Peak Oil – The need to accelerate release from fossil fuel reliance

On the back of my discussion yesterday on the structure of the power bill for the ordinary Australian, I will discuss today why source cost for fossil fuel will be darn high – (refer yesterday where I put forward the modelling of Paul Simshauser an economist who has projected out the impact of source fuel costs (Gas, and Oil) for the next 5 and 10 years).

In support of Paul, I was looking for someone not from the Power industry, but expertise representing the oil industry. As I mentioned in my last blog when you want plumbing you go to a plumber, when you want brain surgery you go to a brain surgeon, so I was looking for someone who could validation of refute Paul’s modelling on source oil costs. Interestingly enough Paul may have been very conservative. Dr Fatih Birol is the Chief Economist from the International Energy Agency (IEA), and definitely the expert who would have the answers (although obviously somewhat biased since not more than a year ago the IEA was saying peak oil was imaginary). Fortunately he was interviewed recently on the ABC science show and there is a transcript and podcast for that event

ABC Podcast & transcription

Another person that bought credibility to this dialog was Chris Skrebowski, formerly of BP and the Institute of Petroleum in London, who in his role of oil consultant was a little more explicit around the challenges that we face. Chris claims at the moment the global oil supply is losing the equivalent the entire North Sea in about 15 months or the entire production of Iran, which is OPEC's second biggest producer, in about 11 months. He claims the intersection of demand being higher than what the world can supply is 2014, if OPEC don’t sit on their spare capacity. If they do the date will come towards us.

Back to Dr Fatih Birol, the economist, he says that the global oil demand will increase substantially, driven by the transportation sector, cars, and also by China consumption growth. He quotes that in China 30 people out of 1,000 people own a car, and in the United States 700 people out of 1,000 people own a car. And with growing wealth in China the impact is obvious – India + China = astronomical consumption.

Fatih says that the IEA believes crude oil production peaked in 2006 and we will soon reach the situation outlined by Chris (a blow out in oil cost, as consumption demands more than is produced). Now Fatih also talks about a way out of the oil constraints – oil substitutes from production in gas, oil sands and possibly synfuel (from coal) – and now we circle back to my yesterdays point from Paul Simshauser (AGL chief economist) that oil price will knock on to gas price will knock on to coal price …… and the low cost energy sources we believe we will have in Australia is a façade that is so easy to see through that you don’t have to be economists like Dr Fatih Birol and Dr Paul Simshauser to see the obvious implications.

Now just for a moment come with me on an imaginary trip into the future. One where Australia’s primary energy sources are free (renewable wind, sun, geothermal and hydro) and cars are electric AND therefore we have released ourselves from the grip of fuel fever post 2014 in the rest of the world; where there is less capacity to produce than that demanded for fossil fuels. In this imaginary setting, Australia is a price setter for coal and synfuel, and not a price taker for oil. In this imaginary setting we are low carbon and our fuel has a low input cost to power for the likes of Aluminium smelters, Nickle refiners etc etc. So we still use our minerals as our national wealth, we use renewables as a low cost input to minerals processing and compete so well against every other minerals producing country. AND we also increase our value add (at the moment much of the minerals processing goes off shore where hydro or nuclear power provides a lower cost energy input to the value chain). Our coal, gas (and we do have oil in Australia) go not into our own electrical production but get a high price for their raw costs or processed product (ie synfuel) in international markets (better balance of payments!).

I know we are just imagining this… but where is the vision amongst our leaders today? The CEO of BHP Marius Kloppers (who is into oil as well as minerals) urged the Australian government to transform the economy now. Don’t wait. Sounds like he has a vision similar to our imaginations above. Even John Hewson formal liberal leader got on the band wagon the other day… again having visions like the one above (refer: Newslink)

Malcolm Fraser, another former Liberal leader with John Hewson signed the pro-carbon "Say Yes" advertisement in national newspapers on the 30^th of May, described the debate in Australia as "pretty miserable" and said the climate change science was "proven"....

