Posts tagged ‘peak oil’

State of the Union: Apparently, Hugh Hefner is Responsible for Abstinence

My column for this week is up at Forbes, and inevitably, deals with the State of the Union address last night.

But the portion that really floored me was Obama’s taking credit for the increase in US oil and gas production over the last several years.  It is certainly true that, against all predictions of peak oil, new technologies have helped drive a surge in US hydrocarbon production.  Combined with a recession-driven drop in demand, America’s oil imports as a percentage of its total use has dropped to 45.6%, the lowest level in over 15 years.

This surge in energy production is a fabulous reminder of how markets work.  For years I have written that the peak oil folks were missing something fundamental by performing an overly static analysis.  They looked at current “proven” reserves of oil and gas and projected forward how many years it would take for these to run out.  But oil and gas reserve numbers only make sense in the context of a particular set of technologies and pricing levels.  As hydrocarbons run short, rising prices tend to spur both innovation and new, more expensive exploration activity.  Oil and gas companies are once again proving Julian Simon’s addage that the only true scarcity is human brain power, and they should be given a lot of credit for the recent production boom.

The one person who deserves no credit for this boom is Barack Obama....

Read it all.

A Great Example Why Peak Oil Theory Has Never Been That Compelling to Me

As I have written a number of times, reserves numbers for oil are not based on the total oil though to be under the ground, but the total oil thought to be under the ground that is economically recoverable at expected prices.  Changes in technology and/or oil price expectations change the amount of reserves, even without the discovery of a single new field.

Oil companies have known about the formation, and the oil trapped in it, since at least the 1950s. But they couldn't get more than a trickle of oil from the dense, nonporous rock.

That began to change in the early 2000s, when companies in Texas began using new drilling techniques in a similar formation near Fort Worth known as the Barnett Shale. They would drill down thousands of feet and then turn and go horizontally through the gas-bearing rock"”allowing a single well to reach more gas. Then they would blast huge volumes of water down the well to crack open the rocks and free the gas trapped inside.

The real shift has come in the past two years as companies honed drilling techniques, leading to bigger wells, faster drilling and lower costs. Marathon, for example, last year took an average of 24 days to drill a well, down from 56 days in 2006."

So apparently, oil production in North Dakota may soon pass that of Alaska, though this is more due to the fact that production can be ramped up in North Dakota without an act of Congress, which is not the case in Alaska.

The largest threat to oil prices and production remains not peak oil, but the fact that most of the world's best reserves rest in the hands of state-run oil companies whose competence and willingness to invest for the long-term is sometimes in question.

So Why Does Joe Romm Even Bother With Cap and Trade?

Joe Romm of Climate Progress is a leading climate alarmist, telling the world that burning fossil fuels will increase CO2 concentrations by 0.04% of the atmosphere over the next century and thus destroy mankind.  As such, he is a supporter of the current cap-and-trade bill in Congress, whose purpose is to raise the price of fossil fuels (either directly as a tax or by restricting their supply) so that less will be used.

On a different but related topic, Joe Romm is also apparently a peak oil alarmist.  As I have written, I suspect real oil prices will rise steadily over the coming decades, but we aren't going to fall off some cliff and see a sudden hyperinflation of oil prices (temporary spikes are a different story).  He writes

The IEA's work makes clear that for oil to stay significantly below $200 a barrel (and U.S. gasoline to be significantly below $5 a gallon) by 2020 would take a miracle

I tend to doubt it, in part because I have seen so many very similar predictions ever since the mid-1970s, but I suppose some day someone will be right with one of these.   I wonder if there is some kind of psychological profile that causes people to see positive feedback-driven accelerating curves everywhere.

