EDITORIAL/OPINION
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The Coming Global Crisis and the Decline of Aviation

Although debated and denied frequently, a massive shortfall in oil production is coming faster than many are willing to admit. Dr. Alex Kuhlman assesses the situation and its effect on the airline industry, and reminds us to start thinking about tomorrow. Pictured is Airbus A380 jumbo jet.

Published: 26-Jul-2006

In the last few months, there has been increased media coverage about record high oil prices and future global oil production. Inevitable tightening of supply is destabilizing oil markets, which now exhibit extreme price responses to the smallest of disturbances. Interestingly, very few people know that world oil production is nearing its all-time peak, and today’s $60 barrel may seem like a bargain a few years from now. Production in more than 54 of the 65 most important oil-producing countries has already gone into decline, with the Middle East predicted to follow soon. The implications of having less oil tomorrow than we have today are far reaching with a global crisis certain to follow. Energy-intensive industries like commercial aviation will suffer first, followed by other industries, national economies, and the global economy. Ultimately, oil shortages will severely limit the world’s ability to sustain its population as food production relies heavily on fossil fuels. This is not a conspiracy theory or bible prophecy. Rather, it is the scientific conclusion of the most widely respected and conservative geologists, physicists, and economists.

PEAK OIL

The world is not running out of oil, but its ability to produce high-quality cheap and economically extractable oil on demand is diminishing. With great effort and expenditure, the current level of oil production can possibly be maintained for a few more years, but beyond that oil production must begin an irreversible decline. More than 95 percent of all recoverable oil has now been found and approximately 90% of all known reserves are currently in production. There have been no significant discoveries of new oil since 2002. Oil is now being consumed four times faster than it is being discovered, and the situation is becoming critical. It is a problem without a remedy and it is the most pivotal challenge facing modern civilization

ALTERNATIVES

There's no readily available source of energy that can replace oil as it steadily declines over the coming decades. In their present form, alternative energies are simply not capable to replace fossil fuels at the scale, rate and manner at which the world currently consumes them. The public, business leaders and politicians are all under the false assumption that oil depletion is a straightforward engineering problem, but humankind’s ingenuity is unlikely to overcome the basic facts of geology and physics. Fossil fuels allow us to operate highly complex systems at gigantic scales. Renewables are simply incompatible in this context and the new fuels and technologies required would take a lot more time to develop than available and require an abundant fossil fuel platform from which to work.

THE AIRLINE INDUSTRY

The Short Term:
Oil provides 40 percent of all primary energy, and approximately 90 percent of our transportation energy. For most airlines, fuel it is the second largest expense category behind labor. As a direct result of the dramatic increases in oil prices, the cost of jet fuel has more than doubled since the beginning of 2004. The profitability of airlines was already under extreme pressure because of increased competition, overcapacity and lower yields. Furthermore, terrorist attacks have had temporary negative effects on demand in general and on specific routes, while the cost of security has also soared. Once again, the aviation industry is suffering. In recent news, Thai Airways’ chairman and Thailand's finance minister have expressed concerns about the carrier’s future amid rising oil prices. In August the airline announced it had lost 4.78 billion baht ($117 million) in its third quarter after being hit by soaring jet fuel costs. Only a few airlines had the foresight, courage and required funds (or credit worthiness) to hedge fuel prices. Southwest managed to hedge their price at $26 for 85% of its fuel with profits soaring 41% in the second quarter of 2005 as a result. In 2004, Delta Airlines held positions but was forced to sell them in a short-term cash crunch. Those hedges would have protected about a third of its fuel needs. Their share price has collapsed from more than $8 a year ago to less than $0.70 today. Continental has no hedges in oil-futures contracts this year. United Airlines, which filed for bankruptcy protection in December 2002, has 30% of its fuel hedged at $45. Recently, American has cut routes as a result of high fuel cost, while the outlook for Northwest is far from optimistic with shares having dropped from over $22 to less than $4 in the past 12 months while under Chapter 11 bankruptcy protection. Ryanair hedged at around $45, while Easyjet managed to cap at $60. In the short term, hedging has become a crucial part of business for the most successful airlines.

Airlines with more efficient jets will have a distinct advantage in years to come.

