Prepare for a liquid fuel emergency

In July 2007, CSCMP's Supply Chain Quarterly published my article titled: "The end of cheap oil: Are you ready?" The article concluded that "supply chain managers must take action today to prepare for the end of the oil age tomorrow."

Three years later, I would amend that title slightly: "The end of cheap oil: Preparing your supply chain for a liquid fuel emergency." We have waited too long, and it is now inevitable that the world is headed toward a fuel emergency that will impact every facet of how supply chains work.

A growing consensus
There has been recent evidence of a growing consensus that global oil production will peak at a rate of about 92 million barrels a day in the 2012-2015 time frame.

In February 2010, the United Kingdom Industry Taskforce on Peak Oil and Energy Security published a report called "The Oil Crunch: A wake-up call for the UK economy." The report warned that the global supply of oil is now expected to be limited to 91-92 million barrels per day of capacity. Furthermore, it will remain in that range until 2015, at which point depletion will offset any capacity growth.

In early March, Ibrahim S. Nashawi and two colleagues from the College of Engineering and Petroleum at Kuwait University revamped the famous Hubbert model, which accurately predicted that U.S. oil production would peak in 1970. The researchers applied advanced mathematics to the Hubbert model to account for technology changes and ecological, economic, and political influences on reserves and production for 47 oil-producing countries. They concluded that world oil reserves are being depleted at a rate of 2.1 percent per year and that global production will peak in 2014. The report is interesting not only because it applies a new level of mathematical rigor but also because of where it originated—Kuwait, deep in the heart of OPEC (Organization of Petroleum Exporting Countries).

This was followed, also in March, by the U.S. Joint Forces Command's "Joint Operating Environment 2010 Report" on national security challenges. The report warns: "By 2012, surplus oil production capacity could entirely disappear, and as early as 2015, the shortfall in output could reach nearly 10 million barrels per day."

Then, on March 22, former U.K. Chief Scientific Adviser David King and researchers from Oxford University released a paper claiming that the world's oil reserves had been "exaggerated by up to a third," principally by OPEC, and that demand may outstrip supply as early as 2014 or 2015.

On March 25, an unlikely candidate confirmed some worries: Glen Sweetnam, former Director of the International, Economic, and Greenhouse Gas Division of the generally optimistic U.S. Energy Information Administration (EIA) in the U.S. Department of Energy (DoE). Sweetnam told the French newspaper Le Monde that the world could experience a decline in the production of liquid fuels between 2011 and 2015, unless the oil industry makes certain, unspecified investments ("unidentified projects") after 2012.

Unless these "unidentified projects" fill the gap between oil supply and demand, the DoE predicts, global oil supply will decline by about 2 percent each year—from 87 million barrels per day in 2011 to 80 million barrels per day by 2015—while demand rises to 90 million barrels per day. That means a shortfall of 10 million barrels per day by 2015—the same number referenced in the U.S. Joint Forces Command report discussed above.

Finally on July 4, 2010, Saudi King Abdullah told the Zawya Dow Jones, "I have ordered a halt to all oil explorations so part of this wealth is left for our sons and successors, God willing." This is very similar to a statement he made in April 2008. So even if Saudi excess capacity is real, it may not be available.

What the reports don't say
Almost as worrisome as the data itself is what the reports don't include. All of these reports—except the last one—came out before the Deepwater Horizon oil spill and the moratorium on drilling in the Gulf of Mexico, which will certainly hasten the coming oil supply crunch.

They mostly ignore the many geopolitical flash points, instabilities, and potential "Black Swan" (highly improbable yet high-impact) events. These events could include war in the Middle East, revolution or civil war in a major oil producing country, inaccurate estimates of excess capacity, a successful terrorist attack on a key oil processing facility or transport choke point, or the collapse of a significant oil field. The reports also do not explicitly discuss the 80 percent of the world's population that wants a prosperous, Western-style life, including the energy appetite that goes with it.

In fact, the U.S. EIA and the International Energy Agency (IEA) are both forecasting growth in world oil demand. They anticipate demand will top 86 million barrels a day in 2010, up 1.6 million barrels a day from 2009. Particularly interesting is data from the EIA showing that even at the depths of the worldwide economic crash in 2009, oil consumption was down by only about 2.5 million barrels per day. As world growth has resumed, so too has oil consumption, and with a world population exceeding 6 billion, it is hard to see how that growth could slow down. Consider that the annual per-capita consumption of oil in China is two barrels per year, and in India it's .9 barrels a year; then compare that to the United States' 23 barrels per year. There is no way that China will stay at two barrels or India will stay at 0.9.

What the reports do focus on is production flows, and they all reach the same conclusion: World oil production will likely peak within the next 24 to 36 months at somewhere around 92 million barrels per day—sooner if the Oxford Report is right and excess capacity is overstated. Later if nascent growth stalls and the world enters a double-dip recession.

While economic slowdowns might buy some time, we will ultimately have to confront this developing liquid fuel emergency. When economic growth increases, demand and prices for oil will rise. At some point, however, prices will climb to economy-damaging territory, and demand will fall. This volatile cycle will be repeated until the transition from the Oil Age is well along.

A destabilizing force
For all these reasons—geology, geopolitics, oil industry constraints, and demand growth—a liquid fuel emergency in the near future is almost a certainty, especially if the economy rebounds.

This emergency will not be an "energy crisis" in the usual sense of the term. It will be narrowly focused on the transportation sector because this industry has no substitutes for oil in the short to medium term. Supply chains will therefore be subject to intense focus and redesign. There will be no quick fixes, and we will be forced to begin a mitigation effort that will require at least a decade of intense, expensive effort. (See the sidebar for a checklist of what you can do to prepare.)

This transition will destabilize society. Governments will be forced to intervene to maintain critical levels of oil supply, reduce volatility, and prevent economic, political, and social chaos. "We will need to stay flexible and keep a sense of history and humor and remember that it is not the end of the world; it is only the end of the world as we knew it.