Seven Questions: The New World Energy Order

Why are oil prices soaring so high, and will they ever return to Earth? Fatih Birol, chief economist at the International Energy Agency in Paris, explains why peak oil is real, why biofuels are indispensable, and how China determines what you pay at the pump.

FREDERIC J. BROWN/AFP/Getty Images Pumped up: More than any other factor, Chinas growing thirst for oil will shape what your gas bill looks like in 2018.

Foreign Policy: The Wall Street Journal recently reported that your agency is preparing to revise its estimate of future oil supplies. Can you tell us a little bit about your preliminary findings?

Fatih Birol: We publish a book every year, World Energy Outlook (WEO), that lays out strategies related to energy and climate change. For this years WEO, we wanted to look at oil-supply prospects, as there are a lot of question marks. So, we are looking at 400 top oil fields, on a field-by-field basis, asking how much oil we can realistically expect to come to market. We not only look at the geological part of the issue, but also the economics. We are going to publish our study on the 12th of November, so I dont know the results yet. What I can tell you is that what we are experiencing in the last few yearshigh prices, lack of investment in many areas, and the significant decline rates, especially in the North Sea, Gulf of Mexico, and elsewherewill be considered.

We are entering a new world energy order. Today, demand for oil is dominated by China, India, and even by the Middle East countries themselves. The main actors of the recent pastnamely the OECD countries, rich countries, the United States, Europe, Japantheir time is pass. Its over.

FP: Why arent more new supplies coming online, given the current high prices?

FB: The bulk of the oil has in the past been produced by the international oil companies, so-called Big Oil. But their existing reserves are declining in what they have under ownership. They have no access to new reserves, the bulk of which are in Middle East countries. In most of these countries, only the national oil company can, by law, invest. So, even though the international oil companies may have the capital and the technology, they dont have access to the reserves. Therefore, the bulk of the growth in the future needs to come from the national oil companies, and perhaps price will no longer be the main determinant when they make their [production] decisions, because for many countries, oil is their only natural endowment. And those countries legitimately value and want to leave their one and only natural endowment for future generations.

FP: Do you believe in peak oil?

FB: Of course, but the question is when? Global oil resources are limited. We have conventional oil; we have unconventional oil. We have oil in the North Sea, in the Gulf of Mexico. We have more oil in the OPEC countries. What I can tell you is that one day global conventional oil will peak. This will depend on many factors, including the role of technology, investment, and production policies. When we look at oil outside of the OPEC countries, when you put all of them together, I think it is going to peak very soon. But we have unconventional oil, and we have oil in the Middle East as well. How much will come to the market from unconventional oil?

FP: As were seeing at the United Nations food crisis meeting in Rome, biofuels are becoming a huge source of controversy. What impact would a backlash against biofuels have on energy prices? How important are biofuels to the oil market?

FB: Biofuels, in the last two years, played a crucial role. When you look at the numbers, almost one third of the growth in liquid [fuel] production came from biofuels. If we didnt have that one third, the prices today that we are experiencing could be much higher.

FP: How much of the current oil price is explained by financial speculation? Is there an oil bubble, as George Soros and others are claiming?

FB: There is definitely financial speculation, but the main reason for the high prices is the growing perception in the markets that the future demand growth may not be met by the supply growth. This provides fertile ground for speculators, and they play a triggering role in increasing prices.

FP: Will prices stay at this level for the next, say, 12 months? Do you believe the Goldman Sachs estimate that oil will hit $200 a barrel next year?

FB: As the chief economist of the IEA, I cannot by law make any predictions about prices. But what I can tell you is that I expect that for the next years to come, we will have a high price trajectory. There may be zigzags, but I would be very surprised if prices go down to the levels we saw three or four years ago, in the long term.

FP: The price, or even the price trajectory of oil, is notoriously hard to predict. What are the biggest uncertainties in trying to make forecasts?

FB: On the demand side, I think the biggest uncertainty is how much the Chinese economy will grow in the next 10 to 15 years. If the Chinese economy grows at 7 percent level or 9 percent, there is a huge difference for global oil demand growth. This two percentage-point difference has implications on oil demand that are higher than all OECD countries oil demand growth.

On the supply side, when we look at how much money we need to invest to increase production, we mainly look at how much oil demand will grow in the future. But this is only the tip of the iceberg. The main problem here is that the existing fields, many mature fields, are declining. So we have to increase production, not only to meet the growth in demand, but also to compensate for the decline in existing mature fields outside of OPEC. These decline-rate issues are not really taken into consideration, which is much more important than demand growth when it comes to production prospects. Our book, World Energy Outlook 2008, will provide a lot of data on that.

Fatih Birol is chief economist at the International Energy Agency.

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