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Corn+Soybean Digest

Prepare For A Bumpy Ride

One thing controls the price of oil — the law of supply and demand. Lately, a growing number of energy experts and members of Congress have begun to look closely at the supply and demand problem, and they believe we are in for steadily rising prices that could damage agriculture and the rest of the economy.

If oil were in plentiful supply, the law of supply and demand would work in our favor. But it isn't. As a result, any number of factors can send the price upward. They include events such as Hurricane Katrina, which temporarily disrupt the flow of oil to market. They also include a rapid rise in worldwide demand for oil that threatens to outstrip the supply.

A growing number of petroleum experts believe we are approaching the day when worldwide oil output will actually begin to fall because we're running out of oil. In that case, there would be progressively less oil output even as demand for oil continues to rise — a prescription for shortages and ever higher prices. So the probability is that prices will follow an upward curve, as they have since the early 1970s when a gallon of gas cost 25¢. Here's a detailed look at what we face.

There is the likelihood of more temporary disruptions like Katrina. When oil supplies are plentiful, disruptions don't have much effect. But worldwide supply has been tight in recent years, and anything can upset the fragile balance between supply and demand and send the price soaring. That's what happened when Katrina ravaged the Gulf of Mexico oil production infrastructure.

Hurricanes aren't the only events that can send prices up. “Political upheavals in oil producing nations, labor strikes, terrorist acts and accidents such as the recent explosion at a huge British fuel depot can all cause prices to spike,” says H. Gordon Harris, professor of petroleum engineering at the University of Wyoming.

Fortunately, the price tends to drop when the crisis ends. That's what happened as the oil industry recovered from Katrina. But it's a volatile world and one disruptive event can sometimes be followed by another. In oil-rich Iraq, for example, terrorists have repeatedly dampened production by sabotaging pipelines. And long-range climate forecasts call for more hurricanes in the coming years than we've seen in recent decades.

Fast-rising world demand is also pushing prices up. The world has had a hard time keeping up with surging demand for oil for the past 10 years and as the margin between supply and demand has stayed tight, the price has gone up. Still, in the past there has usually been enough oil to go around. During the decade that ended in 2004, worldwide output increased by about 13 million barrels a day and oil consumption increased by about the same amount, according to data compiled by BP Oil, the British energy giant.

Unfortunately, the situation is about to get worse. The U.S. Energy Information Administration has calculated that the world must come up with another 25 million barrels a day by the end of the next 10-year period, about double the increase of the past 10 years. To do that, oil companies must find a lot more oil or figure out ways to get big increases from existing fields. Neither may happen.

There have been no major new oil finds in recent years, and among existing oil fields much of the easy-to-get oil is gone. Take Saudi Arabia, the world's leading producer, for example. “Thirty years ago, all Saudi Arabia had to do was turn the valve to increase production,” says Harris. “Now, they've got to drill new wells. It requires time and money to do that. They no longer have the luxury of upping production rapidly to meet world demand.”

The world might squeak by with less pain if demand weren't rising so fast. But it's in large part due to the surging appetite for oil by the new industrialized giants, China and India, countries with a combined population exceeding 2 billion people. These countries once got by on bicycles, foot power and public transit. Now they want cars. Overall, China, India and other Asian nations are expected to account for 45% of the increase in world oil consumption over the next two decades, the Energy Information Agency estimates.

“The Chinese middle class is about 250 million people, so it's comparable to the size of the middle class in the U.S.,” says Harris. “I've been to China several times. Their middle class wants cars, and they can afford them. This is having a large impact on oil demand worldwide. I'm sure the same situation is true in India. And other smaller Asian countries are following the same route.”

This scenario could lead to a crunch, says Cutler Cleveland, director for the Center for Energy and Environmental Studies at Boston University. “You could get into a situation where worldwide demand outstrips production even though you're producing more oil,” he says.

Or we could face something worse — a future in which worldwide production actually falls even as demand for oil surges. A number of prominent oil industry experts and members of Congress subscribe to this scenario, which amounts to a prescription for oil shortages and very high prices.

The scientist who first raised the threat of falling oil production was M. King Hubbert, a respected petroleum geologist with Shell Oil. In 1956, he stunned his colleagues with a prediction that U.S. oil production would peak around 1970 and then begin to fall. Critics scoffed. Then 1970 arrived, and U.S. production began to slide.

Hubbert followed his first forecast with another: Worldwide oil production would peak around the year 2000 and then begin to fall. While that hasn't happened, production figures compiled by BP Oil show oil output is falling in dozens of countries, and is rising slowly in others.

For example, U.S. production fell by 2.5% between 2003 and 2004 while consumption rose by nearly 3%. China managed to boost production by 3%. But its consumption jumped by more than five times that.

Experts differ widely on when worldwide production will begin to fall. Some think that point is decades away. Others think we are hitting worldwide peak production now. These include Hubbert's protégé, Kenneth Deffeyes, a retired Princeton University oil specialist. “The supply of oil in the ground is not infinite,” he wrote in his 2004 book, Beyond Oil: The View From Hubbert's Peak. He noted the annual increase in worldwide output had been only about sixth tenths of one percent in recent years. “The next step is decline,” he wrote. “The picnic's over.”

Others stake a middle path. “I don't think peak oil production is far off, but it's not going to happen next week,” says Boston University's Cutler. “But I do think that within 10-15 years we'll see a peak in world oil production. And as we approach the peak, this will put upward pressure on prices.”

This forecast of falling oil output has begun to attract attention from the U.S. House of Representatives, which held hearings Dec. 7, 2005, on the issue. One of those who spoke was Roscoe Bartlett, a Republican member of Congress who also operates a Maryland farm.

“The only question is when the peak will happen,” Bartlett says. “The Chinese are preparing for a global production peak in 2012. Without contingency planning and preparation at least 10 years in advance, the U.S. will have a really bumpy ride. Oil runs our economy. Oil runs our military. Oil makes and transports the food that we eat.”

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