ‘peak’, the rate of total world oil production volumes cannot increase but will decline.1 Be aware:Peak oil generally refers to conventional sources of oil peaking and does not include unconventional resources such as natural gas liquids (NGLs), oil sands, or oil shales.2 Key Factorsto determine Peak Oil … Key Questionssurrounding Peak-Oil … Remaining Reserves3 How much economically extractable oil remains? 3) Rate of decline? Investment When/whether additional production capacity will be brought online? What is the impact of prices on investment? Peak 1) Level? 80 60 Technology How will our ability to extract and substitute for oil change in future? Production in mm barrels per day 40 20 2) When ? Geopolitics Will some countries prevent access to reserves? 1990 1995 2000 2005 Demand How will demand develop, particularly in developing economies, and how price elastic will global demand be? • ‘Controversial arguments’… • “There is little oil left to be discovered…” • “OPEC countries have overstated their reserves…” • “The world has already produced half of its original endowment of Ultimately Recoverable Reserves (URR)” Peak Oil? 1 Hirsch, Bezdek, Wendling 2005 2 This report is only interested in a supply-constrained peak, not a peak in demand. 3 Typically the debate concerns how much of the earth’s original endowment of economically extractable oil has not (yet) been produced.

Agree to Disagree 8 Opinions on if and when there will be a supply-constrained peak vary widely. Views on conventional sources peaking range from imminently to within the next 10-15 years… IEA* Some estimates of the timing of conventional peak oil from the literature • Hubbert peak theory • …and the role of prices and technology • The Hubbert curve projects the rate of oil production over time. Based on the observation that oil is a finite resource, • Hubbert hypothesised that the production curve mirrored the discovery curve and thus predicts that discoveries will follow a roughly bell shaped curve (a Hubbert curve), expanding quickly at first to reach a peak, and then trailing off as the quantity of remaining undiscovered reserves declines. • According to this model, the rate of oil production is determined by the rate of new oil well discovery. The relative steepness of the projected rate of decline of the production curve is the main cause for concern about the economic and social impact of peak oil. This is because a steep drop in the production curve implies that global oil production will decline so rapidly that the world will not have enough time to develop sources of energy to replace the energy currently gained from oil. • A number of authors, notably those with a background in geology, use this methodology. Shell* CERA Word Energy Council Laherre Campbell Goodstein Deffeyes Skrebowski* Simmons Bakhitari Hubbert 2005 2007 2009 2010 2015 2020 2025 2030 Source: Peaking of World oil Production: Impacts Mitigation & Risk management (Hirsch, Bezdek, Wendling 2005) DECC itself has not attempted to predict the timing of peak oil. *updated • In 1956 Hubbert closely predicted the peak of production in the United States in the 1970s. However, US production in 2005 (in the Lower 48 states) was 66 percent higher than Hubbert had projected. Also, Hubbert’s US estimate was based on very reliable resource estimates and assumed an economically rational exploitation. • Criticisms levelled at Hubbert’s approach: • Discovery – Hubbert’s treatment of discoveries focuses exclusively on geological scarcity. It fails to account for the influence of the oil price, changing technology and governments’ policies. • Reserves – An estimate of finite recoverable reserves lies at the foundation of the theory, but estimates have changed significantly over time and are dependent on technology (and oil price), limiting the models predictive power. • Production – Hubbert assumes a fixed time lag between discovery and production, but the capacity and incentives to produce are likely to change over time and invalidate this assumption. Also, countries such as those in the Middle East do not necessarily exploit resources based on market principles but may decide to keep resources for the future.

Total petroleum initially in place Discovered petroleum initially in place Commercial Production Proved (1P) Proved+ probable (2P) Proved+ probable+ possible (3P) Sub-commercial ContingentResources Low estimate Best estimate High estimate Unrecoverable Undiscovered petroleum initially in place Prospective Resources Low estimate Unrecoverable Best estimate High estimate 9 The Main Points of Contention“Depletion has built a chasm between the Natural Scientist, who observes nature and applies its immutable physical laws, and the Flat-Earth Economist, who thinks that investment creates resources under ineluctable laws of supply and demand. “ – C.J. Campbell Counting Oil Reserves…the variety of existing measures leads to confusion when measuring and comparing resources • How Much ‘Oil’ Remains? • In the literature on peak oil, the use of different data and a lack of standardised definitions and methodologies leads to significant disagreement about even the basic empirical facts. • Definitions– there is no agreement whether to include Natural Gas Liquids (NGLs), oil sands under active development or all proven oil sands as part of oil reserves.2 • Methodology– The amount of proof required to demonstrate a discovery varies, as do the assumptions used to asses whether reserves are economically recoverable. • Reported Data – Some authors use problematic but publicly available data, while others use confidential data sets from industry. OPEC data has, at least in the past, been of questionable quality. Similarly, companies may have exaggerated finds. Source: IEA World Energy Outlook 2008 The Future of Technology There is little systematic treatment of the role of technological improvement in the literature. However, where it is mentioned, viewpoints differ. Proponents of an earlier peak suggest that technology may lower production costs and hasten production, but doesn’t actually add to reserves. Others note that technology has allowed for the expanding definition of ‘oil’ and allowed access to previously unrecoverable reserves. Discovery Rates Many proponents of a near-term peak in oil production note that, in recent years, production has exceeded new discoveries. They take this decline in discoveries to indicate, in line with Hubbert’s peak theory, an impending peak in production. On the other hand, the IEA has stated that the reduction in oil discoveries is largely the result of reduced exploration activity, given ample existing proven reserves. 2Although unconventional oil has traditionally been excluded, it is not clear that it makes sense to do so when considering the impact/risks associated with peak oil.

