After the oil crunch?

The end of cheap oil helps renewables, but makes far dirtier alternatives viable. A low-carbon futur

There are two competing explanations for today's high oil prices. One sees the price rise as the result of a temporary imbalance between supply and demand, exacerbated by a weak dollar and a bubble of speculative commodities trading. Fix these problems, adherents suggest, and the price can return to previous low levels, allowing business to continue as usual. The other sees the current price spike as symptomatic of a much deeper crisis, one that could end life as we know it in the rich, consuming west as global supplies of cheap oil begin to run short, not temporarily, but for ever. As Chris Skrebowski, editor of the UK Petroleum Review, puts it: "This is what I would describe as the foothills of peak oil." An imminent oil peak is no longer just a fringe theory: increasing numbers of experts view the topping out point as very close, if not actually upon us. "Easy, cheap oil is over, peak oil is looming," warns Shokri Ghanem, head of Libya's National Oil Corporation. If they are right, we are about to move into a very different world.

But while the reality of global warming is now nearly universally accepted, the potential problem of peak oil is still widely doubted or ignored. There is no official policy for a smooth transition to a post-oil future; the British government blithely reassures us (in response to a peak oil petition on the No 10 website) that "the world's oil and gas resources are sufficient to sustain economic growth for the forseeable future". Both the International Energy Agency and the US government issue projections based on oil reserve estimates which many geologists and oil industry insiders suggest are grossly inflated. This complacency smacks of a fatal combination of ignorance and denial. Recent oil production figures suggest that the peak oil crowd is winning the debate. For the past three years world crude production has flatlined at about 86 million barrels per day, despite a rapid upward trend in prices. This lack of increase in supply, combined with rapidly rising demand in countries such as India, China and Brazil, lies at the root of today's soaring prices.

Unlike the oil price shocks of the 1970s, caused by political factors, the present crisis is caused by something far more intractable even than the Middle East conflict - geology. David Strahan calls this "the last oil shock" in his book of the same title; the one after which supply and demand can never be rebalanced and the world totters towards economic catastrophe. As Strahan points out: "For three years the oil supply has been a zero-sum game in which if one country consumes more, another has to consume less."

In this case, unusually, it is the rich world which is losing out: countries which are members of the Organisation for Economic Co-operation and Development (OECD) have seen crude oil use falling for two years, as price rises choke off demand. Indeed, what we do here no longer seems to matter much: car sales in Russia leapt by a staggering 60 per cent last year, while new vehicles flooded the roads in India and China. With oil massively subsidised in many Opec countries, some of the strongest growth in demand is now coming from oil producers themselves. Whether the actual moment of peak oil is now, next year or in five years' time is not what matters most; what defines this new era is the conclusive end of cheap oil. Never again will oil be bought at $20 a barrel, as it was through much of the 1990s. Instead, we will see crude prices rising steadily - if not uniformly - towards $200, $300 and $400 a barrel in years to come.

The oil crunch has created a crisis for western leaders. George Bush made two humiliating trips to Riyadh to beg the Saudis to pump more. He was rebuffed: whether the Saudis can't or won't remains unclear. In France, President Sarkozy has had to contend with striking fishermen, and in Britain the hauliers are blocking roads and refineries once again. Gordon Brown's absurd response was to ask North Sea producers to increase output - despite the fact that offshore production peaked in 1999 and has since fallen by 40 per cent. The hauliers' protests have now spread to France and Spain. All seem to believe that the rising cost of energy should be borne by someone else, not them. They huff and puff to no avail - the rules of geology cannot be broken.

But peak oil may not be quite the crisis the catastrophists predict. So far, the price hike has been an environmental boon: the rise in fossil fuel prices has made emitting carbon more expensive, helping to make up for the more or less total failure of world climate change policymaking. Higher oil prices have made renewables more competitive, spurring rapid developments in wind and solar power: installed capacities of each are now doubling every two years. In the US, SUV sales have slumped - General Motors may now drop t he Hummer and focus production instead on its new plug-in electric hybrid model, the Chevrolet Volt. The aviation industry has seen its profits evaporate, with many analysts declaring that the era of cheap flights is over. All of these should be causes for celebration. In global warming terms, oil at $139 a barrel has been the best thing to happen for a decade.

Betting on failure

But high oil prices cannot substitute for proper carbon regulation indefinitely. Even as the "green tech" sector soars to new heights - $100bn flooded in last year - equally big investments are being ploughed into the dirtiest fuels of all: unconventional oil and coal. An upcoming report from the WWF and the Co-operative Insurance Society suggests that oil sands in Canada are three times as carbon-intensive as conventional oil, while oil shale in the US Rockies may be up to eight times more so. And these reserves are vast, estimated at 1.7 trillion barrels for Canadian oil sands and up to 1.5 billion barrels for US oil shale. Proven reserves of 174 billion barrels in Canada place the country second only to Saudi Arabia, which claims 260 billion barrels.

But extracting this oil is environmentally devastating. Some open-cast mines in Canada's oil sands are so huge they can be seen from space, and they have already laid waste to vast areas of fragile boreal forest. This is not oil that can be drilled easily out of the ground: each barrel requires the extraction of two tonnes of tar-soaked sand, which is then washed with hot water to remove the hydrocarbons, using both gas and water in massive quantities. Current operations use enough natural gas to heat a quarter of Canada's homes, according to the WWF/CIS report, while 300 million cubic metres of water are diverted from the nearby Athabasca river. Ponds to hold the resulting toxic sludge measure up to 50 sq km each.

Coal-to-liquids technology is also being ramped up worldwide, using the Fischer- Tropsch chemical process to produce synthetic petrol, diesel and kerosene from solid coal - but again this is vastly more carbon-intensive than pumping conventional oil, doubling CO2 emissions. The Economist suggests both oil shale and coal to liquids become competitive with world crude prices at $70 a barrel or above. With high prices likely to continue, all the majors are moving rapidly to invest in this area.

Even after making record profits on the back of high prices - $27bn for Shell and $40bn for Exxon-Mobil in 2007 - the evidence suggests that oil companies are moving away from renewables and instead "recarbonising" by ploughing billions into unconventional oil as they run down their conventional reserves. In May this year, Shell pulled out of the London Array, expected to be the world's biggest wind farm. Instead, the company plans to double its output from the Canadian oil sands, and is being closely followed in investing in unconventional oil by BP, Exxon-Mobil and ConocoPhillips. However, as the WWF report asserts, these companies are exposing their shareholders to a significant investor risk: essentially they are betting that world policy failure on greenhouse-gas regulation will continue indefinitely.

If policy improves, high carbon prices will likely make dirty fuels uncompetitive when compared with renewables, and investors in solar, wind and other clean energy sources will win out at the expense of the oil majors. This has to be the best-case environmental scenario: that high oil prices continue, and that the pricing of carbon in world markets chokes off investment in dirty replacements. Then a true transition to a post-oil, low-carbon future becomes a real possibility. But this scenario depends on policymakers having the vision to squeeze fossil fuels further even as restive populations protest at losing their foreign holidays and big cars. As David Strahan concludes: "All it needs is some brave political leadership. What a terrifying thought."