But here is my confusion -- he is absolutely convinced that oil is going up by $140 a barrel or more.  Let's look at this in the context of Co2.  The CBO estimates the clearing price for a ton of Co2 emissions under the current bill will be between $20-$30 a ton.  Since a barrel of oil creates about a third of a ton of CO2 emissions, this implies the cap and trade bill might increase the price of oil by $7-$10 per barrel.  But if Romm think oil is going up by natural market forces by $140+, why even bother?  Why not just put a tax on coal and be done with it?

I congratulate Mr. Romm, however.  If he is so sure of 2020 oil prices, there are all kinds of fabulous ways to become ridiculously wealthy with this knowledge.

Postscript:  There are two reasons why people have been making this same forecast for 30 years and have been wrong most of the time.

First, there is a very human tendency to assume current conditions and trends will go on forever.  Everyone is subject to this bias, even the smartest analysts.  Romm might argue that these are savvy, detail-oriented commodities analyst, but I only have to point to the recent behavior of savvy detail-oriented debt security analysts.

Second, analysts tend to apply current understandings of what technologies and substitutes are economic at $60 oil to a world where oil is priced at $160.  It just doesn't work that way.   The market for petroleum and its substitutes is enormously multi-variate and complex.  A $100 bump in prices will do things that are sometimes hard to predict in detail to the markets for exploration, new technologies, substitutes, conservation, etc.  But in all this complexity, the one thing we do know is that time and again, such changes have occurred quickly and decisively in response to rising oil prices, and have acted to mitigate and reverse price increases.

One ironic way of looking at it, since this is Joe Romm, is to say that there are negative feedbacks that cut in to slow and even reverse sharp rises in oil prices.  Romm seems to reject these negative feedbacks, in favor of a price model that rapidly accelerates.  This is all ironic, since this issue of negative vs. positive feedback is what separates climate alarmists like Romm from many climate skeptics like myself.

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

Will Mexico Follow Chavez?

As in Venezuela, the Mexican government is facing the problem of declining oil production in a state whose national government relies on oil revenues for much of its operating funds.  And, like Venezuela, this is a problem that is self-imposed. 

The ignorance with which most of the media writes about oil reserves is staggering.  Most writers fall in the trap of talking about oil reserves as if they are big pools underground that will eventually be sucked dry and have a fixed recoverable size.  The reality is that the amount of oil that can be pumped from any field depends greatly on how much capital investment one puts into the field.  In the short term, wells even in perfectly viable fields will start to fall off in production unless they are reworked every so often.  Longer term, addition of pumps, water/steam/CO2 injection, drilling deeper, etc. all can greatly extend the life of fields.  There are fields in Texas just as old as those in Mexico which continue to be reinvigorated by investment.  And we continue to find new fields in the US through exploration investment, and would find more if the government did not restrict the most promising areas from exploration.  (by the way, this is why much of the peak oil analysis is BS)

The problem, then, is not that Mexican oil reservoirs are going dry but that the amount of investment required to keep them producing is rising as they age (the converse of the law of diminishing returns is the law of increasing capital investment requirement).  And the Mexican government, like that in Venezuela, is committed to siphoning off oil revenues for short term political spending and to provide gas at below-market pricing rather than reinvest the money in the fields.  In this context, the Mexican government is seeking foreign investment to help bail them out of this problem, while the socialist elements want to keep foreign corporations out.

For once, I agree with the socialists.  I see no reason why US oil companies should venture back into a country that still celebrates as a holiday the day in 1938 when the Mexican government stole the assets of US oil companies.

Postscript: 
special recognition to the AZ Republic writer who gratuitously tried to justify nationalization of assets owned by US citizens by claiming that the US oil companies essentially asked for it by "evading Mexican taxes and paying meager salaries."  The entire history of the third world oil industry can be written as follows:
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

Update: Here is a great example of why peak oil analysis is probably flawed -- such analysis assumes that the size of reserves are static.  But in fact they are not.  They can vary greatly with the price of oil, because the size of the recoverable reserves, as discussed above, depends on how much one is willing to invest in recovering them and that depends on price.