World Oil OPEC WEC BP IHS O&GJ 1,000 1,050 1,100 1,150 1,200 1,250 1,300 1,350 Proved Billion barrels Proved & Probable 1,400 Asia/Pacific North America 1,200 Latin America Africa 1,000 Europe and Eurasia Middle East 800 600 400 Billion barrels 200 0 1980 1990 2000 2007 10 Known Knowns & Known Unknowns– Remaining Reserves Proven Reserves Estimates vary, often as a result of differing definitions, but at 1.2-1.3 trillion barrels, remaining proven reserves are equal to over 40 years of production at current rates. Proven reserves have continued to rise, but mainly due to the large revisions made by OPEC members in the ’80s. Some authors question the reliability of these revisions. Ultimately recoverable resources(URR) Comparing proven reserves against estimated URR provides an indication of when peak oil is likely to occur. The IEA estimates URR at just under 3.6 trillion barrels, of which 1.1 trillion has already been produced. The US Geological Survey 2000 states 3.0 trillion barrel. Estimates of URR may continue to increase as knowledge grows, technology advances and the economics of oil extraction change. Sensitivity A number of sources, however, note that the timing of peak oil is relatively insensitive to the URR estimate used. Adding 900bn barrels to the above USGS estimate only delays the peak by 10 years in scenarios published by the US Energy Information Administration.* Resource Exhaustion Concern about resource exhaustion lies at the heart of the peak oil debate. The extent of ultimately recoverable resources is contentious, as is their effect on the level of production. The traditional peak oil argument suggests that the discovery rate falls as remaining reserves are depleted, and that production mirrors discoveries. However, this simple model is complicated by the ‘expanding’ definition of oil, changing exploration efforts, shifting decline rates, geopolitical constraints and the level of productive investment. Source: IEA WEO 2008 Incentives to overstate reserves or discoveries? OPEC data on reserves rarely changed despite ongoing production and exploration and no objective review of reserves has been possible. Also, there may be periodic incentives for OPEC members to overstate reserves in order to increase OPEC production quotas. International Oil Companies may have an incentive to overstate assets to boost share prices but to underestimate resources to negotiate better exploration conditions Revisions Source: IEA WEO 2008 * Long-Term World Oil Supply Scenarios (Wood, Long, Morehouse 2004)

Accessibility of Proven Oil Reserves Saudi Arabia Inaccessible Canada Restricted Iran Accessible Iraq Kuwait UAE Venezuela Russia Libya Nigeria Kazakhstan United States China Qatar Algeria Brazil 0 50 100 150 200 250 300 Mexico Billion Barrels Angola Azerbaijan OECD Pacific Norway OECD Europe Latin America Asia Middle East Africa E. Europe/Eurasia OECD North America 0 500 1,000 Oil – conventional Billion dollars (2007) Oil – non-conventional 11 Known Knowns & Known Unknowns– Investment • Investment • Arguably, peak oil is less about a lack of oil than a lack of investment. The IEA’s WEO 2008 has noted that around $5 trillion (2007 $) of upstream oil investment is needed between 2007-2030. An annual $350 billion (2007 $) on average in both upstream oil and gas investment. • Global oil and gas exploration and production (E&P) expenditure was estimated at $454bn in 2008, according to Barclays Capital. • The IEA thinks that a major shift in investment is needed and much more capital needs to go to resource-rich regions, notably the Middle East, where unit costs are the lowest, but political barriers remain. • Resource nationalism is making access increasingly problematic. Most reserves are controlled by National Oil Companies, limiting access to International Oil Companies that are often better at extracting the resources. • Decline rates are key to determining how much investment is required to maintain production levels. The IEA estimates that the production-weighted average decline rate worldwide is projected to rise from 6.7% in 2007 to 8.6% in 2030. Using these estimates, even if oil demand was to remain flat to 2030, 43 mb/d of gross capacity – roughly four times the capacity of Saudi Arabia – would be needed to offset decline from existing oilfields. However, technological progress on EOR techniques means that future decline rates are also subject to considerable uncertainty. • Upstream projects currently under construction and planned will add in total around 28mb/d of new peak oil-production capacity in the period to 2015, on the assumption that their completion is not delayed or cancelled. Cumulative Upstream Investment Needed 2007-2030 Investment in the recession Low prices and financial constraints may hinder investment if national and international oil companies decide to put new investments on hold, spend less money on future investments, delay investments that are already underway or invest less in maintenance at maturing fields. A lack of investment could accelerate for example decline rates at maturing fields . However, the recession also decreases recently increased costs of investments. Source: IEA WEO 2008

