Let’s play “Jeopardy” Category – Oil shock

First Published in Telegraph Journal  August 5,2006

This country is warm all year long. 

This country has been called a third world country with first world people.

The language you hear is not English.

The President of this country has been in power for 47 years. The United States government tried to assassinate him.

In 1992 the cost of oil here rose such that the government had to dramatically reduce oil imports.

If you answered “What is Cuba?” you win.  Many Canadians visit Cuba for the lovely beaches, warm sun and its friendly people but few realize the tremendous shock it received in the early 1990’s when its preferential trade agreements with Russia stopped. Oil, food imports, spare part, and agro-chemicals from the Soviet Union stopped arriving. Cuba’s sugar was no longer required. Trade had instantly dropped by 85% and they could no longer pay for oil. Usage of oil dropped from 13 Million tons to 1.8 Million tons in 1992. In contrast, Canada uses roughly 89 Million tons per year. Looking at their experience shows us the results of large reduction of oil on any economy.

Within a short time, electricity rationing took place by rotating blackouts; no refrigeration meant spoiled food. Cuba’s farming had always been oriented towards export of sugar cane, citrus, and tabacco. These exports paid for importation of other food. Agriculture machinery and buses stopped running with reduced planting or harvests rotting in the fields. The Cuban GDP dropped by 50% over the 1989-93 period. The prime activity became the search for food to sustain life. The average Cuban lost 30 pounds. Life was grim for many years. Imagine a country with a year round growing climate and excellent arable lands, yet being unable to feed its citizens.

Dramatic change became necessary with oxen taking the place of tractors. Food for cities was planted on vacant lots and rooftops. The government bought 3 million bicycles from China. Horse-driven carts are still seen today on major highways. The recovery of the economy has taken many years and Cuba still has difficulties paying for oil.

Around the world, farming has become an industrial activity with export of food as a primary objective. Standard economic theory suggests that each country produce the goods that correspond to its natural advantages and everyone gains with this trade. This works as long as oil is available to run the machinery of industry and transportation.

However, there are significant differences between Canada and Cuba:

  • Canada is self sufficient in oil overall, although we import almost a million barrels a day in the east. Perhaps some vulnerability issues here.
  • Canada uses considerably more oil than Cuba – for winter heating requirements, large industrial production and huge transportation requirements due to the great distances in Canada. Our wealth permits us to use energy on what most of the world would consider unattainable luxuries or non-essentials (SUV’s, huge homes, vacations around the world, etc.)
  • Our export economy is totally linked to the world. Cuba’s is the exact opposite being somewhat isolated by the United States and internal government policy.
  • One major similarity Canada and pre-shock Cuba shared is the export oriented agriculture model. (Canada sells large quantities of beef, wheat, and potatoes to other countries) We also import a great deal of our food products, as the climate does not permit year round production in present farming modes. Most of the farming is done on industrialized farms with fertilizer and oil being a substantial input.

    Some thoughts on their experience:

  • The good news is that the Cuba experience is unique and shouldn’t affect us in Canada. Canada has not been affected by $75 oil. The Cuba experience was “extreme rationing by price” felt by an impoverished economy. Other poor semi-industrialized countries without the wealth to purchase high priced oil could be at risk in the next 15 years but not to the same extent as Cuba.
  • The bad news is that extremely high oil prices are expected sometime in the next 15 years when oil production declines. This will deliver substantial loss of jobs and inflation followed by depression to the Canadian economy when oil goes to unexpected highs. GM, Ford and Chrysler may be out of business if they fail to adapt their car models with poor mileage. Ontario has 330,000 jobs in the auto sector. Quebec has significant jobs in the aerospace sector. When the airlines are negatively affected by oil, they don’t buy planes, which affects part suppliers and jobs in Quebec. Atlantic Canada has an export economy that will catch pneumonia when the US economy loses strength.
  • When we examine our personal budgets, most of us have very little money left over after the essentials like food, rent or mortgage car payments and gas. As oil prices skyrocket, the cost of living for the majority of Canadians will be greatly affected. The impoverished majority will have to make serious choices.

    Something about this situation makes me think about Aesops fable of the industrious ant who prepared for the coming winter and the lazy grasshopper who danced the summer away having fun. Certainly, life should include lots of fun, but can we also prepare for the day when oil will not be cheap and plentiful? It would be intelligent and thoughtful of us to reduce our oil usage now so that our children and grandchildren will have a decent life. Can we ask our political parties what they propose when the next election is called?

    The next series of articles will examine the choices that governments and individuals can make to ease our transition into the post oil era. Some of these will include conservation, various power production methods and costs, housing and transportation alternatives and many other subjects.

