There is plenty of oil, but . . .

This is a post I wrote about a year ago that has been very popular. It was originally posted on The Oil Drum. It is based on a presentation I gave.

There is a huge amount of oil which theoretically can be extracted, but the question is whether the cost will be cheap enough for us to be able to afford to extract it. If the oil is too expensive to extract, the shortage of oil seems to cause a recession, similar to what we are having now. I discuss this in purely monetary terms, but it is also an issue with respect to low energy return on investment (EROI), because oil which is of low EROI needs a high price to justify its extraction.

In many ways, the folks who say we a have lots of oil are correct. All one has to do is include the oil which is extremely expensive and slow to extract. Much of the cheap, easy-to-extract oil has already been removed.

Economic theory seems to say that if oil prices rise, substitutes are likely to be found, and these will tend to bring prices back down. When oil prices rose, we found substitutes, but they were poor substitutes. They are more generally more expensive, when all of the costs are included. Biofuels interfered with food supply; wind is a substitute for natural gas and coal in electricity production, but it is not as a transportation fuel, which is one of the things that we specifically expect to be short of.

In the above slide, I purposely exaggerated the impact of an oil price rise on food and gasoline. The effect would be greatest on a low income individual. It would also be very great, if the price rise were to something like $400 barrel.

This is pretty obvious, if you think about it. Does it sound like anything we have run into in the last few years?

 

Many people think of the effects of peak oil as a future event. But we are really experiencing them here and now. Oil production stopped rising in 2005, so by 2006, we were feeling the effects of the squeeze. The effects were being felt as early as 2004, when oil prices began to rise.

I have omitted several slides, showing the rise and fall of oil production in the US 48 states, Alaska, and the North Sea. At this point, most of the fields that are in easy to access locations are in decline, and we are “stuck” with what is left–the slow to extract, expensive oil from difficult locations.

So many people have equated high prices with oil shortages, that people have come to believe that if prices are low (or at least relatively low, compared to last years’ prices), everything is OK. But we really need lots of quite inexpensive oil to fuel the economy, or it goes into a recession. Reduced credit reduces demand, and has the effect of bringing oil prices down.

In the above slide, the cutback in credit is especially important. Without credit, many people cannot buy new cars, new houses, or expensive Christmas presents. All of these use oil in their manufacture and distribution, and keep oil prices up.

US consumer credit (including things like credit card loans and auto loans) peaked the same month as oil prices. Mortgage loans peaked about the same time, and many types of commercial credit have been affected. The government has tried to pick up the slack with additional borrowing, but this is not the same.

The EIA indicates that on a constant dollar basis, energy expenditures more than doubled between 1990 and 2008. Going forward, the EIA sees more increases in energy expenditures, on an inflation adjusted basis.

I might mention that one of the major uses of new technology is to bring down prices. There are limits to what can be done–if oil is very deep in the ocean, it is likely never going to be cheap to extract. The need for new technology to bring down prices is probably as great or greater with fossil fuels as it is with things like wind, solar, and biofuels. Fossil fuels are at least well adapted to running our current infrastructure. Anything that is very different will require huge expenditures for conversion.

In my view, the big question mark is how debt (and financial institutions) will do. The front page story on today’s Atlanta Journal Constitution is “Troubled banks find it hard to stay afloat”. How long will bailing out failing banks with printed money work?

The growing gap is the concern. Regardless of whether oil production remains flat, or declines fairly steeply, we have a major problem. With many people from around the world interested in using oil products, and many new cars in places like China and India, the gap between production and what we would normally consume (if prices were low and credit were available) is likely to continue to grow, even if somehow oil production could be kept flat.

In the recent past, the advanced economies have been able to “offshore” their energy intensive industries to places like China, giving the illusion that countries can get along with only non-energy intensive services like finance. But for the world as a whole, there seems to be a close relationship between growth in oil consumption and GDP growth. Since finance and some other services don’t need much oil to grow, the relationship is not exactly 1:1. Efficiency growth would also tend to raise make GDP growth higher (but declining EROI would tend to lower it).

My big concern is international trade. If debt defaults are a problem, this could interfere with the workings of the whole system, especially if it leads to major countries (perhaps Greece) defaulting on their debts.

In the years since fossil fuel use has developed, world population has greatly expanded.

We are already seeing problems with people in some of the poorer nations having adequate food. Even in the US, there are people at the margins who are “food insecure”. Currently, there are government programs to help, but states are finding it increasingly necessary to cut back, because of falling tax revenue.