140 High of range 120 Billion barrels Low of range 100 80 60 40 20 0 Middle East North Former Latin Africa Asia/Pacific Europe America Soviet America Union 12 Known Knowns & Known Unknowns– Technology Technology Technological innovation has the potential to dramatically expand potential ‘oil’ production and reserves, allowing for both improved recovery rates of conventional sources and an expanding definition of oil. Also, new technologies for producing oil could to some extent ease our dependence on conventional crude oil extraction. Enhanced Oil Recovery (EOR) – A variety of sophisticated techniques to raise field recovery rates above those achieved through simple gas or water injection (secondary recovery) Deepwater & Ultra Deepwater – Extraction techniques that provide access to deep sea fields Heavy Oil & Oil Sands – Viscous, dense bitumen sometimes mixed with sand and clay Oil Shales – Rocks containing a large proportion of solid organic compounds that can be converted into oil Gas-to-Liquids – Conversion of natural gas into liquid fuels (i.e. diesel) Coal-to-Liquids – Conversion of coal into liquid fuels (i.e diesel) Of these, EOR and heavy oil will probably make the largest near-term contributions, owing in part to the relatively low production costs involved. EOR accounted for 2.5mb/d of production in 2007 and a further 6.4mb/d of supply is expected to be added by 2030. Meanwhile, oil sands and extra-heavy oil may ultimately add between 1 and 2 trillion barrels to economically recoverable reserves, albeit at a significant environmental cost. The extent of potential additions to recoverable resources and historic technology advancements are shown on the right. Technology advancements in deep sea recovery 0 m 250 m 500 m 750 m 1000 m 1250 m 1500 m 1750 m 2000 m 2250 m . . . 1988 1993 …1997… 1999 2003 2010? Source: IEA 2008 Potential Additional Recoverable Oil Resources Using CO2-EOR Source: IEA WEO 2008

Both supply and demand matter Price GDP growth Demand Supply Efficiency Depletion Volume 13 Conclusions from the literature review Prices – Long-Term Oil-Supply Cost Curve • Conclusions • Apples & Oranges – Given the confusion over terms, authors often ‘debate’ fundamentally different questions. • Prices – Proponents of an early peak play down, or overlook entirely, the role of higher oil prices in stimulating exploration, investment, technological development and changes in consumer behaviour. Especially very few of the authors acknowledge the feedback from prices into demand. • Market Constraints – Proponents of a late peak often fail to account for significant rigidities, which slow the market’s ability to respond, and ignore the risks posed by insufficient investment. • Confidentiality – Often arguments are based on confidential information so it is impossible to verify the conclusions • Uncertainties – Exist around the amount of global reserves, production capabilities, human resources and demand behaviour. • Impacts – Surprisingly, many papers do not mention the impact of peak oil on prices and price volatility and also do not calculate the full costs to the world/economy in terms of GDP, inflation etc. Only recently papers have looked on the differential effects that peaking may have on developed and developing countries. • Mitigation - There is very little in the literature on the “so what?” and the potential for mitigation of the effects of peak oil. Only Hirsch 2005 calculates that initiating a mitigation crash program 20 years before peaking appears to offer the possibility of avoiding a world liquid fuels shortfall during his forecast period Unconventional sources could add new oil supplies even if conventional sources have peaked. Source: IEA WEO 2008 Exploration and extension Technology and cost reduction Source: BP 2007

Executive Summary What is peak oil and what do others say? Oil in the UK Economy Alternative Technologies Scenarios of peak oil and their impacts Conclusions Bibliography Annex A: Global System Model (available on request) Annex B: Literature Review (available on request) 14 Content

The Impacts of Peak Oil… how demand may respond to peak oil ... How will GDP respond to price increases? In 2004 research by the IEA estimated that, as a rule of thumb, a sustained $10 per barrel increase in international crude oil prices would cut average real GDP by around 0.3% in the OECD and by about 0.5% in non-OECD countries as a whole. Overall world GDP would thus be reduced by about 0.4% (based on a baseline price of $25). Most of this effect would be felt within one to two years, with GDP returning broadly to its baseline growth rate thereafter. The adverse effect may be four times worse on very poor developing countries (WEO 2006). A 2005 analysis by the International Monetary Fund (IMF) quantifies the macroeconomic effects of a spike in oil prices on the global economy. An increase of about $37 in the year 2005 compared with the base case ($43) – falling back to the base case level by 2009 – showed that GDP growth in the industrialised countries was projected to fall by 0.6 percentage points in the first year and inflation to be one percentage point higher. If the price increase was perceived to persist, the GDP and inflation effects were much more pronounced, with GDP falling by as much as 1% in the industrialised countries. (WEO 2006) Work by Oxford Economics for the London Energy Meeting (December 2008) showed that a price rise from on average $80 to $100 in 2008 may have reduced global GDP growth by 0.3% (US$ 150bn) Earlier disruptions have been shown to have the following impacts on prices: *Source WEO 2005 and own estimates. For price impacts we used month on month data pre 1981 and daily data thereafter. However these estimates are very approximate as they do not take into account other impacts on prices and the influence of expectations/risk premiums on price impacts. The WEO 06 also caveats that these estimates assume that all other economic factors remain unchanged. In practice, changes in other factors may outweigh the impact of higher oil prices, limiting or increasing GDP losses.

