The Black Gold Sands

Image: Terry Bain [cc]

Barring a complete catastrophic collapse of the global economy and credit markets (which happens not to be overly improbable), the Canadian oilsands will remain in a relatively strong position despite correcting oil prices.

In the absence of a breakthrough scientific discovery like cold fusion, there exists neither a viable alternative fuel source for oil, nor a likely prospective one in the near future. It certainly isn't impossible, but a cold-fusion type of discovery is highly improbable. The Manhattan programme and Apollo project are often cited as major scientific investments yielding results; but neither one required the kind of infrastructure overhaul that would be required to reduce demand for fossil fuels. With rising energy costs, nuclear, wind, solar and the other alternatives to fossil fuels will all become more competitive with oil. In fact, from a price-energy perspective, $100/bbl crude oil is already fiscally disadvantaged compared to its alternatives. One joule of oil priced at $100/bbl is even more expensive than the same amount of energy produced from wind energy. Residents of Hawaii paid 24 cents per kilowatt hour for their electricity because oil is the primary fuel used for electricity generation in the state (the cost of electricity produced from wind is on the order of 14 cents/kWh). The only reason oil remains so prominent is that it happens to be convenient (batteries are not well-suited to power cars) and current infrastructure, which will take decades to update, necessitates it.

A common mistake people make is to think that the rate of change of the consumer electronics industry can be replicated in the energy industry. The reason consumer electronics can evolve so quickly is mass (or lack thereof). Replacing a 20 ounce cell phone requires considerably less work than replacing a quarter-ton vehicle. This is because a cell phone has relatively little total intrinsic value in the materials used, which is in part why many electronics become cheaper as the become smaller (for example, a 1 GB flash card now costs less to make than a 1 GB magnetic hard drive).

How Long Will It Take?
In terms of energy substitutions, the change from wood to coal took 75 years. The change from coal to oil took 100 years. Natural gas took even longer because of the extensive pipeline infrastructure that was needed to accommodate it--in fact, over 28 trillion cubic feet of natural gas associated with oil wells has been discarded in the U.S. alone since 1936 (U.S. Department of Energy). The gas is simply burned at the wellhead or vented to atmosphere without capturing its useful energy because the pipeline infrastructure would cost more than the potential revenues from selling the gas. This does not happen much anymore in North America, but continues in places that have no market for natural gas such as deep offshore production and some middle eastern oil producing nations. Liquification of natural gas (LNG) and gas hydrates are emerging alternatives to pipelines, but both are expensive because of the energy inputs involved.

Transportation Industry
The transportation industry uses about 50% of the world's oil. The United States has about 250 million automobiles. Even if automobiles that didn't use fossil fuels were available today at a competitive price, it would take 9 years to replace most of them (9 years is the mean age of these vehicles, according to the Bureau of Transportation Statistics.

Electric vehicles can't be competitively priced today without making significant infrastructure changes. Batteries that meet the range requirements for American automobiles are simply too expensive. Also, too many steps in the electrical conversion process make it an intrinsically inefficient way to turn wheels. The figure above shows potential paths to turning the wheels of motorized land-based transportation. Each step loses energy due to thermodynamic constraints (the fewest number of steps are often the best route). Ethanol and other biofuels have a lower energy density than hydrocarbons as well as other significant challenges (discussed below). Heavy trucks are nowhere close to using alternative fuel sources and the aviation industry does not even know of a potential alternative to jet fuel.



1970's Lessons Learned?

Those who are old enough to remember the oil shocks of the 1970's and early 1980's can recall long lineups at gas stations and the economic chaos it caused. It prompted everyone to rethink the dependency of crude oil because of the economic impacts it had on oil importing economies around the globe. The first crisis occurred in 1973 when the Arabic members of OPEC imposed an oil embargo aimed at countries that gave military and political support to Israel. A resolution was reached between OPEC members and the United States in early 1974, but the shortages it created would leave prices elevated for several years. In 1979 another crisis occurred the Shah of Iran was exiled. Oil production from Iran would fall 75% in the next two years as a result of political instability and the resultant war with Iraq. Over the next several years however, other countries were able to fill the supply gap as a result of higher prices. Virtually every oil consuming nation devised an energy strategy in light of these price shocks. It would be left up to the policymakers to see these strategies through to completion as an oil glut ensued and very cheap energy prices left the general public unconcerned about energy independence for the rest of the 20th century.

