Will 2011 be a rerun of 2008? (Longer version)

A post similar to this is in today’s ASPO-USA Newsletter.

We all remember the oil price run-up (and run back down) of 2008. Now, with prices similar to where they were in the fall of 2007, the question quite naturally arises as to whether we are headed for another similar scenario.

Of course, we know that the scenario cannot really be the same. World economies are now much weaker than in late 2007. Several countries are having problems with debt, even with oil at its current price. If the oil price rises by $20 or $30 or $40 barrel, we can be pretty sure that those countries will be in much worse financial condition. And while governments have learned to deal with collapsing banks, citizens have a “been there, done that” attitude. They may not be as willing to bail out banks that seem to be contributing to the problems of the day.

If we look back at what happened three years ago, there was a huge run up in the price of oil, but very little change in oil supply.

Figure 1. Production of oil (crude and condensate) for OPEC and Non-OPEC countries, compared to West Texas intermediate oil price, in September 2010$. Based on EIA data.

Oil price roughly corresponded to today’s price in October 2007. Between then and July 2008 (the peak in both prices and production), OPEC increased its oil supply by 1.3 million barrels. Non-OPEC actually decreased its supply by about 0.3 million barrels a day between October 2007 and July 2008, providing a net increase in oil supply of only about 1 million barrels a day, despite the huge run-up in prices.

A person can see from the above graph that the supply of OPEC oil has tended to increase, as oil prices increase. Non-OPEC supply has been much less responsive to price. This is another way of graphing the relationship between oil price and oil production:

Figure 2. Relationship of oil production (crude and condensate) and West Texas Intermediate price, expressed in September 2010 $, based on monthly EIA data from January 2001 through September 2010.

In Figure 2, as oil price increases along the horizontal axis, we see that non-OPEC oil production remains virtually flat. As oil price increases for the OPEC 12, we see the kind of supply curve we might expect to see for a supplier that has a small amount of more expensive capacity that it can put on line when prices justify it. The catch is that the amount of supply added as prices rise isn’t really very much–as we just saw, 1.3 million barrels a day, between October 2007 and July 2008.

Eventually, the economy could not handle the high oil prices, and prices dropped. Credit availability began dropping and recession became a greater and greater issue.

Will this time be different? It seems to me that OPEC has done a good job of convincing the world that it has a lot of extra supply, but it is less than clear that it has much more excess capacity than it had in the 2007-2008 period. OPEC shows this image on its website, but this may just be a long-standing approach aimed at convincing the world that it has more oil (and power) than it really does.

Figure 3. OPEC’s view of its own spare capacity.

Spare capacity, like oil reserves, is not audited. The higher the numbers proclaimed to the world, the more powerful OPEC appears, both in the eyes of its own people, and in the eyes of people around the world. OPEC shows lists of new projects and investment amounts, but it is not clear that the new capacity being added is more than what is needed to offset declines in other fields. The new production amounts listed come to something like 6% of production – this could simply represent offsets to declines in fields elsewhere. The problem is we really don’t know, because no auditing is ever done. We are just expected to trust Saudi Arabia and OPEC, on a matter of importance to the world.

OPEC tells us it is acting as a cartel, but when a person looks closely at the data, only three countries appear to be pumping at less than full capacity: Saudi Arabia, United Arab Emirates, and Kuwait. Production rises and falls with price for these countries. It is not all that difficult to coordinate the activities of three countries, especially when one of them–Saudi Arabia–is doing most of the adjustment to oil supply. So all of OPEC’s marvelous abilities may not be all that marvelous. If Saudi Arabia knows it can sell oil it withholds from the market at a higher price later, it is not a bad move to hold a bit of oil off the market, and claim that the amount being held off the market is much higher.

In the next year, there is a significant chance that oil demand may rise. While oil supplies are at this point adequate, if demand continues to grow, we could very well see another surge in oil prices, and another test as to whether there really is spare capacity. If the supply curves shown in Figure 2 are any indication, we won’t be getting much more oil, perhaps another 1.5 million barrels a day, even if prices spike.

The one possibility that would seem to postpone such a price run-up is if world economies in the very near term start heading into major recession. Such a recession might indicate that even the current oil price is too high for economies to handle, in their weakened state.