It would be a lot easier to get politicians to talk about the situation if there were a good solution in sight. There are some partial mitigations, but they likely don’t get us back to “business as usual”. Voters are likely to be very unreceptive to such news.

About Gail Tverberg

My name is Gail Tverberg. I am an actuary interested in finite world issues - oil depletion, natural gas depletion, water shortages, and climate change. Oil limits look very different from what most expect, with high prices leading to recession, and low prices leading to inadequate supply.
This entry was posted in Financial Implications, Introductory Post, Oil and Its Future and tagged , . Bookmark the permalink.

8 Responses to There is plenty of oil, but . . .

  1. majorian says:

    Theoretically the price of oil is based on the difference between supply and demand.
    Let’s assume the supply of cheap oil declines. The logical result will be the price will rise increasing the supply of substitute liquid fuels and unconventional oil.
    The capital price of unconventional oil/ethanol/methanol is $100,000 per daily barrel equivalent or less therefore the price for 86 mbpd is $8.6 trillion dollars which is 17.2% of a $50 trillion dollar world economy. If the decline takes 50 years that’s $172 billion dollars per year of capital investment(compare that to the total Bush tax cut of $400 billion per year) to produce an additional 1.72 mbpd in unconventional oil or a total of 785 Gb of unconventional oil/ethanol/methanol which is less than
    all the oil sands (+200 Gb), oil shale(400 Gb), extraheavy(200 Gb), other heavy oil(130 Gb) plus methanol from coal( +2000 Gboe total resource)or natural gas(+600Gboe total resource) plus biofuels plus electricity.

    http://pubs.usgs.gov/fs/fs070-03/fs070-03.html

    The technology of running cars on alcohol is cheap and could be mandated into all new transport vehicles or retrofited to old ones.
    The biggest advantage of unconventional oil is that it ‘grows the pie'(disadvantage if you think carbon should be left in the ground).
    Perhaps you fear that the EROI of unconventional oil will plummet. This is not reasonable.
    Technology increases EROI over time to match the relative declines in energy density. Today there are fewer than 70000 coal miners in the US compared to
    700,000 in the 1920s producing 4 times the coal . The oil industry is also far more efficient.
    Gail, I honestly have no idea why I am alone in understanding the situation.

    • I do not like the way GDP is calculated. It stacks up many things that depend on each other on top of each other, and combines them into GDP. To me, nearly all taxes fall back (directly or indirectly) on people’s incomes, because governments and businesses ultimately get their revenues from private individuals, who buy their goods and pay their taxes. Theoretically, there could also be taxes on capital gains, but these are going to go away, as the world shift from growth to decline. There could also be taxes on rents and on goods mades through long term investment, but in practice, these have to be purchased by someone, and most of the money for this purchase will come from income. If one looks at income rather than GDP, one gets a total that is half as high as the $50 trillion, or less. So the 17.2% you are quoting is way too low, relative to the resources of those who will ultimately have to pay the cost.

      Another issue is that a huge share of the income is already spoken for because of government programs. This is a post I wrote recently on this issue. It is hard for me to see how we are going to fund what it already committed, much less add more.

      Another issue is that with oil shortages, income (and GDP) is likely to decrease in the future. So even if the relationship worked now, it wouldn’t work long term.

      A final issue is that I question how valid your assumption of $100,000 investment for a daily barrel of oil. We know that investment cost is tied to the price of oil. If oil price goes up, so does investment cost. We also know that we use the best resources first. So while there may be improvements in technology, this doesn’t mean that oil from oil shale can be produced for less than $100,000 a barrel investment, or that very deep low quality oil sands can be produced for that price. The general direction of investment cost per barrel of production has been up, and I would expect that to continue.

      • Don Millman says:

        Oil price can go up, even if investment cost per barrel stays the same. Whenever OPEC reduces production much below capacity to produce, that can raise prices enormously (as happened during the nineteen seventies) without any corresponding increase in the cost of investment per barrel.

        In the long run (say ten years), the price of oil will tend to follow the long-run marginal cost of producing an additional barrel of oil, but in the shorter run we should remember that OPEC is a cartel, a kind of oligopoly, and they have a strong incentive to restrict production and thereby drive oil prices well above the long-run marginal cost of producing that extra barrel of oil.