In the next 30 days the USGS (U.S. Geological Survey) will release
a new report giving an accurate resource assessment of the Bakken Oil
Formation that covers North Dakota and portions of South Dakota and
Montana. With new horizontal drilling technology it is believed that
from 175 to 500 billion barrels of recoverable oil are held in this
200,000 square mile reserve that was initially discovered in 1951. The
USGS did an initial study back in 1999 that estimated 400 billion
recoverable barrels were present but with prices bottoming out at $10 a
barrel back then the report was dismissed because of the higher cost of
horizontal drilling techniques that would be needed, estimated at
$20-$40 a barrel.

Big Round Number

It is always amazing how big round numbers hold the media in thrall.  Last week we saw the inevitable spate of articles about oil crossing the $100 mark, if only for a few minutes of trading  (actually, the more interesting milestone was somewhere back in the low $90 range when we exceeded the highest past price for oil in inflation-adjusted dollars).

I don't get hugely worked up about gradual commodity price changes.  Oil price increases are signals, signaling marginal consumers to use less and suppliers with historically marginal sources and substitutes to consider their development.  Also, our economic dependence on oil per dollar of GDP has declined, meaning that $100 oil has less impact on the economy than, say, it would have 20 years ago:

Insightnov07energysec3

I would certainly prefer lower oil prices, and my business suffers to some extent when gas prices rise, but it is not a disaster  (it is interesting that higher oil prices are considered bad in the media, while lower home prices are considered bad in the media).  I know from past experience in the oil patch that oil price bubbles are often followed by oil price drops.  The high oil prices of the seventies were followed by rock-bottom oil prices in the eighties, and subsequent recession in the oil patch (causing the housing bust I discussed here). 

Also, given how we got to these higher oil prices, I tend to take them as good news.  Oil prices are not rising due to some drop off in supply.  Instead, they are rising because of a strong global economy, in particular with millions of people entering the middle class in Asia.  This is GOOD news. 

I have written on peak oil a bunch, so I won't get into it again.  Oil production at worst is going to flatten out for a long time, meaning we will have a steady rise in oil prices over time as the economy grows.  If you want a third party evaluation of peak oil theory, go ask climate catastrophists who believe that CO2 production is an impending disaster for the economy.  These guys know that there are lots of unproduced hydrocarbons out there, and it terrifies them.   Al Gore and James Hansen were running around last week trying to close off Canadian tar sands from development.

Finally, after this series of random thoughts, one more interesting take on this via Megan McArdle:  $100 oil was a stunt

Some observers questioned the validity of the price mark when it
emerged that the peak was the result of a trader "“ one of the "locals"
who trade on their own money "“ buying from a colleague just 1,000
barrels of crude, the minimum allowed, industry insiders said. The deal
on the floor of the New York Mercantile Exchange was at a hefty premium
to prevailing prices.

Insiders named the trader as Richard Arens, who runs a brokerage
called ABS. He was not available for comment. Analysts said he may have
been testing the ceiling of the crude price, but the premium he paid
surprised the market.

Before the $100-a-barrel trade, oil prices on Globex were at $99.53
a barrel. Immediately after the trade, prices went down to about
$99.40, suggesting a trading loss of $600 for Mr Arens.

Stephen Schork, a former Nymex floor trader and editor of the
oil-market Schork Report, commented: "A local trader just spent about
$600 in a trading loss to buy the right to tell his grandchildren he
was the one who did it. Probably he is framing right now the print
reflecting the trade."

State-Run Companies and Investment, Part 2

In my earlier post, I commented that one reason a number of foreign oil fields may be "peaking" is not necesarily because they are hitting their production limits, ala "peak oil theory," but because state run companies tend to be terrible at making the intelligent long-term investments that are needed to maintain oil production in aging fields.  I observed:

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. 

So today, via Hit and Run, we see this exact same effect 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.

State-Run Companies and Investment

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. 