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    Canada’s national pipeline dream

    What sort of dreams should we propose for ourselves as a nation? What would stir our imagination? Certainly elimination of poverty, social justice or building peace in Afghanistan would be worthy goals but are they really practical or attainable? Certainly, we built a national railway, but that was a hundred years ago or more. What challenges of magnitude have we undertaken lately?

    Canada, a self-proclaimed energy superpower is self sufficient in oil production. Our 2004 annual usage was 1.8 Million barrels per day and domestic production was 2.5M b/d of which 90% is from Western Canada. 65% of our production is exported to the United States mostly via the pipeline systems shown below.

    One might conclude that north to south exports is virtually the whole energy game. Presently Central and Eastern Canada import 900,000 b/d of oil from offshore. With Alberta conventional oil in decline by 5% per year, non-conventional supply (oilsands) is receiving large investments and overall production will increase in coming years.

     overall-pipeline-network-rev2.jpg

     Pipeline map from NEB website

     A brief history of pipeline construction 1941 – Pipeline built from Portland Maine to Montreal as a wartime security measure and to provide year-round access when shipping is closed by ice.
    1950Interprovincial Pipeline built to transport oil from Edmonton to Superior, Wisconsin. First shipment arrived in Superior in early December.
    1953 – Interprovincial Pipeline extended to Sarnia, Ontario

    1953 – Trans Mountain Pipeline (oil) completed from Edmonton to Burnaby, BC (225,000 b/d)

    mid 1970’s – Following the first oil embargo, the government of Canada supported the construction of line 9 (300,000 barrels a day) between Sarnia and Montreal to provide additional energy security. Over time, the problem became a faded memory and the line now feeds east to west with crude oil from offshore.

    Oil is delivered by ship to Saint John-250,000 B/d, Halifax-85,000 B/d, and Newfoundland by tanker from offshore producers. A pipeline feeds the refineries in Montreal and in Ontario from Portland, Maine.

    As the tar sands are exploited, additional increases will lead to a production rate of between 3 and 4 million barrels a day. By 2015, over $100 billion dollars of investment in oil producing projects will be complete.

    To get this new production to market, Enbridge plans building the “Gateway” pipeline, 1200 km, 400,000 Barrel/day from Edmonton to Kitimat BC to send oil to California and Far East markets. They also propose to reverse the south-north flow of an existing pipeline from Chicago to Cushing, Oklahoma and will require expansions to the main line in Canada. Terasen has a proposal to increase production capacity to BC called TMX. These examples point out an expansion of production destined to serve other customers south of the border and elsewhere.

    The development of the Canadian pipeline system has been a natural evolution of the distance to major markets and the low cost of oil. Oil at $10 dollars a barrel couldn’t finance a pipeline that cost $5 a barrel to transport it. As the cost of oil has risen substantially, it may be time to evaluate the benefits of adding some sections of pipeline to permit the sale of Western Canada oil to the center and east of the country:

  • As overall world oil production will decline in the future, many countries will be tempted to nationalize their oil industries to achieve better return on resources and perhaps conserve supplies for the long term. Witness the efforts of Russia, Venezuela, Bolivia, etc, to either re-negotiate or nationalize industry.
  • The availability of oil on the world market may not be just a function of the free market. China is making investments and signing agreements with many suppliers to furnish the rapidly growing Chinese market (Nigeria, Iran, Venezuela, Canada, etc.) This production may not be available to others at any price.
  • The NAFTA and IEP agreement uses our highest shipments of oil to the US as the baseline to maintain when there are shortages. Worldwide shortages of 10% would impose demand reductions on Canada so increasing shipments to the East would not be possible if offshore supplies were not available to Central and Eastern Canada. Winters in Canada will always be cold and unforgiving to those with a shortage of oil. If the West has oil and the East does not, then the federal government would be accountable for a lack of foresight. Should we all move to Alberta to stay warm?
  • Any increase in oil exports will benefit the Canadian balance of payments. Similarly, a 600,000 b/d pipeline toward the east would improve our balance of payments by $16 Billion per year at $75/b
  • The oil industry is rapidly changing and not for the better. The expected shortage of resources elsewhere in the world may lead to oil wars. Indeed, some have suggested that Iraq is an example. A prudent policy would evaluate whether a high capacity Trans Canadian pipeline from west to east should be built before any more pipelines to export oil are approved. Given the chance, most Canadians would much prefer that their oil dollars go to Alberta as opposed to offshore.

