Who cares if oil peaks?

A new study out of Cambridge Energy Research Associates claims peak oil is still 30 years off.  For peak oilers, this just pushes off the inevitable.  For economists, it leaves time for markets to react.

What do economic models predict?  As oil becomes more scarce, oil will become more difficult to find, more difficult to extract and less profitable.  In short, prices will rise.  As prices rise there will be incentives for additional exploration (if you can make more money, you'll look for more oil), incentives for conservation (who likes to pay high prices?), and incentives for investment in alternative energies (hydrogen may not be cost effective now, but if gas hits $10 a gallon, it might be).  The upshot:  peak oil doesn't matter.  There's no particular significance to reaching the peak, the real problems come when we reach the bottom of the hill.  But most economists and CERA don't see that as too big a problem either...prices are creating the right incentives*.

The CERA study debunks the so-called Hubbert Peak Oil Theory, first espoused in 1956 by geologist M. King Hubbert. Working at the time for Shell Oil Co., he predicted that world oil production would follow a bell-shaped curve in which production grows steadily until it peaks, followed by a rapid decline.

Hubbert was pretty accurate on the timing of U.S. peak oil production, coming within two years of 1970, the year experts now recognize as the peak of continental U.S. production.

But his theory failed to recognize that new technologies enabled reserves to grow over time. His theory preceded the exploitation of massive oil reserves in Alaska and the Gulf of Mexico.

That's why Yergin dismisses talk of peak oil.

"This is really the fifth time we've `run out of oil,'" Yergin said in a teleconference with journalists on Tuesday. He recalled past predictions dating back to 1880 of an end to oil or gasoline production.

Yergin's views carry weight because he won the Pulitzer for his 1991 book "The Prize," an exhaustive history of oil economics.

He and colleagues believe that the decline in oil availability will play out as an "undulating plateau," in which annual production produces a series of ups and downs, eventually peaks and then declines slowly.

"We see the undulating plateau existing one or two decades, rather than a sharp decline," said Peter Jackson, CERA's director of oil industry activity. He sees outright decline beginning no earlier than 2030 and perhaps after 2050.

Future oil supplies, said CERA, will be accessible by new technologies that permit drilling more than 7,000 feet below the ocean's surface or extracting oil from tar-like deposits in sandy soil found in western Canada.

"Ours is not a view of endless abundance of resources," said Jackson, cautioning that he doesn't want CERA's findings to "distract us from addressing real issues."

Another source of optimism for this energy-hungry world emerged from another report this week, this one a technical paper from the Los Angeles-based think tank Rand Corp. It ran 1,500 simulations of varied energy prices and technology costs to estimate future supplies of both renewable and nonrenewable fuels.

It concluded that up to one-quarter of the electricity and motor fuels consumed in the United States in 2025 could be produced from renewable sources, up from only 6 percent today. For that to happen, the price of fossil fuels must remain high and the costs of producing alternative energy must keep falling.

"The renewables case could displace about 2.5 million barrels a day of petroleum products in the United States in 2025, or 20 percent of total consumption," the Rand report said.

Together, the two reports give hope that energy will be plentiful for another generation or more.

"I've never seen so much activity in terms of energy technology all along the spectrum," Yergin said. "I think the system is responding."

Gotta love the system.

*I'm ignoring the climate change externalities here.  If we account for those externalities, prices would have to be higher now, which actually extends the life of oil--pushing the peak off even further, doh!

Comments

[pete]

Hail! to the victors valiant
Hail! to the conqu'ring heroes
Hail! Hail! to Michigan
the leaders and the best

Some song I remember from my childhood.

[Tim Haab]

Sung to the tune of "The Old Grey Mare"

O, we don't give a damn for the whole state of Michigan
The whole state of Michigan, the whole state of Michigan
We don't give a damn for the whole state of Michigan, we're from Ohio

Here's audio: http://users.frii.com/~nmetro/osu/songs/michigan.html

[pete]

Catchy tune. Not sure about the words:)

Pete

[J.S.]

Can we finally lay peak oil to rest? Please.

[John Whitehead]

J.S.,

I think that yesterday I convinced 23 +/- undergraduates not to worry about it too much.

[Tim Haab]

I just added 20. Can we call 43 a counter-movement?

[Mike@HCVN]

Just because I've enjoyed being on the side opposite Tim for the last few weeks, I'll play contrarian.

Even though the article says that we'll be able to supply oil well into the next century, it makes no claim as to the price you'll have to pay to get it. The reason increasing prices allow higher production is because more expensive to produce oil becomes viable. This is great, because more supplies are available, but this sets a price floor. An economically minded oil supplier will not pump at a loss for very long.

They can argue about how much oil there is until blue in the face. It's how much "cheap" oil there is that'll matter.

