Working Papers

Peak Oilers in Simon-Ehrlich Wager

A group of Peak Oilers put their money where their mouth is:

Reveling in the role of the fly tweaking the elephant, a group of peak-oil proponents has challenged prominent oil-industry consultancy Cambridge Energy Research Associates to a not-so-friendly wager.

If CERA proves correct in its prediction that global oil production will rise by 20 million barrels per day by 2017, then the challengers, the Association for the Study of Peak Oil & Gas, will hand CERA a check for $100,000 nine years hence. If oil production falls short of CERA’s projection, as the group known as ASPO projects, ASPO will get the bragging rights and the check – and donate the money to charity.

CERA, the Boston-based company headed by prominent consultant Daniel Yergin, forecasts that global oil-production capacity could rise to 112 million barrels per day in 2017. Today, according to CERA, capacity is about 91 million barrels.

“That’s a vision in search of reality,” Steve Andrews, co-founder of ASPO’s U.S. branch, said in a statement it sent out yesterday. Who knows whether ASPO’s finances will peak before then. But along with its press release, ASPO sent a copy of what it said is a bank letter of credit guaranteeing its $100,000 bet.

While it’s scary to think the peak oilers have this much money to throw around, their willingness to back their view with an Ehrlich-Simon type bet is praiseworthy.  Having said that, the criticism of peak oil does not necessarily turn on specific outcomes for oil production, but on whether a prospective peak in production has any long-term relevance.


posted on 08 February 2008 by skirchner in Economics, Financial Markets

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While it’s scary to think the peak oilers have this much money to throw around

T. Boone Pickens and Matthew Simmons seem to have done ok for themselves.

Having said that, the criticism of peak oil does not necessarily turn on specific outcomes for oil production, but on whether a prospective peak in production has any long-term relevance.

Of course, as long as you don’t worry about “externalities” such as climate change, destruction of tropical forests and nuclear waste.  We can certainly substitute conventional crude for oil sands and coal-to-liquids, as long as you can ignore (or deny) the climate change impacts.  We can also substitute conventional crude for biofuels and long as you’re happy to ignore the destruction of tropical forests and competition with food crops.  Ultimately we can substitute the internal combustion engine for electric vehicles, as long you’re happy to ignore the emissions from all those new coal-fired power stations we’d need, or waste from the nuclear power stations.

If you simply label these things as externalities, then certainly peak oil has no long term relevance, but tackling peak oil without horrendous environmental impacts is a considerably more difficult problem.

But hey, its easy to ignore if you just pretend it ain’t happening eh Stephen?

Posted by .(JavaScript must be enabled to view this email address)  on  02/08  at  03:00 PM

Only recently you were ridiculing the concept of peak oil altogether in The Demise (Yet Again) of ‘Peak Oil’.  Now you appear to be accepting of it, (my how quickly things change), except you say that things won’t be so bad since we’ll be able to motor on for many more decades, as technology and the market will save us with miracles of substitution and innovation.  However you fail to mention or understand that said technology and markets are totally beholden to very cheap oil its meant to replace, volumes of it.  Oil that is soon to peak.

Posted by .(JavaScript must be enabled to view this email address)  on  02/08  at  04:12 PM

“whether a prospective peak in production has any long-term relevance” - Can I suggest that you acquaint yourself with the laws of thermodynamics, particularly the first and second laws.

Then you may appreciate that the significance of the peak in oil production will not easily be explained by constructs involving marginal utility, however elegant.

Economists need to understand something very simple. Oil is finite and there are no substitutes. None!

The procurement of energy is about flows and what the physical limits are to production of energy in flow terms, taking all the relevant factors into account – including the laws of thermodynamics, geology, geo-politics, capital equipment and finance.

This is where substitutes run into trouble, they do not scale, either in time or in volume. For instance, bio-fuels are a non-starter, more energy is derived from fossil fuels in the US than the entire photosynthetic gain across the whole US continental landmass. Oil sands? Forget them, they are a dirty little side show. If production grows to 3m barrels per day as promised (quite a big if), they will max out at less than the current annual decline of existing oil fields.

And that is the nub of the problem. It is getting harder and harder to replace existing field decline. When replacement does fail to achieve this, Peak Oil will a past-tense subject.