    At a cost of between $1-3M per km, it is expected that the total cost of the pipeline would be between $5 and $10 billion. We’re almost talking money here. At the upper price of $10 Billion, this annual costs amounts to approximately $5 per barrel delivery charge. If oil is $100 / barrel when the pipeline is in service, this is a 5% transportation cost which is not too excessive. After all, it costs money to ship oil from the Middle East or Venezuela. Oil for Atlantic Canada refineries would be shipped from Quebec City, the end of the pipeline or from Portland Maine.

    This is a very brief analysis of a complex issue with inadequate pipeline estimates. Would a pipeline make a sufficient national challenge for this decade? Should the rest of Canada be allowed to buy Alberta oil? If new pipelines of many thousands of kilometers can be built in the near future from Edmonton to the BC coast or to the United States to export oil, can we not first build one from the west to the center of Canada through Canada? Do our political leaders have a plan to insure our energy future?

    The regional case for building Lepreau 2

    There is an Arab saying: “My father rode a camel. I drive a car. My son flies a jet airplane. His son will ride a camel.”

    Will we see a Canadian version of this prediction become a reality in our country? Stories from my father about working in the woods with a bucksaw and hauling wood out of the forest with horses remind me of how close we are to the lifestyle of the pioneers of this country. And perhaps that was not a bad thing to live closer to nature. Certainly, the oil-fuelled industrial prosperity has brought us many benefits that we will miss greatly if we don’t succeed in reducing our energy footprint and substituting renewable and other sources of energy for oil.

    In the other category is the paradox of nuclear energy, which has been troubling for many citizens. Certainly, over the past 50 years, we have not succeeded in implementing a satisfactory permanent solution to the spent fuel. There are many who worry about the possibility of some type of accident whether based on a technical glitch or the actions of a terrorist. These worries may or may not be founded.

    On the positive side, the safety record of the nuclear industry has been remarkable over the past 50 years and the reduced CO2 and other pollutants from these clean plants has delayed the onset of global warming.

    Some interesting information gleaned from NB Power annual reports

    • 25% electricity comes from nuclear generation at Lepreau
    • 15% from Hydro (varies with rainfall)
    • 60% from Carbon sources (oil, coal, natural gas, and misc.)

    Its heavy oil bill has been close to $200 million in recent years. The 04/05 annual report put their heavy oil cost per barrel at $28USD. Heavy oil, also called #6 residual oil, is the left over oil after the refining process. Presently, the cost of heavy oil varies in the $45 to $50 US$/barrel range.

    NB Power points to oil prices as driving up rates. What will be the rate increase when their oil hedging runs out and they have oil costs of $350 Million a year? ($50 / $28 = 1.78 x $200M = $350M). If $10M equals 1% rate increase then we can expect ($150M/10M) a 15% increase. Subtracting the recent 8% increase, we might believe another 7% rate increase will be brought forward in the near future, just for oil. There, we’ve saved a $10M hearing at the PUB. Just give NB Power another 7% or more next spring.

    Beyond the reality that oil is just too expensive for electrical generation even now, is the looming decline in oil production that will start sometime in the next ten years. When production does not meet demand, the price of oil is going to rise to extreme levels. If NB power is still buying oil at that time, then rate increases could be as high as 100%.

    In contrast to the high cost of oil, the fuel for Lepreau was $9M in 2004/05 fiscal year. The site at Point Lepreau has the potential for other units that would significantly displace oil generation in NB, PEI, and Nova Scotia and perhaps be of interest to Quebec as a resource when hydro is low there.

    The annual mortgage payment on a $2 billion nuclear generating plant at 7% interest would be $171 million per year. Given some fuel, and operating costs, the mathematics looks very attractive.

    The benefits would be:

    • Reduction of CO2 emission by 4 or 6.3 Million tonnes, depending on the size of the plant chosen. To put this in perspective, annual emissions in New Brunswick are 20 million tonnes. This reduction could bring us to the Kyoto targets.
    • More stability of price and security of supply when compared to oil. Displacement of oil delays the onset of peak oil decline.
    • Improves the Canadian balance of payments and creates employment in Canada. A 1000 MW plant displaces 12.7 million barrels of oil a year. At $45 / barrel for residual oil, this is $571 Million per year.

    Personally, I would prefer extreme conservation measures, wind and small hydro power additions as the initial step towards a saner energy policy, but is the general public ready to change their lifestyles? Are we going to continually export petro-dollars to oil producing countries when we have other options within our grasp? What is the best forum for energy leadership on this most important issue? Will the newly formulated PUB serve this purpose?