        Because of the kinked oligopoly demand curve, oligopolists, however, do not have the ability to jack up prices to whatever level they desire. Also, in a cartel there is a big incentive for producers to cheat on quotas, and currently I think more than half of OPEC countries are indeed producing significantly more than their OPEC set quotas. This cheating does not bother Saudi Arabia, the price leader, because supplies are restricted enough by production capacities that KSA is able to maintain its announced prices (first $75 about two years ago, and now $90 announced several weeks ago) merely by restricting its own production. According to Rune Likvern’s article on theoildrum.com a few weeks ago, the Saudis probably have about one and a half million barrels per day of excess capacity. It is interesting that every time the price of oil has gone up to $90 in the past few weeks, something happens to knock the price down a couple of dollars or so.

      • majorian says:

        How about a world gross income of $72 trillion dollars?
        US gross nation income is $14 trillion.

        http://www.google.com/publicdata?ds=wb-wdi&met=ny_gnp_mktp_pp_cd&tdim=true&dl=en&hl=en&q=gross+national+income+world

        The price of a barrel of oil is the capital cost over 30 years + the operational cost. Let’s say that a ton of coal costs $50 per ton to mine(oil sands) and produces 2 barrel of ersatz gasoline.
        Lets say
        the cost of a 50000 bpd processing plant is $100000 per daily barrel (Fischer Tropsch is ~$80000 /daily barrel).
        The price per barrel is, $50/2 + $100000/(365×30)=$34 per barrel x 1.2 = $41/barrel.

        It costs $ 1 billion dollars for a 140 million gallon per year cellulosic ethanol plant. This is equal to 9132 bpd or $109500 per daily barrel.

        Cost of switchgrass is $50 per ton and you get 50 gallons from a ton of grass.

        Therefore $1bE9/30yr x140E6 +$50/50=$1.23 per ethanol gallon or
        $1.81 per gasoline gallon equivalent, times 1.2 for markup you get $2.21 total cost per gallon equivalent or $92.82 per boe.
        http://en.wikipedia.org/wiki/Cellulosic_ethanol

        You make a good point about low energy feedstocks.
        At 400 Gb Colorado oil shale contains +1/2 barrel of oil per ton.
        Mining costs (such as in oil sands ) is about $15 per ton or
        $30 per barrel so adding in $100k per daily barrel; $100000/365×30=$9.1 we end up with $39.1 per barrel or $47 per barrel.
        This is slightly more expensive than CTL, but it doesn’t draw down coal stocks, ‘growing the pie’.

        http://www.fossil.energy.gov/programs/reserves/publications/Pubs-NPR/40010-373.pdf

        As you can see almost all unconventional liquid fuel sources are economic at current prices.

        As far as real world oil shale goes, the Stuart Oil Shale project produced
        shale oil for $13 per barrel. The project was frozen due to environmental concerns.
        http://en.wikipedia.org/wiki/Oil_shale_economics

  2. RobM says:

    Very interesting and intelligent discussion above. My contribution is not as good…

    The worldwide financial system today is mostly insolvent and teetering on collapse because there is insufficient growth in real wealth to pay our interest on debt. Growth in real wealth has slowed or stopped because growth in total energy use has slowed or stopped. If we now decide to divert a significant portion of real wealth production to new energy producing capital (which has a significant delay before returning value), then our ability to service debt will worsen leading to a self-reinforcing collapse.

    It might work if we could somehow reset our debt (which means big net worth haircuts), and establish a new monetary system that does not require exponential growth (which means balanced government budgets, low bank profits, and pay as you go consumption), and we convinced the citizens to accept a lower standard of living and fewer entitlements so that their children might enjoy a more comfortable life, and we convinced the military-industrial complex that they are no longer in business, but I don’t see how to get from here to there.

    • I pretty much agree with you. It seems like resetting debt would be a problem. Those holding debt would simply expect longer maturities, but this wouldn’t work either–with longer maturities, there would be more interest to pay, and debtors would still not be able to pay. If someone tried to cancel debt, it seems like their would be retaliation. For example, if the US decided it couldn’t pay its loans, I expect that other countries holding its debt would try to retaliate by seizing property owned by US based multinational countries.

      And it very often would’t work to give the collateral on loans to lenders. Too often, there are several lenders with competing claims on property. And if the property is a home, it may have dropped in value.

    • DavidB says:

      Actually Rob, I disagree that your contribution is not as good.

      What you describe is a very accurate ‘vignette’ of the financial situation we find ourselves in and it’s implications to future energy possibilities.

      Keep up the poor contributions.

      David

  3. step back says:

    “In many ways, the folks who say we have lots of oil are correct.”

    There is another way of framing that thought without giving credit where credit is not due:

    Folk who say we a have lots of oil are telling only half a truth, not the whole truth and therefore they are misleading the public.

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