Immediate impacts Transfer of income from importing to exporting countries Deterioration in balance of payments for net oil importers Short- & medium-term impacts Higher Inflation Increased input costs (transport, industry) Reduced non-oil demand (because of higher prices for goods) Potentially reduced oil demand and consumption Lower investment in net oil-importing countries Upward pressure on wages Higher unemployment Consumer and business confidence falls Downward pressure on GDP Tax revenues fall Falling exports due to economic impacts in our main export markets Other possible impacts Social unrest Resource nationalism Increased geopolitical competition for resources/supplies possibly leading to an increase in long-term supply contracts Greater emphasis of security of supply over climate change objectives The Impacts of Peak Oil… peak oil’s effects on the economy would not be limited to higher oil prices – there could be a number of other potentially significant impacts on the economy … In exploring the potential impact of peak-oil on the UK we need to consider both thedirect and indirect impacton the UK economy resulting from changes in oil prices and supply pressures as well as theshort term versus the long term impacts. The short term versus the long term impacts are outlined below. If we consider the direct and indirect impacts, the direct impacts are more likely to be channelled through economic variables such as inflation, output, current account of balance of payments and tax revenues, whereas the indirect impact will arise as a result of economic and political reactions of other countries’ to changes in the oil price and supply pressures. Price rise Shorttermimpacts Longer-termimpacts Otherimpacts

17 Oil in the UK Economy… Generally, the more dependent an economy is on oil, the less resilient it would be to deal with the impact of rising and highly volatile oil prices due to peak oil. Energy ratio in OECD countries Indicators we need to look at to estimate ‘oil dependency’: Oil Import Dependency Import dependency is defined as the ratio of oil imports to total consumption. Although oil is traded and priced in a global market, countries such as the UK that are an oil exporter as well as an oil importer will, in the event that international supply is disrupted, have relatively robust access to physical supplies. As the UK becomes increasingly reliant on imports of oil for its consumption, disruption of physical supplies can have significant effects on the economy. Energy consumption (1000 t of oil equivalent) per bn $US (2000 prices) Oil and Energy Intensity Energy intensity is defined as energy consumption per unit of output. The extent to which economic activity (GDP) is directly reliant on oil and energy consumption provides an indication of both the economy’s vulnerability to peak oil and the scope for efficiency measures to improve resilience. Low energy ratios, defined as the ratio of overall primary energy consumption to GDP, are also very important to define how hard increases in energy prices will hit economic activity. Source: UK Energy Sector Indicators 2008,IEA Energy use by sector in the UK UK consumption patterns Transport Domestic Oil Consumption Patterns Patterns of consumption determine which sectors of the economy are likely to be hardest hit in the event of peak oil because it determines the economies’ ability to substitute away from oil consumption. Consumption patterns determine the extent to which substitutes for oil consumption can be found and the so called ‘elasticity of demand’ – the ease to substitute demand if price rises. Energy Ratio Service Industrial Source: UK Energy Sector Indicators 2008

18 Oil in the UK Economy…how does the UK perform in terms of the indicators? • Oil Import Dependency • Overall, the UK currently produces about the same amount of oil as it consumes, such that the net import balance is still quite small. • However, oil production from the UK continental shelf peaked in 1999 and is now in terminal decline. As domestic production falls, and demand continues to rise gradually, the UK’s import dependency will increase significantly over the next 10 years. • By 2025, net imports will likely make up more than 60% of domestic demand, compared to around 8% today. • The speed at which the UK’s dependence increases is a function of both the level of investment in UK oil production and future developments in the UK’s demand for oil. • Oil and Energy Intensity • The UK is the least oil-intensive G7 country. Among OECD nations, it also has one of the lowest ‘energy ratios’, defined as the ratio of primary energy consumption to GDP. • This is due, among other things, to the UK’s high population density, high fuel taxes and relatively mild climate. • The UK economy has become less dependent on energy over the years, with the energy ratio having fallen steadily at about 2% per year since 1970. By contrast, energy intensity in the transport sector has remained fairly flat over the last 30 years and is currently just 2% lower than in 1970. • OECD oil-intensity is forecast to continue to decline, as OECD oil demand contracts. • Oil Consumption Patterns • Total UK demand for primary oil was around 81m tonnes in 2007. • In 2007, 70% of the UK’s demand for petroleum products went towards transport fuel, compared with just 41% in 1980. One of the most significant changes in consumption in recent years has been the switch from fuel oil to natural gas for electricity generation. • According to the IEA, between 2006-2030 OECD oil demand is expected to contract in all sectors other than transport, where it remains essentially flat. The largest falls are in residential and industrial demand. • In the event of peak oil, the ability to substitute away from oil consumption will be crucial to the economy’s resilience. However, few viable alternative energy sources exist for road and air transport and demand remains fairly unresponsive to rising prices. UK Net Oil Imports as a Share of Demand UK Petroleum Products Demand by Use (2007) Barrels Consumed per $1000 GDP Sources: DECC Sources: DECC calculations, IEA Oil Information 2008, IMF WEO Database 2008 Sources: DUKES 2008

Alternatives to using oilAs the transport sector is the largest user of oil products alternative technologies could change our use of oil in this sector… Quantitative factors – number of vehicles and/or substitutability of fossil fuels Technological efficiencies efficiency improvements Consumption factors smarter choices 20 In the UK, road transport relies almost exclusively on oil for energy* Transport Transport is by far the biggest consumer of oil in the UK economy accounting for around 70% of the total oil consumption. Within transport the main user of oil is the road sector followed by the air sector. Currently there are few widely available alternatives for using oil products in transport and thus, while the UK is less dependent on oil for its economy than many other countries, the majority of the oil that it does consume is not easily substitutable in the short term. UK Petroleum Products Consumption by Industry (2007) UK Petroleum Products Consumption by Transport (2007) Policies The high penetration of conventional fossil fuels in the transport sector can be reduced through various means. The changes currently envisaged for the transport sector include substitution of fossil fuels by cleaner fuels (i.e. biofuels, hydrogen, electricity), improvement in the efficiency of current technologies as well as policies to encourage smarter transport choices (incl. use of public transport). If consumers can find ways to substitute away from oil products and demand can be made more responsive to price signals, then the economic impact of falling oil production could be reduced. Overall, many of the policies currently being pursued in order to reduce the UK’s CO2 emissions from transport, are likely to reduce oil consumption and thus to improve the UK’s resilience against any “peak oil” scenario. *Sources: DUKES 2008 Fuel demand in the transport sector is determined by: Examples of policies in place to reduce fuel/transport demand: • Renewable Transport Fuel Obligation (RTFO) • Support for research in alternative transport • technologies • Incentives for Electric Vehicles uptake • Tax incentives for biofuels (to 2010) • EU CO2 emissions targets for cars • Vehicle Exercise Duty (VED) incentives for fuel • efficient cars • Increased investment in public transport • Campaigns to reduce low value journeys • Attempts to lower motorway speeds