    How do we change from an oil-centric society to a conserving sustainable society? What are the targets for energy reduction that would be necessary? How much is wind power going to help? When are solar cells coming down in price enough to help us? Is coal even an option if we consider global warming to be important? As well, will coal prices be stable for long when coal-to-oil gasification takes off?

    A recently announced wind turbine project 13 miles off the coast of Cape Cod has seen environmentalist Robert Kennedy Jr. opposing the installation of 170 turbines. What part will NIMBY (Not In My Back Yard) play in our decisions? The wind is typically consistently strongest over water. If we can’t agree to install something as benign as wind turbines, then we have a great problem. The Bay of Fundy is shown on wind charts as having excellent wind speed for wind turbine production. Where does aesthetics rank in the battle to reduce greenhouse gases? What will local environmentalists say about the Bay of Fundy as a location if it is suggested here?

    If nuclear is a part of the energy and Kyoto greenhouse gas solutions, then it would normally be built by NB Power. Given its present financial situation, an alternative might be to form a cooperative entity between NB Power, Nova Scotia Power, Maritime Electric, Hydro Quebec, and others interested parties to develop this site. This transfer of Lepreau 1 and construction of Lepreau 2 to this partnership would see NB Power’s balance sheet improved with new generation in the region and less dependence on foreign oil.

    Where’s my parachute

    Recent columns have examined the reasons why world oil production will soon decline, when that may occur and what effect it will have on our economy and to our lives personally. Previously we explored the dark side of the oil decline (worst case) and it was a doom and gloom article.

    Is it possible to have a soft landing when the production of oil is less than the world’s demand and when most people don’t realize the havoc that a small shortage of production will have on their lives? In recent years surplus production capacity has decreased from many million barrels a day to approximately 1 Million barrels. This means that the margin of error for hurricanes, political unrest in Nigeria, Iran, Iraq or terrorism events is just over 1%.

    It is that narrow margin along with fears caused by Hurricane Katrina among others incidents that caused the price to rise to almost double. Based on experience in the 1973 oil embargo, it is believed that a 5% shortage will raise prices to at least four times above the existing $75 a barrel. It is unlikely that the initial shortage would be greater than this.

    In order to limit the damage caused by high prices, it is essential that when a crisis situation becomes evident (oil at higher than $140 / barrel) all governments of the world will cooperate and quickly:

    • Introduce rationing of their national oil usage by more than the shortage.
    • Clearly inform their citizens of the necessity and reasons for conservation.
    • Introduce long term measures to promote fuel switching, conservation and fuel production by other means.

    These actions may ensure that prices, although higher than normal, will not destroy the economy. Some inflation and recession may occur with job losses in certain sectors. However, this scenario depends entirely on the world recognizing the danger and acting in a cooperative manner. What we are more likely to see is wars over resources, repudiation of contracts, nationalization of oil fields and disorder all over.

    Once the production decline starts, it will continue and the gap will become larger in the second and subsequent years. After ten years of decline, world oil production may have dropped to 75% of peak levels. Along with recession comes a reduced demand for oil which will lessen the decline situation. We wish to believe that a soft landing is possible but the reality is that preparation for this eventuality should start at least ten years before the event in order to improve our likelihood of survival.

    To illustrate, think about the average family mileage of 20,000 km per year. At seven litres per 100 km, this is 1400 litres or roughly 30 dollars per week at present day prices. Now, if the average life of a car is roughly 12 years, about 8% of vehicles are scrapped every year and a new vehicle is purchased. This means that if vehicle efficiency of 3.5 litres per 100 km were the law and it is technically possible to achieve this, then we wouldn’t see the full benefits for 12 years.

    If transportation of goods over several hundred kilometers were mandated by rail, then we could save substantial fuel. But we have torn up half of the tracks. How many years to restore the rail system in Canada? What about the use of the rail lines in the Kennebecasis and Saint John River valley for commuter traffic to Saint John? Can it be done? Are we still spending hundreds of millions on four lane highways to be completed just when gas becomes too expensive for traffic? We are building excellent roads that few will use. Should we not turn all of our capital resources to energy conservation and renewable energy development?

    How many years to achieve the maximum number of wind power plants in the Maritimes? These installations can be completed in less than a year after proper site selection. What about the development of small hydro sites at appropriate sites? Seven years or more? How many years to install a second nuclear plant at Lepreau to displace oil usage in New Brunswick and Nova Scotia? Seven years, perhaps.

    How many years until high speed Internet is available in small communities so that some workers can work and shop at home?

