Peak Oil Update

I haven't written about Peak Oil lately, but there is a pretty good editorial on the topic in the NY Times today.  Michael Lynch makes a technical point I have been making for years:

Let's take the rate-of-discovery argument first: it is a statement that reflects ignorance of industry terminology. When a new field is found, it is given a size estimate that indicates how much is thought to be recoverable at that point in time. But as years pass, the estimate is almost always revised upward, either because more pockets of oil are found in the field or because new technology makes it possible to extract oil that was previously unreachable. Yet because petroleum geologists don't report that additional recoverable oil as "newly discovered," the peak oil advocates tend to ignore it. In truth, the combination of new discoveries and revisions to size estimates of older fields has been keeping pace with production for many years.

But Lynch's editorial misses two issues I think are important.

First, nothing ever flat runs out.  If supply declines over time while demand continues to rise, prices increase.  The increased prices cause some buyers to conserve or to find substitutes.  On the supply side, higher prices make recovery of incrementally more difficult oil economic, and provides a higher price umbrella under which substitutes can compete.  This is particularly true in oil, where there is never a fixed limit to the amount of oil recoverable -- estimates are always based on price expectations.  Higher prices mean more investment can be justified, generally allowing more oil recovery.

Second, I think Lynch is misguided in some of his discussion of political risk.  While I am not hugely worried about an OPEC-like embargo in the future, the fact is that more and more of the world's future oil supplies are controlled by public rather than private oil companies.  For countries like Mexico, the state-run oil company is the post office, comparable both in terms of its management competance (or lack thereof) and its focus on non-economic missions (like providing jobs for key political supporters).  Ronald Bailey wrote a while back:

The problem arises because 77 percent of the world's known oil reserves are in the hands of state-owned oil companies. Such "companies" do not respond with alacrity to market signals and so are under-investing in new production technologies and even in maintaining the production facilities that they currently have. I have earlier pointed out that an "oil crisis," that is, a steep rapid run up in the price of oil may occur at any time due to government incompetence or maliciousness.

I wrote about Mexico in particular:

Kevin Drum is concerned that projected drops in Mexican oil production are a leading indicator that the "Peak Oil" theory is coming true.  I would argue that, in fact, it is a trailing indicator of what happens when you let governments run producing assets.  Drum says:

The issue here isn't that Cantarell is declining. That began a couple
of years ago and had been widely anticipated. What's news is that, just
as many peak oil theorists have been warning, when big fields start to
decline they decline faster than anyone expects. So far, Cantarell
appears to be evidence that they're right.

Actually, fields in the US do not tend to decline "all of a sudden" like that.  Why?  Because unlike about any other place in the world, oil fields in the US are owned by private companies with capital to make long-term investments that are not subject to the vagaries of political opportunism and populism.  There are a lot of things you can do to an aging oil field, particularly with $60 prices to justify the effort, to increase or maintain production.  In accordance with the laws of diminishing returns, all of them require increasing amounts of capital and intelligent management.

Unfortunately, state owned oil companies like Pemex (whose assets, by the way, were stolen years ago from US owners) are run terribly, like every other state-owned company in the world.  And, when politicians in Mexico are faced with a choice between making capital available for long-term investment in the fields or dropping it into yet another silly government program or transfer payment scheme, they do the latter.  And when politicians have a choice between running an employment meritocracy or creating a huge bureaucracy of jobs for life for their cronies they choose the latter.

Ditto in Venezuela.

No one sees an immediate crisis at Petróleos de Venezuela. But its windfall from high oil prices masks the devilish complexity and rising costs of producing heavy oil. Meanwhile, the company acknowledged last month that spending on "social development" almost doubled in 2006, to $13.3 billion, while its spending on exploration badly trailed its global peers. And Petróleos de Venezuela's work force has ballooned to 89,450, up 29 percent since 2001 even as production declined"¦ Petróleos de Venezuela's cash is said to be running short as Mr. Chávez uses its revenue to cement political alliances with Bolivia, Cuba and Nicaragua.  The company has borrowed more than $11 billion since the start of the year, a rapid debt buildup that reflects a wager by Mr. Chávez that oil prices will remain high indefinitely.

The oil industry in these countries follow the following cycle:

1.  US companies invest huge amounts of capital and know-how to build oil industry
2.  Once things are producing, local government steals it all
3.  Oil fields go into extended decline due to short-term focused and incompetent government management
4.  US companies invited back int to invest huge amounts of know-how and capital
5. repeat

  • Bart Hall (Kansas, USA)

    The Mexican problem is far bigger than we believe. The Alberta oil patch paid for my M.Sc. in geology, so this is not unfamiliar territory. Consider this:

    40% of the Mexican federal budget is provided by revenues from Pemex.

    A huge portion of the Mexican federal budget is applied to purchase social peace, yet even so Calderon won his presidency but narrowly -- and Obrero brought tens of thousands into the streets in an attempt to overturn the election results. There's another election coming in 2012, and it probably will not be pretty.

  • Rick C

    "And, when politicians in Mexico are faced with a choice between making capital available for long-term investment in the fields or dropping it into yet another silly government program or transfer payment scheme, they do the latter."

    Just wait until a refinery has a failure similar to the dam failure in Russia last week.

  • Bob Smith

    Is there a non-{European,US} state oil company that didn't get its start by stealing its assets from a Western oil company? ARAMCO got its start that way, as I recall.

  • http://www.grouchyconservativepundits.com Mike C.

    That's pretty much all correct. Pemex is in just about the worst shape of all nationals that have significant reserves/production, because Mexico has a constitutional restriction against non-government investment in the oil industry. Not even Mexican corporations can take a working interest in petroleum development, much less foreign ones. And there is no chance that that constitutional provision can be removed or modified any time in the foreseeable future. Efforts by Pemex to entice participation by commercial companies on a TSA basis (with no share in production) have fallen flat, unsurprisingly. Basically, they're screwed.

  • Roy Lofquist

    Historically we have always had about 25 years of proven reserves. Exploration is very expensive. The oil companies and state actors spend just enough on exploration to find reserves that meet their own projected needs for the next 25 years - the time it takes to fully develop those reserves.

  • Dan

    The U.S. is going to have to wean itself quickly from Mexican oil, which is a problem because Mexico is a large supplier. It's unfortunate that Mexico can't get its act together, because from what I've read, Cantarell should still have huge supplies of viable oil. The problem isn't that the oil is disappearing; the problem is incompetence and lack of interest in finding new supplies within the field. As Saudi Arabia has demonstrated, it's possible to keep a large field going for 60 or more years, with production not flagging, if the proper technology is applied. My hope is that someday, Mexico will get its act together. But the U.S. had better not count on it.