Well what does it take? It’s not hard to stretch the mind. Even if you are totally against the concepts or science of climate change the economics of oil should convince you that transformation from a fossil fuel economy is not just good environmental sense.. it sets Australia up for a fantastic boost in our balance of trade, international competitiveness in the longer term. Those who say it will make us uncompetitive are just downright wrong. Please go and take advice from the economist and understand the midterm future scenarios in Australia. The scenario without carbon is tremendously bright and delivers a legacy of wealth capability for our children, not a economy steeped in a financial model that says “10 years ago coal was cheap and the best thing for our economy was to keep that model – resist change!”.

We must look to the future. If we were the owners of Wells Fargo (stage coach based transport 100-150 years ago) do we ignore the up and coming train or road infrastructure for vehicles because the investments are high and therefore we stick with our horse transport model? I’m afraid most of our politicians today would be in the Wells Fargo camp and not the with the visionaries of the train and road model that had a good century of boom. Now we must move from the fossil fuel car, train and energy model to something newer, something visionary; something with a future. Can anyone identify the leader that can execute this vision? And would you think a carbon tax or ETS is a transitional lever? We need it, and we need the passion for a very fast change that can place Australia at least at the same pace as the rest of the world – that is if we are not comfortable to be ahead of the game.

Ah, a mental challenge for voters

We live in politically challenging times. We face on one side a media and political argument that is transfixed with emotion….. and, little fact. On the other side scientist, economists and a percentage of business leaders that advocate transformation of the economy before we are left behind. In this blog I’d like to address the economics of the humble Australian household power bill.

Sure, I am not an economist. Maybe I could say thank goodness, but sadly those in politics with that skill are few and far between; and we actually need this skill and advice for factual decision making. We trust mechanics to fix cars, plumbers to fix toilets, brain surgeons to fix brains, pilots to fly planes but politicians to set fiscal policy and policy on climate and carbon!!!! Those in politics ignore the wonderful span of financial expertise available, they ignore the reality of the makeup of a power bill and they foster confusion and dramatic stories into the media with respect to climate and carbon. And, they make “strategic” decisions for us (all with a 3-4 year life!) where we have to live with the consequence of carbon for 100’s of years. What is that you say; “of course we can trust the decisions they make”.

Let me introduce Paul Simshauser - the Chief Economist at AGL Energy Ltd. In a wonderful article called “The Boomerang Paradox: how a nation’s wealth is creating fuel poverty - and how to defuse the cycle”. It’s an inspection of what drives one of the engineering problems of our current electrical system – peak demand and source power station fuel costs. Paul first introduces the key driver: The fact that advanced economies such as Australia has continual growth in household income and plunging costs of electric appliances. Result… more stuff! More appliances; and their subsequent exponential growth in energy consumption.

I think Queensland where I now live there is a classic example. In 1999 23% of households had air-conditioners. Ten years later in 2009 it was 72% of households (and 34% have 2 or more). PC’s - homes with one or more in 2009 – 48%; in 2009 – 98%!! Well, do we see a pattern? In Australia we have also had in this ten year period an increase in household floor space; so we buy more stuff and have a larger area to cool and heat. With one of the lowest prices for power in the world, peak demand growth has been not only rapid but beyond predictable capability. Result? We haven’t built a network capacity that copes. So outcome 1: We have to reinforce the technical capacity of the electrical network at an enormous rate. One that will take the cost of the distribution grid from 40% to 60% of our bill. This is all capital expenditure that is demanded because on the hottest hour of the hottest day of the driest year we want power for whatever consumption we want; the capability to turn on our air-conditioners; live inside; turn on big screens, and be cool, comfortable plus enjoy the comfort of a pool outside with pumps, chlorinators and everything else that comes with our Australian society. This in itself isn’t bad; but it’s our doing as consumers.

These network charges; the ones that define the what each of us pay the transmission and distribution grid (coping for this huge capacity for PEAK POWER) are the “network charges”. So the network charges will increase our bills by 106 % calculated in NSW and 70% in Queensland over ten years. Wow! That is amazing but a calculation by Paul Simshauser from AGL based on CONSUMPTION….. nothing to do with carbon.