Alternative Road Technologies – 21 This summarises the findings from a brief review of literature on the key technologies to displace oil consumption in the transport sector. 1 Sources: http://www.greencarcongress.com and http://www.afdc.energy.gov/afdc/data/vehicles.html, and http://www.berr.gov.uk/files/file48653.pdf 2 The King Review of Low-Carbon Cars, 2007. http://www.hm-treasury.gov.uk/king In what timeframe is it most likely that alternatives reach maturity and will be widely deployed? Hybrid Motor Fuel Efficiency Biofuels 2nd Generation Electric vehicles Hydrogen Biofuels 1st Generation 2015 2020 2030 2010 today

Other Transport Alternatives–What could they contribute to a reduction in oil consumption?What do we conclude? 22 AviationAviation previously has a good record for delivering improvement in efficiency in the last 40 years. New craft are expected to be 20% more efficient than the current fleet. Hydrogen fuel cells have the greatest potential to be used in aviation, however hydrogen aircraft would require new engines and structures and are likely to be several decades from market.Biofuels use limited. RailIncreasing the amount of rail network powered by overhead electric cables has high infrastructure costs and uncertain lifecycle carbon reductions. Could potentially reduce fossil fuel dependency if electricity generation is ‘green’. Biodiesel has been considered, however costs and impact on carbon emissions uncertain. Hydrogen fuel cells are a longer term alternative but time frame and costs are uncertain.ShippingBiodiesel is a potential alternative, close to market but cost and corrosive nature is prohibitive. Hydrogen fuel cell again a longer term alternative however several technological challenges to be overcome. Energy Efficiency Incremental improvements in the Internal Combustion Engine of vehicles can be available in 5 – 10 years if the demand and supply side barriers have been resolved. The higher costs of these vehicles can be paid back through the improvements in fuel economy they offer to consumers. • Conclusion on Transport Technologies • Some hybrid technologies are currently commercially available. Blended biofuels currently offer some advantages and are likely to occupy an increasing share of the transport fuels market. However, the ancillary impacts of biofuels, i.e. the impacts on land use and biodiversity may slow down their wider use. • Infrastructure; suitable infrastructure needs to be developed for either electric vehicles or hydrogen fuel cells to be widely used. Public/private investment to provide the infrastructure for these technologies could increase the speed with which they are brought to market and increase the incentive for firms to invest in their development. • Alternative fuels are available, however few are yet commercially viable and there are still concerns around sustainability and wider deployment. Mass deployment of alternative fuels will take time and it will take time before it will have a significant impact upon fossil fuel consumption in the transport sector. Government may have a role to play in increasing the speed with which these alternatives are brought to market.

Executive Summary What is peak oil and what do others say? Oil in the UK Economy Alternative Technologies Scenarios of peak oil and their impacts Conclusions Bibliography 23 Content

Scenarios of Peak Oil… to create the following scenarios about the timing of peak oil we used different assumptions about reserves, investment and demand. We also considered the possible implications of a ‘Very Early Peak’- Scenario though we could ourselves not rationalise the underlying assumptions. 24 The aim of these scenarios was not to try to predict when peak oil is going to occur, but to provide a framework to look at the possible implications of peak oil on the economy. Given that it is impossible to predict exactly when 'peak oil' might happen, four scenarios on the timing of peak oil were developed to provide a framework to look at the possible implications of peak oil on the UK economy. The scenarios were developed around the interaction between the three likely drivers of peak oil: resources, investment and demand. The scenarios are therefore for illustrative purposes only! They allow us to consider the implications of our energy policy, and do not reflect our view of when the actual peak of oil production will occur. ¹ Source for the assumptions of demand, investment and reserves underlying this scenarios is almost exclusively the Association for the Study of Peak Oil (ASPO) ² IEA scenarios refer to WEO 2007 ³ USGS US Geological Survey

25 Very Early Peak*Scenario This scenario is included to show the more extreme of all of possible (even though not thought likely) scenario, which has been considered and put forward by a few experts What the impacts mean and what they do not mean… Most ‘impacts’ presented in the following were in their majority informed by reviews of the economic literature on the impact of high oil prices, the literature on the prospects of alternative technologies, our understanding of energy markets and the descriptive global oil market system model developed for the project. A quantitative model looking at the interactions between the various economic variables would be required for a better understanding of the impacts. In the absence of such a model we have examined the conclusions made by other studies to assess the possible impact of the estimated oil prices on the UK economy. This work was done before the 2008 oil price hike and the credit crunch. Below we focus on the circumstances leading up to ‘the peak’ … implications for the UK are shown on the next slide. * This report does not try to rationalise the circumstances that lead us to the peak under this scenario, the scenario is based on assumption from ASPO.