I am not arguing that US politicians are any different from their Mexican counterparts, because they are not -- they make these same stupid choices in the same stupid ways.  The only difference is that we have been smart enough, Mr. Drum's and Nancy Pelosi's heartfelt wishes notwithstanding, not to put politicians in charge of the oil fields.

By the way, I wrote on Peak Oil here.  A while back I dug into the 1870 archives of our predecesor publication, the Coyote Broadsheet, to find an article on the "Peak Whale" theory:

[April 17, 1870]  As the US Population reaches toward the astronomical
total of 40 million persons, we are reaching the limits of the number
of people this earth can support.    If one were to extrapolate current
population growth rates, this country in a hundred years could have
over 250 million people in it!  Now of course, that figure is
impossible - the farmland of this country couldn't possibly support
even half this number.  But it is interesting to consider the
environmental consequences.

Take the issue of transportation.  Currently there are over 11
million horses in this country, the feeding and care of which
constitute a significant part of our economy.  A population of 250
million would imply the need for nearly 70 million horses in this
country, and this is even before one considers the fact that "horse
intensity", or the average number of horses per family, has been
increasing steadily over the last several decades.  It is not
unreasonable, therefore, to assume that so many people might need 100
million horses to fulfill all their transportation needs.  There is
just no way this admittedly bountiful nation could support 100 million
horses.  The disposal of their manure alone would create an
environmental problem of unprecedented magnitude.

Or, take the case of illuminant.  As the population grows, the
demand for illuminant should grow at least as quickly.  However, whale
catches and therefore whale oil supply has leveled off of late, such
that many are talking about the "peak whale" phenomena, which refers to
the theory that whale oil production may have already passed its peak.
250 million people would use up the entire supply of the world's whales
four or five times over, leaving none for poorer nations of the world.

More on Peak Oil

Everything old is new again.  Back in the late 70's, all the talk was about the world running out of oil.  Everywhere you looked, "experts" were predicting that we would run out of oil.  Many had us running out of oil in 1985, while the most optimistic didn't have us running out of oil until the turn of the century.  Prices at the time had spiked to about $65 a barrel (in 2004 dollars), about where they are today.  Of course, it turned out that the laws of supply and demand had not been repealed, and after Reagan removed oil price controls and goofy laws like the windfall profits tax, demand and supply came back in balance, and prices actually returned to their historical norms.

Today, as evidenced by the long article on "peak oil" in the NY Times Magazine this weekend, we are apparently once again headed for imminent disaster.  The Freakonomics blog has already chimed in with a partial rebuttal, but I wanted to share some of my own thoughts.

Are the Saudis hiding a reserve shortfall?  Much of the peak oil phenomena consists of Paul Ehrlich type doom-saying that takes pains to ignore the laws of supply and demand.  However, the question of Saudi behavior is an interesting one.  Lets for a moment hypothesize that the Saudis were indeed somehow running out of oil.  One thing the article misses is how bad a thing this would be for the Saudi leadership.  The author notes that the ruling family shouldn't care, since it is already rich, so declining oil revenues won't hurt it.  But that misses the point.  With a large percentage of the world's oil, the Saudis are a country that must be treated with respect and deference.  Without oil, Saudi Arabia becomes that Arab nation that virtually enslaves half its population (ie the females) and that funds much of the world's terrorism, including the 9/11 attacks.  Suddenly, without oil reserves, the Saudi's might find themselves moving up the Bush-Rumsfeld priority list for a little visit from the US military.  I have no way of knowing if the Saudis are hiding anything -- the fact that some Saudi fields are using secondary and tertiary recovery methods (as noted in the article) really does not mean much.  But if they were losing reserves, they sure would have the incentive to hide it.

