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  Of course, it turned out that the laws of supply and demand had not been repealed, and after Reagan removed oil price controls and goofy laws like the windfall profits tax, demand and supply came back in balance, and prices actually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


  1. Duane Gran:

    To clarify, the research behind Peak Oil (Hubbert and more recently Deffeyes) doesn't claim that we "run out of oil" when the peak is reached, but rather that it becomes more costly and difficult to extract. I recently saw a lecture from Deffeyes and I was impressed at how he personally doesn't exude a chicken little attitude about this at all. In fact, he is skeptical of certain conservation efforts as being naive. One thing is for certain though: He and others who ascribe to the Peak Oil theory have sound reasons for being concerned.

    In his lecture I was particularly astonished to hear that 94% of our current oil is drawn from oil fields that were discovered over 33 years ago. The last one billion barrel producing oil field was discovered in 1968. While there may be some big finds left, it is plausible (and rational) to conclude that we have exhausted the easy targets. Efforts in repurposing of older oil fields with newer extraction technology is encouraging, but in the long run it is no substitute for new field discoveries.

    There is really little doomsday discussion among serious academics on this matter, but rather a sombre realization that the party for the last 100 years will come to an end unless something changes. Whether that end is a soft or hard landing no one can predict.

  2. Monkeydarts:

    Roughly 75% of all oil wells drilled into the Earth's surface have been drilled in the USofA. Another 20% have been drilled in Europe including the former Soviet Union. The entire rest of the world has seen just 5% of the oil well drilling since oil was first discovered in PA. We have barely begun the search for oil on the globe. The idea that we are running out is hysterical. We're swimming in the stuff if anyone wants to drill for it-- however, nations where citizens don't have mineral rights offer little incentive for exploration. The price of oil vis a vis the price of gold has never been this high since the dollar was taken off the gold standard. Something will "give" either gold will soar or the price of oil will collapse. The current price of oil has very little to do with supply & demand. It's largely what we traders call a "trading function."


    No one could have predicted 5-10 years ago how much oil countries like China and India would consume. While our demand is more or less stable, there is no way to satisfy the appetite of these countries unless the supply/demand is balanced soon.

  4. Matt:

    I for one am looking forward to the day when the price of oil stabilizes at a point where buying it from Canada becomes economically viable. Then we can finally get serious about the real Middle East enemy instead of constantly pretending like they're our friends.

    I'd pay the higher gas prices with a smile on my face so wide that my muscles started to hurt, if we could manage to see our way to that day.

  5. Ward:

    I for one sure sleep better at night knowing the "TRADERS" have figured out the world is awash in oil. I guess that's the reason companies spend over 500K a day to drill in deep water for wells that hit a steep decline after 18 months. These wells happen to be on goverment leases as are most of the wells drilled in the US. As for shale oil, Exxon is firing up the retorts in western CO this week. They have sold all the equipment to an Australian company.

  6. Joshua Swink:

    You said, "At $65 a barrel, even nuclear starts looking good again". Did you mean that it would start looking good even under the restrictions that it currently suffers in the U.S.? I believe that nuclear has been looking good for quite a long time now, absent the irrational regulations that it suffers under.

  7. DeeDee:

    Thanks for some of the information you provided. Good stuff.

  8. tom RYAN:

    THIS iS IT

    break up the oil co.let them be buyer or sell,or finders ,not everthing then the price will come down,, look what happen with the phone co whem
    the court order break up

  9. Chris Newman:

    Oh dear me.

    I think the author should seek to understand what Peak Oil actually means before attempting to write this sort of article. Any article on Peak Oil that uses the phrase "run out of oil" should be avoided at all costs.

    Peak Oil, although an easy concept, can easily be misunderstood and deliberately obfuscated.

    For instance Peak Oilers will not disagree that supply and demand will not hold true. They would just say that its the the demand side will have to be destroyed to keep it in check with decreasing supplies. Only flat earth economists would disagree.

    For nuclear, at least try and understand the concept of Energy Return on Energy Invested, and the world supplies of U235 before thinking outloud.


  10. hao_hao:

    if goverment didn't subsidy the oil price what he can do