Impacts of a ‘Very Early Peak’ globally & on the UK 26 .. this scenario is likely to have serious consequences for the UK economy …consumer’s demand for oil will decline substantially but not diminish entirely - in the short term it will be difficult to shift to alternatives, especially in transport.. In assessing the impact, assumptions about the market behaviour were made, both on the supply side (producers) and the demand side (consumers). We assume that both producers and consumers are aware of the permanent oil supply constraint and as a result, there is a behavioural change in both production and consumption of oil. Alternative technologies Supply Very limited potential for alternative technologies within short term (5yrs). Biofuels use is likely to increase but may have knock-on effects for food production. Energy conservation measures will be quickest and most cost effective to introduce, however the scale of such measures would depend on sector and price. Post the peak, the oil market’s vulnerability to shocks and supply problems will be increased due to a lack of spare capacity. Demand GDP growth The fall in oil demand due to high oil prices is more than offset by growing demand for oil in the transport sector. Given that UK is one of the less oil intensive economies and also an oil producing country, the impact is likely to be less severe than elsewhere, but still substantial. GDP growth may be affected and stay below trend growth for a number of years. There may also be adverse impacts on employment through wage pressures and reduced consumer and business confidence. Impacts are likely to be more significant in emerging Asian economies such as China and India. This is because those oil-importing developing countries use more than twice as much oil to produce a unit of output and may also be less able to weather the financial turmoil brought by higher oil-import costs.The scenario analysis suggest that in 2010, average real GDP could be around 0.9% lower in OECD countries relative to the underlying baseline growth and even more thereafter (based on the WEO 2006 rule of thumb, slide 15). Supply demand gap There may be a ‘gap’ of 0.5mbd by 2010, around 30mbd in 2020 and around 60mbd in 2030, which would need to filled by alternative fuels (and/or a reduction in oil demand). Price Increased price volatility and higher forward and spot prices. High level estimates suggest prices could increase around 160% within 10 years. Prices may need to reach $155/bbl Brent (in 2006 prices) by 2015 (compared to $71 in the baseline) to reduce demand enough to balance with the available production (this is sensitive to assumptions on price elasticity and the extent of behavioural change). . Geopolitical Inflation With price rises likely to be greater than growth in GDP, oil will become unaffordable for some sections of oil consumers. This will have socio-economic impacts especially in emerging and developing economies, and may even lead to social unrest. Energy deals may become more common and some countries may be tempted to achieve political objectives by utilising their oil leverage. The overall effect on inflation may be between an additional 0.4% and 0.8%* inflation. However, these figures do not consider the knock-on effects of higher oil prices driving up the prices of other fuels, magnifying the overall macroeconomic impact. *The Impact of High Oil Prices on the UK economy: A Slippery Slope?, 02 November 2004. Roger Bootle.

Scenarios Demand Investment RecoverableResources Early (btw 2010-2015) Rapid economic and demand growth particularly from developing countries. Global demand growing by 2.2.% during 2007-2015. Deferment of investment - for political reasons or technical constraints there is little or no increase in capacity beyond 2012. Investment is deferred in OPEC and FSU, and it becomes increasingly difficult to find or access new reserves. OPEC production stagnates after 2020 and FSU production from since 2015. Low estimate of recoverable reserves (close to low level from US Geological Survey) and access constraints due to political and geological constraints 27 Scenario 2 – Early peak (between 2010 and 2015) Supply/demand balance to 2040 in this scenario Apart from the assumptions about demand and resources, this scenario is highly dependant on decisions about investment. Thus, one (or more) of the following needs to hold if the investment scenario is realistic: OPEC strategy is increase revenue in short term by keeping prices high and limiting investment, and Demand elasticity stays lowand thus high demand for oil guarantees high (and easy) revenues for producers in the short term, and Producer governments will limit International Oil Companies’ access to oil reserves to ensure national and political control on resources, or National Oil Companies lack expertise to develop mature fields and discover and bring new fields to market Source: DECC

28 Early Peak – Impact globally and on the UK… this scenario is also likely to have serous consequences for the UK economy – it may result in an increase in geopolitical tensions but investment in low carbon technology prior to the peak reduces overall risks compared to the very early scenario… Supply Alternative technologies The scope for substitution is still limited by the availability of the technology and infrastructure to support it but the additional 5 years investment into alternative technology development increases the potential volume of substitution compared to the Very Early Peak. As technologies are more mature at the time of the impact the potential impact from switching is likely to be greater and seen sooner. Energy conservation measures impact likely to be less as some ‘easy’, quick wins have already been implemented, The potential for biofuel substitution for oil demand will be greater and less harmful than in the very early scenario. Some additional conventional capacity may start to come on stream as a result of non-OPEC investment prior to impact, reducing pressure on supply. However, post peak, there is no spare production capacity and thus markets are vulnerable to supply or demand-side shocks. Demand The continued high growth in oil demand maintains pressure on the oil price. However, pressures are lower relative to the very early scenario as the demand gap is comparatively less significant. GDP growth Supply demand gap Given that UK is one of the less oil intensive economies in OECD and is an oil producing country, the impact is likely to be less, but substantial. GDP growth could be affected for a number of years but relatively less than under the very early peak scenario. Impact on countries with high oil intensities will be greater, as those use more oil to produce a unit of output. Thus they will face larger impacts on income through secondary effects of oil price rises on the price of domestic products. In 2015, average real GDP growth could be around 0.8% lower in OECD countries relative to the underlying baseline growth. (based on the WEO 2006 rule of thumb). The demand gap in 2013 amounts to 0.7 mbd reaching 9.3 mbd by 2020. This gap could be filled through demand reduction, non-conventional oil, other fuels or new technology. Price The increase in supply from non-conventional sources and demand side impacts, slightly reduce upward pressure on prices. The scenario results in prices reaching $98 (in 2006 prices) by 2015 and $124 (in 2006) by 2020 (baseline $71 and $76 respectively). This is sensitive to assumptions on price elasticity and the extent of behavioural change. Geopolitical Consuming countries will become nervous about future supplies resulting in an increase in the number of deals from developing countries to buy long-term contracts or assets, but also greater emphasis on policies to reduce oil demand. Inflation The overall effect on inflation may be between an additional 0.4% and 0.8%* inflation. However, these figures do not consider the knock-on effects of higher oil prices driving up the prices of other fuels, magnifying the overall macroeconomic impact. *The Impact of High Oil Prices on the UK economy: A Slippery Slope?, 02 November 2004. Roger Bootle.

