Coyote Blog

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  Of course, it turned out that the laws of supply and demand had not been repealed, and after Reagan removed oil price controls and goofy laws like the windfall profits tax, demand and supply came back in balance, and prices actually returned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.