Reserve accounting is a tricky thing.  The vagaries of reserve accounting are very difficult for outsiders to understand.  I am not an expert, but one thing I have come to understand is that reserve numbers are not like measuring the water level in a tank.  There is a lot more oil in the ground than can ever be recovered, and just what percentage can be recovered depends on how much you are willing to do (and spend) to get it out.  Some oil will come out under its own pressure.  The next bit has to be pumped out.  The next bit has to be forced out with water injection.  The next bit may come out with steam or CO2 flooding.  In other words, how much oil you think will be recoverable from a field, ie the reserves, depends on how much you are willing to invest, which in turn depends on prices.  Over time, you will find that certain fields will have very different reserves numbers at $70 barrel oil than at $25.

Trust supply and demand.  Supply and demand work to close resource gaps.  In fact, it has never not worked.  The Cassandras of the world have predicted over the centuries that we would run out of thousands of different things.  Everything from farmland to wood to tungsten have at one time or another been close to exhaustion.  And you know what, these soothsayers of doom are 0-for-4153 in their predictions.  Heck, they are about 0-for-five on oil alone:

Most experts do not share Simmons's concerns about the imminence of peak oil. One of the industry's most prominent consultants, Daniel Yergin, author of a Pulitzer Prize-winning book about petroleum, dismisses the doomsday visions. ''This is not the first time that the world has 'run out of oil,''' he wrote in a recent Washington Post opinion essay. ''It's more like the fifth. Cycles of shortage and surplus characterize the entire history of the oil industry.'' Yergin says that a number of oil projects that are under construction will increase the supply by 20 percent in five years and that technological advances will increase the amount of oil that can be recovered from existing reservoirs. (Typically, with today's technology, only about 40 percent of a reservoir's oil can be pumped to the surface.)

One of the problems with oil is that governments have a real problem with allowing supply and demand to operate.  I have wondered for a while why Chinese demand has kept growing so fast in the face of rising prices.  The reason is that the Chinese government still is selling gasoline way below market rates, shielding consumers from incentives to reduce consumption.  On the supply side, I also wondered when I was in Paris why gasoline prices as high as $6 per gallon were not creating incentives for new sources of supply.  It turns out that nearly $4 of the $6 are government taxes, so none of this higher price goes to producers or creates any supply-side incentives.  Instead, it goes to paying unemployment benefits, or whatever they do with taxes in France.

Even in the US, which is typically more comfortable with the operation of the laws of supply and demand than other nations, the government has been loathe to actually allow these laws to operate on oil.  During the 70's, the government maintained price controls that limited demand side incentives to conserve, thus creating gas lines like the ones we are seeing in China today for the same reason.  When these controls were finally removed, a "windfall profits tax" was put in place to make sure that producers would get none of the benefit of the price increases, and therefore would have no financial incentive to seek out new oil supplies or substitutes.  Within a few years of the repeal of these dumb laws, oil prices fell back to historical levels and stayed there for 20 years.

But meddling with prices is not the only way the government screws up the oil market.  I laugh when I see people with a straight face say that we have not opened up any big new fields in this country since Prudhoe Bay.  This is in large part because the three most promising oil field possibilities in this country -- ANWR, California coast, and the Florida coast -- have all been closed to exploration by the government.

In addition, the government has, through a series of energy bills that are each stupider than the last, managed to divert valuable energy investment capital into a range of politically correct black holes.  All we seem to get are unsightly windmills in Palm Springs that always seem to be broken and massive ethanol subsidies that actually increase oil consumption rather than decrease it.  It should come as no surprise that  despite government subsidies for a range of automotive technologies like fuel cells and all-electric cars, the winning technology to date has been hybrids, which weren't on the government subsidy plan at all.

Don't Ignore Substitutes.  All the oil doomsayers tend to define the problem as follows:  Oil production from current fields using current methods and technologies will peak soon.  Well, OK, but that sure defines the problem kind of narrowly.  The last time oil prices were at this level ($65 in 2004 dollars), most of the oil companies and any number of startups were gearing up to start production in a variety of new technologies.  I know that when I was working for Exxon in the early 80's, they had a huge project in the works for recovering oil from oil shales and sands.  Once prices when back in the tank, these projects were mothballed, but there is no reason why they won't get restarted if oil prices stay high.  At $65 a barrel, even nuclear starts looking good again, though we would have to come up with a more sane regulatory environment.  Look for venture capital to steer away from funding the next shoelace.com and start looking for energy investments.