Next; let’s consider the core source of energy. Obviously it’s not free. We burn coal, or gas, with a little bit of Hydro power. Without explanation of why coal, why gas….. we do it because of market economics and the need for technical responsiveness. The wholesale cost of energy results from our dominate power source cost; the cost of coal. We burn little broken fossils bits of vegetable and organic matter matter that have decomposed over millenniums into black or brown coal. We dig it up. We transport it (if the mine and power station are close we do it on a huge conveyor belt), we pulverise it to dust, we burn it, we collect the sulphur produced with a scrubber (by the way we didn’t in pre 1980’s and produced acid rain) we then boil water to steam, we take the steam through a turbine and direct the energy to a shaft. On the back of the shaft we have a power generator that spins in a magnetic field producing electrical current. Thank you Edison! Well in a wind turbine we have blades that turn in the wind and turn ra generator. That’s it! No mine site, no conveyor or transport, no boiler, no steam turbine… just a generator of power turned by the wind. How is it that we can’t get our heads around the science that renewables are cheaper in the long run? (When we get “build” or quantity / volume)

You know what? That’s OK, it’s not explained by the media that in years to come if we keep burning coal it’s a higher cost option than renewables. That’s the transformation I talk of doing now. What Paul our esteemed economist tells us is this… Fossil fuel cost will go up. It’s quite simple. Oil, which has reached its peak of production (but not consumption!) will go up. (Greater demand for a commodity than its supply capacity = increasing commodity price). I think we can all get our heads around this without an economist. Even the politicians would have a hard job convincing you that oil will go down in price (or stay steady). However when oil price gets to a threshold, there will be a migration to gas. OK, we can also probably understand that the international price of gas goes up. So that also knocks onto coal prices which will also substitute for some gas sources. All fossil fuels are burnable substances that yield heat (our form of power for conversion) and therefore oil, knocks on to gas, knocks on to coal. Lost you yet? Well back to Paul. The economists say if you can understand this, the forecasts are for the source fuels of our power stations (predominately Gas and Coal) to increase. Increase in accordance with the predicted international demand.

Source energy cost will increase say 33% increase in 5 years (compared with CPI increased predicted at less than 20%). Under a high gas cost scenario with network cost increases the calculated rise is in the order of 102% increase in the next five years. Over 100% in 5 years! That’s excluding the carbon cost. The actual cost of carbon – given a tax or emissions trading scheme is minuscule compared to the fuel cost themselves and network charge increases. In fact if carbon sensitivity causes us to be more economical, and reduce consumption we will have carbon cost to thank us for saving us from the inevitable fuel and network charge increases. If we go back to my explanation of wind. No fuel source costs, no mine site, no pulveriser, no boiler, no steam turbine; only a generator you can start to see that conversion to this form of energy (wind is just one example) is key to us adopting a lower cost energy profile in industry. In short; transform now or be caught in this ugly mess of fossil fuel as our primary energy source for electricity.

What’s also interesting is that if we move to renewables and get our cars on electricity and away from oil we also reduce our potential exposure to rising fuel cost. This is the transformation that is needed. And a carbon price provides assurance of investment returns for those companies building wind and solar farms. Once that assurance of return exists, they will compete with carbon based power generation and beat it hands down in the long run. This is a good investment, this is the needed transformation. A carbon price puts us onto a lower cost energy spiral (more wind farms, more solar – the lower this cost of energy) and off the high cost energy spiral of fossil fuel energy sources.

Although the logic for this is very simple it’s a long term strategy… one that does require some initial investment and one that a four year political term does not seem to support. We should all embrace the move to a carbon constrained economy in Australia, because if we do it before other countries we will lead the way; not be locked in a death spiral driven by exponential increases in source energy costs – then our aluminum smelters, our nickel refineries, our open cut drag lines that are so energy hungry fed by high energy costs will be uncompetitive – and the lucky country will be unlucky. All for the want of political emotions about carbon in 2010-2011. Let’s look forward and transform our systems now. NOW.