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Volcanic ash and black swans

Natural phenomena occasionally threaten the oil industry, but most of its problems are man-made, writes James Gavin

THE ASH that spewed from Iceland's Eyjafjallajokull volcano last month did not completely spare the energy industry. Air-travel restrictions imposed for safety reasons in northern Europe prevented many delegates from attending the LNG 16 conference in the Algerian city of Oran, thousands of miles to the south, on 18-21 April.

Routine offshore helicopter flights to the UK continental shelf were suspended because of airspace restrictions relating to the presence of volcanic ash in the atmosphere. Oil companies in the North Sea were prevented from executing timely crew turnarounds.

Jet fuel demand, meanwhile, quickly felt the impact of the cancellation of thousands of European flights, slumping by an estimated 1m barrels a day b/d over the week and contributing to a slight weakening of crude-oil prices.

The effects of nature's wrath

Yet missed conferences and a dip in oil prices seem a small price to pay for an industry that has suffered greater effects from nature's wrath – from the capsizing of the North Sea's Alexander Keilland oil rig during a storm in 1980, killing 123 workers, to the devastating Gulf of Mexico (GOM) hurricanes in 2005.

In 1987, two earthquakes, measuring 6.1 and 6.9 on the Richter scale hit Ecuador, destroying a large section of the country's oil-pipeline system and reducing its production that year by more than 50%.

Five years ago, hurricanes Rita and Katrina shut down a large amount of oil and gas production from the Outer Continental Shelf in the US GOM, the source for one quarter of the country's oil production and at least 20% of its natural gas output. At one point, about a third of the nation's refining capacity was shut in by the hurricanes, which also destroyed eight rigs and 115 platforms in the GOM.

These events – analogous to the Eyjafjallajokull volcano's disastrous effects on the commercial-aviation industry – are the energy industry's equivalent of black-swan events, the term coined by Nassim Nicolas Taleb in his 2007 eponymous bestseller to describe high-impact, but hard-to-predict events that can have a decisive role in shaping the future.

Taleb's theory is that markets work on the assumption that black swans are so irregular that it is impossible to prepare for them. The 2008 global financial meltdown conveniently provided proof for his theory – the near-fatal collapse of the international financial system coming outside the realm of bankers' and regulator' expectations.

Volcanologists and meteorologists were similarly unable to provide a straight answer to questions as to when or whether the Icelandic volcano would stop erupting; the last time it happened, it lasted more than a year. Nor could they predict its eruption in the first place. Europe's air-traffic controllers may have overestimated the effect of the ash on modern aircraft, but in the heat of the moment, it was a risk they felt they couldn't ignore: the evidence suggested aircraft passing through oxygen-depleted clouds of ash could stall.

By contrast, some of the events that threaten the oil industry can, to an extent, be predicted. Katrina and Rita, for example, occurred in a region with a history of volatile weather patterns. Although nothing can be done to prevent them, steps can be taken to minimise their impact on oil infrastructure. The hydrocarbons industry's intimate relationship with the natural world makes it uniquely susceptible to disastrous events. But the natural world probably has more to fear from the oil industry – in the form of pipeline leaks or shipping disasters, for example – than the other way round.

On occasion, oil companies' actions have even been blamed for ostensibly natural phenomena; a mud volcano that erupted in Indonesia in 2006 was probably triggered by gas drilling, according to an authoritative study form the Geological Society of America. A 1979 offshore blowout in Brunei was attributed to drilling and it took an international oil company almost 30 years and 20 relief wells before the eruption stopped.

And, of course, the use of fossil fuels is generally blamed for climate change. Environmentalists are particularly scathing about heavy-oil production – in Canada's oil sands, for example. Their objections are not just based on the carbon-intensive nature of those operations: extracting oil from the sand creates toxic by-products that can seep into water sources. Similar doubts about the environmental safety of hydraulic fracturing have led the US to scrutinise unconventional-gas drilling more closely (PE 4/10 p27).

However, while the oil and gas industry can take steps to protect itself from many of the reasonably predictable natural events that could affect it – and while it can also take steps to protect the natural world from its own operations – the risks it faces tend to be man-made.

The 1998 oil price collapse, when prices fell below $10 a barrel, was a self-inflicted calamity brought about by Opec's blind pursuit of expansionary oil-production policies, just as the Asian financial crisis was undermining oil demand (see Figure 1, p38). Adverse political and geopolitical circumstances have, on numerous occasions, impeded the steady flow of oil to markets or the desired growth rate in output – in Iran, Iraq, Nigeria, Venezuela, Mexico and Colombia, for example.

And there is plenty of scope for further disruption. In 2008, an Iranian threat to close the Straits of Hormuz was instrumental in sending the oil price nearly to $150 a barrel. A recurrence of that threat or its implementation could have a disastrous effect on oil supply – and the global economy.

So would a terrorist attack on Saudi Arabia's Ras Tanura oil-processing and export terminal, given the world's heavy dependence on the steady supply of Saudi crude. And it would not be unprecedented; in February 2006, Al-Qaeda militants staged a botched attack on the kingdom's Abqaiq oil-processing facilities, ramming the gates with explosives. The Saudi authorities have over the past five years spent heavily on protecting oil facilities, but no oil refinery is completely invulnerable to a well co-ordinated attack. That much, at least, is predictable.

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