In summary, the market will not simply match demand with supply at any reasonable price. Is $90 reasonable? Consider the trend: the price is up 10 times in 10 years and that should tell you something. That is if you want to hear the message.

Considering the clamour every time “gas” prices make another lurch up, I would say that Peak Oil is relevant now; and will be relevant for a very long time.

Posted by Saildog  on  02/08  at  04:30 PM

As an economist, I find it hard to believe that supply will not (eventually) respond to high prices, just as it has done every other time since we walked on two legs. The thing I would like Peak Oilers to explain is why oil was trading for less than $US10/b in 1998 when all of the facts cited by peak oilers were known. In my view, what’s happened is that we have had a sudden shock to demand and capacity needs time to catch up. If the current high price of oil is not related to a demand shock - ie it was foreseeably inevitable - then why did prices get so low less than 10 years ago?

Posted by .(JavaScript must be enabled to view this email address)  on  02/08  at  06:02 PM

The low prices are explainable by the long lead times inherant in the oil industry. The 1980 prices spike did lead to signifcant investment in new production and that led to the 1990’s glut.

The low prices then led to downsizing and lack of investent; and those self same long lead times are a signicant factor behind the current shortfall.

But that is not the major facctor this time round. Now it the problem is geological. Oil is a finite resource and the oil companies cannot/will not bring more oil production on line.

The IOC’s are doing massive annual share buy backs. This is a not so subtle message that the directors of these companies do believe that they cannot invest the money in the oil business profitably enough, even at these high prices. So they are returning the cash to shareholders. The world has been searched and searched again. If anybody could find it, the IOC’s could. Instead they are quietly, slowly, winding themselves up. Notice too that they are not investing in substitutes.

Meanwhile the NOC’s either are inefficient or believe the oil is more valuable in the ground and wnat to keep it for the future. Either way, whatever the motive, the oil is not for sale today.

These factors - the very long lead times, the uneconomic behaviour of the oil producing countries and the relentless pressure of oil field depletion mean that a de-facto peak in production is inevitable and has either already happened (C+C - May 2005), or will happen soon.

So Rajat, I respect your economics. I have read quite a lot of economics myself, but the oil industry does not fit into the neat and elegant theories your discipline lives by. Economists such as Daly and Hartwick made great strides in resource economics. Your colleague, Jeff Rubin at CIBC is an important and well known and respected economist. Find out what some of these people have to say.

Price theory does not dictate oil production, even if all economists fervently wished it so.

Posted by Saildog  on  02/08  at  07:07 PM

So basically, you’re saying that this time it’s different? You still haven’t explained why if there really is a hard permanant physical constraint on the supply of oil, prices were so low 10 years ago. A hard worldwide physical constraint on oil production for evermore should have been foreseeable and hence reflected in prices back then. You say that prices were low due to previous over-investment and that current high prices are due to long investment lead times, but that somehow “now the problem is geological”. Sure western oil companies are returning money to shareholders. So is BHP, even though it is investing heaps - yet BHP doesn’t believe we are running out of iron ore or copper. It does believe prices will be high for the next 10 years, but that’s very different from saying we are running out of base metals.

Posted by .(JavaScript must be enabled to view this email address)  on  02/08  at  07:27 PM

Rajat (economist);

1) Production was STILL EXPANDING back in 1990’s.  Since then production has increasingly stagnated, but demand hasn’t, hence rising prices.  We are increasing our draw down of existing reserves.  What’s funny is the Economist magazine back in 1999 was predicting $5 barrel oil.  We were drowning in oil it wrote.  I believe by 2000 the price was $30!

2) Oil exists in only a very few places.  All the best finds were made decades ago. You cannot produce what you haven’t discovered. Oil discovery peaked in the 1960’s and has been declining ever since, a trend which has been immune to time, price and technological innovation.  For evidence of this look to the United States, a stable oil region ripe for investment, innovation and exploration to find and produce more oil.  What happened after its geological peak in 1971?  It production has continued to decline ever since at around 2% p.a. despite access to all the money and technology in the world.