29 Putting in perspective… Very Early versus Early Peak Impacts on GDP Based on the IEA assumption that a price increase of $10/bbl may lead to a real GDP decrease of about 0.3% in OECD countries we calculated the estimated long term (sustained impact) of our scenarios. GDP reductions are likely to be higher in non OECD countries. GDP per capita/oil price (real 2006 prices) What do those price rises mean for the UK? To put the price figures into context, this graph looks at the relative affordability of the oil prices in the Very Early Peak Scenario by calculating the number of barrels of oil that can be purchased per capita in different years. In terms of the GDP forecast, given the uncertainties of our GDP calculations, we have used Treasury’s forecast up to 2010 and the assumptions in the Energy White Paper after 2010. Estimates based on oil price in Very Early Peak Scenario . Impacts of Peak Oil on Emissions and Climate Change In the Very Early Peak Scenario it is possible that security of supply concerns will take precedence over climate change action and as a result low carbon technology investment may become less of a priority, unless it provides the quickest way to address energy security concerns. This increases the risk of higher emissions globally. In the Early Peak scenario, investment in low carbon technology prior to the impact of peak oil will reduce the risk that short energy security concerns may compromise long term environmental concerns. Overall, many current UK policies aiming to reduce the UK’s CO2 emissions from transport are likely to also encourage the development and deployment of technologies that provide an alternative to petrol and diesel. As such, they are likely to improve the UK’s resilience against a “peak oil” scenario.

30 Medium Term Peak…despite a relatively constant rate of investment and discoveries of new fields and reserves growth, increase in production is not fast enough to keep up with demand around 2025-2030 … Narrative • Despite a relatively constant rate of investment and discoveries of new fields, increases in production are not fast enough to keep up with demand around 2025-2030. Following the peak the rate of decline could be relatively quick. • There is a steady growth in demand both from developed and developing countries coupled with an increase in capacity over the next fifteen years. • However, capacity additions fail to match demand around 2025. By this time however developments in both non-conventional and alternative fuels ensure a smoother transition to a post-crude energy system. • Whilst oil demand remains high, the growth rate in demand is slower post 2015 due to the combined effect of climate change policies and high energy prices. • High demand in the short and medium term drives considerable investment in new exploration and production. • OECD crude production (which already peaked at the beginning of the century) continues to fall; Supply/demand balance to 2040 in Medium Scenario Source: DECC • Production from FSU countries increases by around a third over the next ten years, but then plateaus at around 15mbd; • OPEC slowly invests in new production and capacity, but under-investment in exploration from some producers and a certain degree of inefficiencies in field development leads to a reduction in reserve expansion capacity and to a peak in crude production around 2025. • Due to tightness in the market, some spikes in prices above are possible following rapid shocks. Prices increase sufficiently to incentivise new discoveries and the development of non-conventional and alternative technologies.

Late Peak Scenario …global peak for conventional oil happens in mid to late 2030s as demand peaks rather than supply hitting a constraint… 31 Narrative Supply/demand balance to 2040 • The lower demand growth is a reflection of both lower economic growth, but also lower demand for oil due to climate change policies. • However, in the short term, a relatively high demand and a more benign investment environment spurs high investment in exploration and development during the early 2010s. Investment in OECD reserves are maximised though production continues to decline. • There is also continued investment in OPEC reserves, as geopolitical tensions are reduced and OPEC countries continue to invest. • The key climate change measure is therefore around demand reduction and some fuel switching, thus moderating final demand for oil. Therefore, supply continues to adequately meet demand. • Prices therefore stay in the range around the IEA WEO 2007 estimate ($60/bbl). Source: DECC • By early 2030s prices begin to increase because having moderate prices over a long period has led to a fall in investment in exploration and therefore spare capacity starts falling. This coupled with the impetus from climate change policies acts to reduce demand even further. • Shifts in technology occur gradually between 2020 and 2040, mainly in response to government incentives and lowering costs of new technologies rather than in response to high oil prices. • Therefore, the global peak happens in mid to late 2030s due to a peak in demand – rather than supply hitting a constraint.