Dueling Catastrophes.  As a final note, its funny seeing the New York Times crying "disaster" over the peak oil scenario.  Those who read this blog know that I am skeptical that the harm from man-made global warming is bad enough to justify large, immediate Kyoto-like reductions in hydrocarbon consumption.  However, the New York Times is on record as a big believer in and cheerleader for immediate cuts in hydrocarbon consumption to head off global warming.  So why is peak oil so bad?  Shouldn't they be celebrating an ongoing drop in oil availability, which would force the world to produce less CO2?  Along the same vain, it is funny seeing a publication that has decried over and over again our dependence on Saudi Arabian and other foreign oil at the same time lamenting the fact that Saudi Arabia is running out.  If that's true, won't Saudi reserve declines solve the whole dependence problem, one way or another?

Postscript:  The other day, I found one of Paul Ehrlich's doomsday books from the 70's in a used book store.  When I have a chance, I am going to post some of its predictions, which were treated with breathless respect by most of the media, including the NY Times.

Myth of Peak Oil

Note:  I have posted a more recent article with updated data here.

Mises Blog has a good article on the "Peak Oil" meme.  You may have gotten investment solicitations urging you to invest in oil because production is supposedly going to peak in 2006.

Oil production will peak some day.  I do not know when.  I do know that when I was in high school debate in the late 1970's, the topic one year was on resource policies.  I read everything there was at the time on oil supply as well as other critical mineral supplies.  Most "experts" at the time were predicting that oil would "run out" in about 1985 or 1990.  As you can see below, folks who invested in oil in 1980, after a price run-up similar to the one we have seen lately, got slaughtered.

Usgasoilprices19181999_1

Think twice or maybe three times about this graph before you invest.  Notice that there is no long term trend in real oil prices, even over one hundred years!  To make money buying oil, you have to do it on timing, buying ahead of sharp temporary increases.  And given that we are at the top of one of those sharp increases, can now really be the time to buy?

You can never get all the oil out of a field, and the exact amount of oil you can recover is dependent on how much you want to spend to do it, which in turn is related to oil prices (or expectations of oil prices).  The first 20% of the oil in a field might just squirt out under its own pressure.  The next 20% might have to be pumped.  The next 20% might need high pressure water injection to help it.  The next 20% might need expensive CO2 injection to help it.  If you ask the field manager how much oil was left, he would give you different answers at $20 and $45 a barrel, because he would make different assumptions about how far along this investment curve he would go.

If you are still thinking about investing, do one more thing: Study the famous bet between Paul Ehrlich and Julian Simon:

In 1980, economist |Julian Simon| and biologist Paul Ehrlich decided to put their money where their predictions were. Ehrlich had been predicting massive shortages in various natural resources for decades, while Simon claimed natural resources were infinite.

Simon offered Ehrlich a bet centered on the market price of metals. Ehrlich would pick a quantity of any five metals he liked worth $1,000 in 1980. If the 1990 price of the metals, after adjusting for inflation, was more than $1,000 (i.e. the metals became more scarce), Ehrlich would win. If, however, the value of the metals after inflation was less than $1,000 (i.e. the metals became less scare), Simon would win. The loser would mail the winner a check for the change in price.

Ehrlich agreed to the bet, and chose copper, chrome, nickel, tin and tungsten.

By 1990, all five metal were below their inflation-adjusted price level in 1980. Ehrlich lost the bet and sent Simon a check for $576.07. Prices of the metals chosen by Ehrlich fell so much that Simon would have won the bet even if the prices hadn't been adjusted for inflation. (1) Here's how each of the metals performed from 1980-1990.