    Canada is one of the most fortunate of countries from a resource point of view. What about a west to east oil pipeline for Canadian economic security? It is time to review our options. (More in a later column)

    The soft landing is possible. Is it probable? No. Without significant planning and focused expenditures, an easy transition to a post oil society in not in the cards. We live in a country where the climate is unforgiving, where we no longer grow enough food to feed ourselves and our economy is dependent on cheap oil to function. Well my friends, the cheap oil is gone and soon it will be much more expensive.

    Some people have great faith in the energy companies to find new oil fields, that a magic new technology will solve the lack of fuel, or that something! will happen. Unfortunately, it takes several years to bring a new oil field into production or to retool and reengineer car factories. The super giant oil field hasn’t been discovered and no coal-to-oil gasification plants are being built in Canada that I am aware of. We aren’t talking about doing things that are uneconomic, just doing good things now to get ready for a future that isn’t too bright. It is call prudent risk management.

    What are our governments doing? Sounds like business as usual. Are they in denial? Are they afraid to be the bearer of bad news? Well that is a subject for another day.

    My name is George and I’m addicted to oil

    George W. Bush recently discovered that the United States is addicted to oil. This revelation comes from a man who lives in a big white house costing a fortune to heat, who travels in a Boeing 747, recently overnight to Iraq to say hello to the troops and takes a helicopter to go to his cottage at Camp David. And he’s calling everyone else addicted? Very interesting George! Have you thought about buying a smart car for your travels or even staying at home some times? Mostly conservation is something the other fellow should do.

    The word addiction is defined as “Habitual psychological or physiological dependence on a substance or practice beyond one’s voluntary control”. I’m not sure that addiction is the right word. Addiction has a very negative connotation.

    Perhaps everyone in the western world has grown up in society’s dysfunctional family where we are taught Consumption 101. The economy requires constant growth and promotes the biggest and most powerful car, the biggest house, and we live in the suburbs where you need two cars, a boat, a 4 wheeler and heaven knows what else.

    Regardless of the label we apply to our lifestyle, the end result is the same. Our high consumption of oil will soon force us to confront extremely high oil prices when declining oil production fails to meet demand for oil.

    How are we in Canada and the world going to deal with this situation? There are two scenarios that I would like to explore – either a hard or a soft landing.

    If you are a pessimist or perhaps a realist, then the hard landing will make the most sense to you. The economy is interactive and higher prices will eventually affect behaviour and lower prices. It will also affect supply given several years. The pessimist believes that these changes will be too late to avoid the destruction of the economy. This scenario assumes an initial shortage of oil of only 5%, that no world rationing of oil takes place and that markets determine prices. Oil prices quickly rise to at least $300 per barrel. But it could be higher.

    Gas at $4.50 per litre causes us grief on a personal basis. We can’t afford to drive to work if we live any distance from our job. If we’re lucky, we use a bicycle or a small scooter or public transport. Car and air tourism dies with the closing of hotels and restaurants. Automakers are not selling cars except the small models and go bankrupt. This affects hundreds of thousands of workers including all of the related industry suppliers.

    Most of our food today travels thousands of kilometers to get to our table. The energy expended for air transport is much higher than the energy extracted from the food by us. Air is clearly the worst example, being 60 times more intensive than transportation by ship. The rising cost of food takes its toll on the poorer sector of society in malnutrition and perhaps some deaths. Those who can absorb the increasing cost of food will survive.

    “Home heating” will become an oxymoron just like “jumbo shrimp” or “rap music”. A tank of heating oil will cost $4000. Natural gas prices will be very high but perhaps affordable. Electricity prices will increase by 60% to 16 cents a kWh. Some will freeze in their homes. Homes with poor insulation will be abandoned. In Atlantic Canada, wood heat will become expensive and the forests will be clear-cut by anyone with an axe.

    You can expect the adjustment to these conditions will involve considerable public unrest and disorder. Politicians will be turfed out and others brought in to solve the problems. The road rage that we occasionally experience today is a very minor example compared to what humans will do to avoid starvation and freezing to death.

    In this scenario, the government is seen to be initially ineffective as no preparation for the worse case is seen as necessary. Ultimately martial law is imposed and rationing of energy and food is brought in. The government has little room to help citizens as tax revenue is down due to the poor economy and increased welfare payments. Government pensions that are not fully funded will be reduced.

    Just how bad our lives will become is a matter of opinion. Canada is a very wealthy country and may survive the initial 5% decline by price induced conservation, oil demand destruction (loss of jobs) and rationing. However, in succeeding years, as the shortages of oil become greater, it will demand tremendous sacrifices and impose great hardship on all. The end result of this scenario is an agricultural society living as our ancestors of the 1800’s did.