United States Strategy
Project Independence was a vision of President Nixon which never got much traction because of extensive costs. Another reason American politicians did not to want to reduce oil consumption was that at that time, the United States was the largest producer of crude oil in the world, meaning that oil production was a very large part of the domestic economy (U.S. oil production peaked just a couple years earlier in 1970). Instead, strategic political measures were favoured such as a strategic alliance with the Saudi's as well as military efforts to ensure unimpeded flow of oil from the producer nations.

France's Strategy
In response to the same crisis, France decided to invest heavily in nuclear energy over a period of 15 years. Today, France leads the world in Nuclear Energy production, and even exports electricity from its nuclear plants to surrounding nations such as Germany. This now leaves them in an economically advantaged position compared to its European counterparts; however, oil consumption per capita only decreased by about 35%. This is because the substitution was only made for electrical power generation and they did not attempt to replace oil the transportation industry (this would have taken much longer and have been much costlier).

Brazil's Strategy
Brazil actually did decide substitute foreign oil in its transportation industry following the oil shocks of the seventies. They used sugarcane ethanol to do it and this conversion took them 30 years to reach a degree of energy autonomy. Flex fuel vehicles are mandated to use the E25 blend of 25% ethanol, 75% gasoline; some can even use E100 (almost pure ethanol). The United States tried recently to model Brazil's strategy, but it is failing for two reasons:

1. Brazil is a developing nation and its average citizen consumes 1/5^th of the liquid fuel that the average American does. It can't be scaled up in an overpopulated world without creating serious food shortages, as we've already started to see.


2. Brazil intersects the equator, meaning considerably more energy is available for the process photosynthesis that ultimately creates the energy used in the biofuels. This is why sugarcane ethanol yields about 8 times the energy required to produce it, while corn ethanol in the continental U.S. hovers around breaking even (optimistic scientists say 1.5 while pessimistic ones say 0.7). This means that for every gallon of diesel a farmer uses to cultivate corn, the amount of ethanol can be processed from the crop contains no more energy than a gallon of diesel--but the farmer can still make money provided subsidies are paid by the government.

Where Prices Will Go From Here
Now it's quite possible (but not probable) that oil could return to $40 a barrel depending on the depth of the global recession (some have even forecasted $10 oil). Even if prices did fall below $40 a barrel, such low prices will not stick once the recession has ended. Sector-specific inflation has increased the cost of production quite dramatically. Production and labour costs are out of control and the cost of production for new oilsands projects now sits between $80 and $120 a barrel. This is far too high for receding demand, and it may need to deflate and correct itself along with the rest of the global economy. This will present short-term challenges and if oil did fall to $10 or $20/bbl, this unlikely scenario would certainly mean layoffs; but even so, long-term supply will remain under pressure. The other supply issue surrounds peaking production in the worlds largest oil fields as I discussed in the past. Saudi Arabia's spare capacity (oil it can produce during shortages) is now limited to sour heavy crude, which only a few refineries in the world can handle.

One problem with projections about the Canadian oilsands ultimate recoverable oil estimates is that they often assume demand for this commodity will remain unchanged through 60 years. Instead, its likely that the oil which is hypothetically recoverable at today's prices will simply be left in the ground. This is analogous to the way many coal reserves remain in the ground from when coal was partially substituted for oil. My best guess is that it will take at least 25-30 years to significantly reduce global dependency on oil. The change is happening though, and Fort McMurray could easily end up being Detroit north if city planners aren't smart about economic development of the future. In the transition period from this now disadvantaged fuel, the oilsands should remain profitable. If not by a windfall, then at least by a small margin.