The Airbuses, especially the A380, are going to burn a lot less per passenger-mile than other aircraft.

Medium Term:
Within a few years, or even sooner, oil extraction from wells will be physically unable to meet global demand. Prices will soar, fuelled by market-based panic, further hurting the airline industry. In addition, high oil prices will decrease consumer’s disposable income and dampen demand. The number of cash-strapped airlines will increase. The weaker airlines without hedging contracts, that somehow managed to survive in the short term, are doomed to collapse. In addition, higher fuel costs will dilute the competitive advantage that the low cost carriers have. The reason for this is that as fuel cost’s share of total cost increases, the relative share of all other operating expenses decreases, weakening the low cost advantages that these airline have traditionally based their model on. Another possible effect may be a relative increase in short haul travel, at the expense of long haul. The most successful airlines will most likely be the flag carriers from the Middle-East as this region will benefit from the high oil prices, allowing these airlines to go from strength to strength. Emirates have ordered 45 of the new giant new Airbus A380’s, which is key element in the company’s future growth, while experts believe that many Arab airlines will place more orders of Airbus and Boeing in the coming few years.

Long Term:
In a worst-case scenario, the long-term future for aviation is disastrous. As oil prices continue to rise, the world economy will be confronted with a major shock that will stunt economic growth and increase inflation. The chief economist of Morgan Stanley recently predicted that we have a 90 percent chance of facing “economic Armageddon.” During the transition period to a post oil era, there may be massive disruptions to transportation as the global decline of oil deepens. There will be social unrest and a strong reduction of business and government activity and very serious unemployment. Eventually, a large proportion of the demand for air travel will be almost completely destroyed, with the risk of the aviation adventure going out of business, with the exception of perhaps a handful of airlines. Once again, air travel will be reserved for the rich and for government business and the world will become a larger place again.

Solutions Must be Grounded in Science:
If we want to have at least a shot at changing this gloom-and-doom future scenario, it is vital that we fully understand the problem. It is what some call "an outside context problem"—so far from our normal realm of experience that we are collectively having a hard time processing it. The decline of oil is a certainty and is guaranteed by the natural laws that govern our physical world, and nothing in science, technology or engineering can prevent it. The world needs to prepare for a post-oil era and make huge commitments and sacrifices to avoid a deep crisis. With the little time that we have left, we need a well-orchestrated and large-scale intervention by governments from around the world to conserve the underlying fossil fuel base required to develop and implement sustainable energy sources capable of running countries like the United States—or even a substantial fraction of it—the way we are running them now. With a dwindling energy base, we may simply lack the tools and time to replace a fluid so cheap, abundant and versatile.

The traditional view of economists that the ever-insightful market will solve all problems is a fallacy. The supreme goal in all countries to raise incomes, living standards, and the GDP as much as possible, constantly and without any notion of a limit, is unattainable. On current trends, a country like China will be requiring 99 million barrels of oil per day by 2031, while total world production today is only 84 million barrels. Even present levels of production and consumption are grossly unsustainable with a shrinking energy base. The theory that economic stimulus will spur discoveries, and the market will maintain equilibrium, ignores the serious technical limitations of various replacement technologies. Furthermore, it assumes that the supply side can respond quickly in the short term, ignoring the long lead times required for any new oil projects and alternative energy projects to go online (up to 10 years) while disregarding the huge cost involved in modifying the trillion-dollar global infrastructure that was predicated on consistently low oil prices (aviation included). Finally, fundamental economic theory fails to address the laws of physics and thermodynamics. For example, looking at energy equations, to extract oil from the highly glorified tar sands takes two units of energy to produce three units and its net energy value is therefore marginal. In the early days of oil discovery, this ratio used to be 1:20. There will always be large deposits of oil left in the earth that would simply require more energy to extract than they yield regardless of the market price.

We must move quickly towards global regulations that will restrict economic growth and consumption of fossil fuels to allow the transition to a post-oil era to be as painless as possible. At present, it is impossible to get people or governments to even address this issue. However, to avert a future that is so drastically dislocated from the present, we must realign our thinking with our goal and take radical actions on a global scale.

For more information on Peak Oil see www.OilDecline.com.

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