Mike

[Mike@HCVN]

On re-reading your post, you've effectively argued that economists shouldn't worry about the supply of oil, energy, raw materials, or, well, anything because the market will eventually take care of it. I find it be a perfectly valid conclusion of absolutely no practical value. And that drives me nuts.

Mike

[Tim Haab]

Mike,

I can see your frustration. The real practical value in the economic model probably comes in understanding how policies affect the price path I describe and debunking fears of economic collapse due to running out of oil. Also note that I intentionally ignored all of the externalities associated with fossil fuel consumption to focus the post on peak oil. I also ignored any mention of industry structure (which clearly comes into play in the oil market). I didn't intend to make the case that the current price path is optimal if we ignore these issues. It's not. Instead I wanted to use the simple argument to make the case that peak oil is not a concern. Once that is out of the way, we can focus attention on the real problem--getting the real price of oil consumption right.

[JMG3Y]

So what is an appropriate level of concern/attention and how should the prudent econ student factor this information into their major decisions (choosing a career, selecting a job, buying a car, investing in a house)?

None, use current prices because the future is too uncertain and appropriate shifts will occur, which is why we discount things, to figure relative costs could double, triple or what in 5, 10, 25 years or what as a worse case scenario?

[Mike@HCVN]

Tim -

Peak oil could've happened yesterday and the market will sort it all out. That's not very helpful. What you have extrapolated is that since the market will sort it out, there will not be a volatile economic correction while the market sorts itself out. That's a bit of a leap.

Now, you could've meant that since this peak oil thing is 30 years out, don't worry about it. That pre-supposes that this study is right and all the others are balderdash. The more interesting approach to the peak oil topic is that supposing that it will happen, how far in advance does the market need to know to not have a volatile market correction. If the answer allows technology/economics/petroleum engineers to detect it in time, you're right, it doesn't matter.

As an aside, I think of the oil markets as lacking the two things necessary for good market behavior - rational economic actors and perfect (or at least very good information). Oil seems to track with nationalism and, shall we say, very religious areas of the world. I would argue that this doesn't result in rational actors. You could counter that they're rational - just not in our typical way, but then the market needs good information on whether the participating countries are optimizing economic utils, patriotism utils, or devotion utils. Regarding perfect information, the oil market is 'distorted' because there's an economic incentive to not provide correct information - OPEC partitions quotas based on claimed oil reserves, not actual oil reserves. OPEC countries havn't revised their reserve numbers in 20 - 30 years, after all. It's here where my economics falls apart since I don't know how to model uncertainty due to possible deception. I'm sure it involves a risk-adjustment factor, but that factor relies on rational actors, see above.

Mike

[ralph]

I'm with Mike, mostly. Peak Oil, in my mind, means only that there will be a point at which afterward "traditional" oil production will decline. The only thing I understand Yergin to be yelling about is a) when it might happen (30 years?) and what it means whem it happens.

I'll have to read his report, but generally speaking people won't know about when the peak was simply because the volatile noise of prices will mask the moving average for quite a while....

...going to read the "new" report now...

[kebko]

I just don't understand why peak oil is even a topic. "Peak Oil" was the point just before the first drop was ever drilled. Actual reserves have only declined since then. Prices, proven reserves, etc. since that time are the products of the marginal cost of drilling and the cost of substitutes. "Peak Oil" has very little to do with the amount of oil in the ground and very much to do with all those comparative costs. If someone invented an individual-sized solar generator tomorrow that compared to gas at 50 cents/gallon, proven reserves would go through the floor. Am I crazy or uninformed? I don't understand how anyone with any experience in the industry could have ever suggested the concept.

[Michael P.]

You guys are absolutely amazing.

Peak oil has to do with reaching a maximum extraction rate. (Economists prefer to call this the oil "production" rate, rather than extraction.) Peak oil is geologic phenonmenon, tracked and studied per oil field by oil companies. That's why petro geologists are yammering about it more than the economists.

After watching oil fields climb in production year after year, geologists will watch the field enter an irrecoverable decline in extraction. See a bunch of these, and its natural to start wondering about extraction rate declines on a more cummulative level. Add up the production from any number of fields, and you also see a peak during the cummulative oil field lifetimes. Keep adding up all the oil in the world, and eventually there's going to be a peak globally.

Now reaching the peak extraction rate doesn't mean we run simply out of oil. Rather, the peak just means that the extraction rate levels off and then declines. On the global level, this is a decades-long phenomenon. And the plots are *not* mathematically-smooth.

The claim is that we need to prepare for the peak in oil production decades in advance of its arrival in order to adjust lifestyle changes and minimize economic side-effects. The economic threat is is not ever-increasing prices, but wide price volatility, declining physical work accomplished (unless efficiency is increased), and increased competition for scarcer resources.