33 Peak oil – what do we already do? Legend: Already part of UK policy; Potential area to investigate further;

Conclusion and policy recommendations Conclusions… Our review and analysis of oil market fundamentals and the peak oil literature shows that it is not possible to predict with any accuracy when or why oil production will peak; While global reserves are plentiful, it is clear that existing fields are maturing, the rate of investment in new and existing production is being slowed down by bottlenecks, the economic downturn and financial crisis and that alternative technologies to oil will take a long time to develop and deploy at scale; The implications of tight oil markets as a result of peak oil, lags in investment or fast demand growth, would be higher and volatile oil prices, to which the UK and its citizens are relatively more immune than those in most other countries, mainly because of its relative low oil and energy intensity. The UK economy would be initially relatively robust to higher prices; however, if peak oil happens before 2015 there would be negative economic consequences for some of the main importers of UK goods and services resulting in a negative impact on the UK economy in the longer term. If the peak happens later, it would be possible to mitigate the impact through greater end-use efficiency and the production of sufficient quantities alternative liquid fuels. The possible risk of high and volatile prices provides a further rationale for pressing forward with policies that reduce our CO2 emissions in the transport sector and, in so doing, generate alternatives to traditional oil-fuelled modes of transport. However, while alternative technologies could be pulled through by the combination of economics and government policies, the lead-times for any real impact on oil demand are long. Globally, in response to a peak, some countries may adopt short-term, partial solutions such as more coal consumption and high carbon oil production that could result in an increase in global emissions. Given the uncertainties around the timing of peak oil and its implications for the UK, there are no obvious additional policies the UK government should pursue to minimise the likelihood of a 'peak oil' scenario and to be prepared to mitigate its impacts in addition to those already in place. While there may be policies that the UK government could put in place, in addition to those above, in order to make the UK economy more robust and resilient to peak oil, it is unlikely that the UK Government can unilaterally influence the global consequences of any peak. 34 • However… • Policies relating to oil consumption in the transport sector, particularly road and air travel, should continue to be monitored closely, as this sector will probably be most exposed to rising and volatile prices in the event of peak oil. • Security and diversity of supply are even more important in the transport sector, as oil cannot be substituted in the short term (or even the medium-long run) without significant investment, large technological improvements and/or alternative fuels. • Economically viable and readily available alternative and renewable technologies are an essential policy area if we are to increase the resilience and flexibility of UK businesses and consumers to high and volatile oil prices. • The UK’s move to a low carbon economy and climate change policies are consistent with these conclusions.

35 … what has happened since? 120 Although the World Energy Outlook published in November 2008 states that, “[the] world is far from running short of oil” (based on its extensive analysis of oil reserves, demand trends and field decline rates)it also recognizes that “the immediate risk to supply is not one of a lack of global resources, but rather a lack of investment where it is needed”. The WEO 2008 has also highlighted that existing oil fields are depleting faster than previously thought and that even if oil demand was to remain flat to 2030, 45 mb/d of gross capacity – roughly four times the capacity of Saudi Arabia – would be needed just to offset decline from existing oilfields. As can be seen on the right – the WEO suggests that we need to develop a substantial number of new fields and also unconventional sources and NGLs. Our scenario analysis pointed in a similar direction. Shell, recently said their ‘outlooks indicate that the maximum production of easily accessible oil could come as early as the coming decade. And maintaining a production plateau for all oil and natural gas will become a serious challenge in the 2020s’.* Clearly the current credit crises and global recession has slowed down demand for oil products in the short term. Global oil demand forecasts now suggest that we face two consecutive years of demand decline (2008/2009), which has not occurred since 1982/1983. We thus expect prices to remain subdued throughout 2009. This will alleviate any pressures from the ‘demand side’ for the short term but it is unclear when and how fast global oil demand will pick up after this global recession. Constraints on credit as well as subdued prices for crude oil may have an impact on investment in new oil production, investment in existing fields (such as EOR) and possibly also on technological development in the oil and alternative technologies sector. Delays in investment or failure to invest in maintenance or efficiency of existing fields may accelerate the rate of decline and/or the future supply of crude oil. Failure to develop new technologies may also increase supply side pressures. Thus, although we believe that we will not face a ‘resource’ peak – there may be a risk of a supply crunch (not peak). Production of conventional crude relatively flat from 2020 onwards. mb/d 100 NGLs 80 Nonconventionals Oil yet to be developed or found 60 40 Oil from currently producing fields 20 Source: IEA WEO 2008 0 1990 2000 2010 2020 2030 Need for alternative fuels and non conventionals in ‘peak’ scenarios *The Oil Crunch: Securing the UK’s Energy Future (ITPOES 2008) Source: DECC

Transport Sector In most plausible future scenarios the global economy will continue to rely on oil as its primary energy source in the transport sector, as there are few alternatives in the medium-term With the potential risk of a supply crunch and rising oil prices, the move to a low carbon and thus less oil intensive transport sector will take time but needs to be pursued Generally The UK Government is showing leadership in the fight against climate change, through its carbon budgets, leadership in the negotiations for a new deal in Copenhagen and its commitment to cap-and-trade Under a robust future carbon price, there may be an increased economic cost associated with a high carbon economy and companies may benefit in engaging early with the move to less-carbon intensive technologies (first mover advantage) So, whilst we are committed to delivering the required investment in both conventional and new sources of oil in order to maintain sufficient supply to meet existing and future demand, it is important that as Government we helpmanage the transition to and opportunities of a low carbon economy Although the report concludes that Government does not need additional policies, HMG needs to continuously pursue its policies towards achieving a low carbon economy … what does that mean for our move to a low carbon economy?

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Report on the risks and impacts of a potential future decline in oil production