3) Conventional oil is a FLOW, stick a drill in the right place and up she comes, unconventional resources are a STOCK, like any ore, and need to be mined at great expense in time, money, energy and other resources to convert them into a liquid suitable for refining.  This is why 1 trillion so-called barrels of oil potential in Canada can never substitute for free flowing oil.  It’s like having a bank account with 1 million dollars, but you’re only allowed to withdraw it at $500 dollars a day.

Finally, NATURE DOES NOT CARE WHAT YOU BELIEVE.  Oil, like clean air, potable water and a stable climate is a finite resource.

Posted by .(JavaScript must be enabled to view this email address)  on  02/08  at  07:33 PM

This time it is different. The last significant new oil province find was the North Sea. Discovery has declined ever since.

Now the production to discovery ratio is around 6 and climbing.

Prices respond to short term factors. They spike if there is a hurricane (remember Katrina?), or MEND do something in Nigeria. Anyway all this was indeed forseen (do a search on Professor Hatfield, Peak Oil), but no one believed it. Now it is happening people are taking notice.

There is another, much more significant factor at hand not yet discussed: Exports/Imports. These high prices have stimulated economic booms in producer countries and exports from the top 3 exporters (Russia, Saudi and Norway) is declining. If current trends are maintained there will be no oil available for export by 2020. This problem is just becoming apparent - exports from the top 3 declined 500k barrels per day in 2006 (v 2005) and it will be interesting to see what happens in 2007. All indicators are that the process will have accelerated.

Note that the UK went from Peak Oil in 1999 and net oil exporter to net oil importer in 2006, just 7 years. This is a cogently powerful demonstration of the problem.

Anyway, if price theory is right, why has production stood still since 2004 when prices have tripled since then and increased 10 fold in 10 years?

Posted by Saildog  on  02/08  at  07:50 PM

Addendum to above post - the key factor in the Export/import issue is that the economic booms have resulted in double digit consumption growth. Production has not grown commensurately and so exports are rapidly shrinking (production is actually declining in Norway at around 10% per year).

I do not need to tell you the impact of 11% consumption growth, or the impact of new car sales increasing 10 fold in Russia since 2002. It is obvious. Find out the figures and do the maths.

Posted by Saildog  on  02/08  at  08:09 PM

Yep, price has gone up almost 1000% since 1998, the famed market signal should have well and truly kicked in by now to usher in a fresh wave of oil discovery, substitution and innovation.  So where is the new North Sea, the new Alaska, hell even the new West Africa to bring down the price of the beastly barrel?  Where is the oil substitute, why aren’t the roosters a-laying, and shouldn’t replacements for the ICE be simply rolling off production lines to take advantage of it?

Posted by .(JavaScript must be enabled to view this email address)  on  02/08  at  08:21 PM

A hard worldwide physical constraint on oil production for evermore should have been foreseeable and hence reflected in prices back then.

A hard physical constraint in the U.S. should have been foreseeable in the late 1960s but it wasn’t anticipated by the market.

Why didn’t the market “know” that from 1971 the U.S. would become ever more reliant on imported oil?  Why didn’t the market anticipate that the world would be at the mercy of oil exporting nations? Why wasn’t this factored into prices in the late 1960s?

The answer is no-one believed U.S. oil production would peak until it actually happened.  Oil production kept on increasing right through the 1960s until it peaked in 1971.

Posted by .(JavaScript must be enabled to view this email address)  on  02/08  at  08:24 PM

One more thing. Relying on price theory to deliver vital oil to our economies reminds me strongly of an island called Tanna in Vanuatu.

There they believe in John Frum and he has been a religion since he walked up the beach during WWII and delivered much needed supplies to a starving island (he was from the red cross, it is all over the island - and is the symbol of the religion). The good people of Tanna believe that John Frum will return and they will never want again. Good on them.

Believing that price will deliver more energy (oil or a comparable substitute) is a bit like believing in John Frum. It will just deliver because it has done so in the past.

Could it be that economics is just another cargo cult masquerading as a serious discipline, all dressed up in fancy theory, but built on sand? It is just as naive, it just isn’t charming and quaint like Tanna.

Anyway “utility” is a meaningless tautology with no basis in science.

Posted by Saildog  on  02/08  at  10:29 PM

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