In response to the CERA report, I invite you to read from their critics. For example, http://www.energybulletin.net/22442.html. Also, please do your research on the background of CERA before putting all your trust in the report.

Guys, a few key questions for you before you write off peak oil as a non-issue.
* Why do they call unconventional petro resources "unconventional"? Could it be because they are a worse deal, economically than the light sweet crude oil we've already burned through? Any thoughts on the fact that we've peaked on production of light sweet crude, and now have to make that up with these other sources?
* What's different about deep-water oil production compared with extraction from the 1930's? Are the economics comparable?
* Are tar sands just another unexploited resource? Or is this a raw deal costing Canada their natural gas supplies, their fresh water, and their environment, all adding up to a very costly liquid fuel? Hmmm, maybe NAFTA is about more than just "free trade", since it also secures US access to natural resources from other countries? Wonder if those Canadians and Mexicans are getting pissed off for a good reason after all.
* What do you think about the statistics on the number of countries already past their production peak? Think an ever fewer number of producers will always be able to make up for the mounting production declines of everyone else?
* How does EROEI play into the economics of the energy extraction business? Could some energy sources be more profitable than others? Might the profitability of a single natural source decline over time?
* What do you think about oil discovery rates declining over the past few decades? Concerned that for some time now we've been buring more than we find each year?
* How does the "scalability" of alternative resources stack up to our current levels of petro consumption? Does your analysis show that we can replace the energy we're consuming through ramping up renewable sources to the same levels?
* Check out the "stabilization wedges" that try to help us minimize global climate change. Replacing our petro consumption with other sources is a very similar problem. The numbers don't really add up.
* For historical situations where we overcame some natural resource limit, what percentage of those were overcome by using vast inputs of cheap energy? E.g. wood supplies, the green revolution, ocean fishing, ground water irrigation, global trade routes, top soil depletion, vertical cities, etc.

The arguments *against* peak oil are simply not holding up to close scrutiny. That's why this topic has been taking off over the past couple of years. Not because its a fad where people simply misunderstand economics, but because people are beginning to educate themselves on the geology, the mathematics, and the science behind our actual and potential energy sources.

John and Tim, keep it up with those econ undergrads. You tell 'em: economic markets will not be constrained by natural resource limits. You might want to also mention fish stocks, lumber supplies, grain production, fresh water availability, and top soil. Adam Smith to the rescue! Way to go, boys.

--Michael P.

[Pete Geddes]

The issue we face is not one of absolute energy scarcity. The real questions are: What prices are we willing to pay and what environmental trade-offs are we willing to accept to meet energy demands?

First, there is a critical difference between resources and reserves. Resources are the total physical stock of a natural commodity (e.g., oil, coal, or gold). Reserves are the portion that can be economically developed with current technology. Technological advances allow us to constantly move commodities from the resource category into the reserve pool. New exploration and drilling and recovery technologies dropped the worldwide finding and development cost per barrel of oil dramatically: from $21 in 1979-81 to $6 in 1997-99.

This helps explain how oil reserves can expand even as consumption increases. For example, California’s Kern River field was discovered in 1899. By 1942, its reserves were estimated at 54 million barrels. But over the next 44 years it produced 736 million barrels. In 1986, another estimated 970 million barrels remained. And the field is still producing.

“Resources are, reserves become.” When institutions foster innovation scarcity never wins against creativity. The historical evidence supporting this is so clear and compelling I wonder why anyone believes otherwise.

[John Whitehead]

Michael P.,

Nice try with that last paragraph, but you whiffed on the curve ball.

All of those other resources are are renewable or, at least, less nonrenewable than oil and coal. Therefore, we use different models to try to understand them.

For example, unregulated markets lead to the tragedy of the commons in fisheries. We've got to have some sort of entry regulation there, preferably individual transferable quotas.

Please note: this isn't the free market blog.

John

P.S. Do you really think we hijacked those tar sands during NAFTA and that makes Canadians miffed at us?

[John Whitehead]

Here is Tim's response to Michael P.

[Michael P.]

John,

NAFTA secures US access to Canadian energy by leveling prices.

Under Chapter 6, Article 605 of NAFTA, Canada:

"may not impose a higher price for exports of an energy or basic petrochemical good to [the US] than the price charged for such good when consumed domestically, by means of any measure such as licenses, fees, taxation and minimum price requirements"

and

"may not reduce the proportion of the total export shipments of the specific energy or basic petrochemical good made available to [the US] relative to the total supply of that good of [Canada] as compared to the proportion prevailing in the most recent 36-month period"

Tar sands weren't in the original design--it was probably focused on US securing Canadian oil and gas when written. (Or do they also have our coal under their mountains?) Nonetheless, Canadians are starting to get pissed over NAFTA.

http://www.energybulletin.net/21899.html