Saturday, February 18, 2006

With the price of oil soaring from less than $10 per barrel in 1998 to more than $70 last year, the world oil market is likely to remain quite combustible. Under these circumstances, there is much that can be learned from policy-makers who operated during earlier crises. James Schlesinger, who is chairman of the Advisory Council of the National Interest, is one such policy-maker.

A Harvard Ph.D. economist, Mr. Schlesinger held posts in Republican and Democratic administrations. He is: a former chairman of the Atomic Energy Commission; a former CIA director; a former secretary of defense, who served during the 1973 Mideast war and the devastating Arab oil embargo, which caused the second-worst recession since the Great Depression; and a former secretary of energy, witnessing the unleashing of an oil crisis that precipitated America’s worst recession since the Great Depression.

Mr. Schlesinger knows more than a thing or two about the U.S. economy, the economics of energy, the geopolitics of oil and the unremitting politico-military caldron that has enveloped the oil-rich Middle East throughout the post-World War II period. So, when Mr. Schlesinger writes an essay about these topics — “Thinking Seriously About Energy and Oil’s Future,” which appears in the winter issue of the National Interest — his views should command the attention of policy-makers around the world. What follows are some of Mr. Schlesinger’s concerns that we found worth repeating:

“The inability readily to expand the supply of oil, given rising demand, will in the future impose a severe economic shock. Inevitably, such a shock will cause political unrest — and could impact political systems.”

Mr. Schlesinger addresses the debate about when the world oil industry will reach Hubbert’s Peak — the moment when half the world’s conventional oil reserves will have been extracted, after which production rates will decline, perhaps steeply. Beginning with the estimate of 3 trillion barrels of conventional oil embedded in the Earth’s crust, Mr. Schlesinger notes that more than 1 trillion barrels have already been extracted. Currently, the world is consuming 30 billion barrels a year, and the Energy Department predicts annual worldwide oil consumption will reach 40 billion barrels by 2025. Assuming a steady increase from 30 billion barrels per day to 40 billion over the next 20 years implies a compound annual growth rate of 1.5 percent. At that rate, cumulative world consumption over the 20-year period would total more than 700 billion barrels. That’s well beyond Hubbert’s peak of 1.5 trillion barrels implicit in the world’s 3-trillion-barrel oil endowment.

At those levels of consumption, the debate over when we reach Hubbert’s Peak may be beside the point. “The implication is clear,” Mr. Schlesinger declares. “Even present trends are unsustainable. Sometime in the decades ahead, the world will no longer be able to accommodate rising energy demand with increased production of conventional oil.”

The central, long-term component of any “energy crisis” will be oil. Because more than half of the nearly 21 million barrels of petroleum America consumes every day are devoted to motor gasoline and jet fuel, Mr. Schlesinger concludes that “[t]he intractable problem lies in liquid fuel for land, sea and air transportation.”

Mr. Schlesinger warns that U.S. policy-makers may be making inappropriate assumptions about the likely availability of oil to meet the world’s soaring demand by 2025. Daily output capacities in 2025 for Saudi Arabia and Kuwait, for example, are assumed to be 25 million barrels and 5 million barrels, respectively. However, the maximum output levels for Saudi Arabia and Kuwait in 2025 are likely to be 15 million barrels and 3 million barrels, Mr. Schlesinger argues.

That poses a vital question: If the world is on track toward consuming 110 million barrels per day in 2025, who will plug the 12-million-barrel supply hole created by overestimating Saudi and Kuwaiti output levels? It’s a question that must soon be answered.

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