To me, the limit on how much oil will be supplied is not the amount of oil in the ground; rather the limit is how high a price economies can afford.  This in turn is tied to the true value of the oil to society–whether oil can really be used to produce goods and services to justify its price. The problems we experienced in 2008, and may experience in the not-to-distant future, suggest that we may be reaching this limit.

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.
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24 Responses to Will 2011 be a rerun of 2008? (Longer version)

  1. Sololeum says:

    Not enough is made of the link between price and EROEI – the high costs of “non-conventional” oil will always be a feature as these oils have a very low energy return on that invested. Those awaiting a high price for oil to make a project viable eg shale oil, will wait forever, as we saw in 08 commodities all rose with oil, and the profit gap will always be too small to justify the investment. Along with demand destruction and recessions that accompany high oil prices, all high tech alternatives will always be out of reach.

    • Don Millman says:

      “. . . all high tech alternatives will always be out of reach.”

      With all due respect, I have to call B.S. on this. Why is it inevitable that high tech alternatives will be expensive? Coal-to-Liquids is cheap and dirty, but it works now (and has been profitable for Sasol even when the price of oil was low) and will probably be expanded greatly in the U.S. as oil imports diminish.

      Windmills have been around for at least a thousand years; there is no reason to think that wind-generated electricity plus electricity storage (pumping water up hill, compressing air, or storage batteries, or possibly flywheels) will not be feasible during the next thousand years. During the nineteen twenties windmills generating electricity for farms was very common and quite durable; it was only the New Deal program of rural electrification that killed them off during the nineteen thirties.

      Nuclear energy provides most of the electricity for Japan and France; there is no reason why the U.S. cannot also get most of its electricity from nuclear fission. There is a huge amount of uranium that can be mined profitably with current electricity prices and capital costs for nuclear energy. And if you have abundant electricity, it is possible to generate hydrogen in place of natural gas or methanol in place of gasoline and diesel fuel.

      So far as “demand destruction” goes, it is not clear whether you are talking about the results of higher prices or recessions or both. During the Great Depression, when up to twenty-five percent of the labor force was unemployed, there were great public works to generate electricity–Hoover Dam of course but also the TVA and dams on the Colorado River. The U.S. will always be able to borrow more money so long as the Fed keeps buying up Treasury Bills, Notes, and Bonds, to finance deficits. So even if there is a lack of private capital in the financial markets, the Federal Government can step into the role of “energy-investor of last resort.”

      I am not a cornucopian. My views are similar to those of John Michael Greer in THE LONG DESCENT. Of course living standards are going to fall drastically, and of course energy is going to cost a lot more as the production of fossil fuels declines; there is no doubt in my mind that those two things are going to happen. But it does not follow from these premises that high tech solutions will always or even usually be unfeasible.

      • I think the reason high tech solutions may become out of reach is because we may at some point start losing some of the major systems (financial, electric, internet, transportation, etc.) that allows our current system to continue operating as it does.

        As I noted in another comment, I think improvements in technology may bring up the EROEI of some types of extraction that are now borderline economic, thus making them economic. But even if EROEI is high enough, high tech goods still may not be feasible for the long term, if we lose some of the major systems needed to continue the manufacture of high tech goods–for example, the international financial system and the international trade system. I expect there will always be some bilateral trade between trusted partners, but if there is a major cutback in trade, this could greatly reduce the amount of goods made with imported materials. The efficiencies we have now, because countries can specialize in what they are good at (for example, Saudi Arabia specializes in oil, but not food) will be greatly reduced, and living standards will fall most everywhere.

        I think wind turbines will go on indefinitely, but not in their current form. They will again be manufactured with local materials and used to pump water and even run factories, like they were a few hundred years ago. I think we will probably stop manufacturing high tech wind turbines in not too many years. It seems likely to me that we will end up going back to ways we did things a few hundred years ago, with a few upgrades because of our better knowledge level now.

        • Don Millman says:

          I agree that eventually–say in 200 years–we’ll go back to ways of doing things that resemble what the world was like in 1810. But I think for the next hundred years it might be realistic to think of going back to 1910, when cars were essentially playthings of the rich, and most roads were macadam or gravel or worse. In 1910 railways and street cars carried a lot of passengers, and I think this is feasible over the next fifty to hundred years. In 1910 most cities had enough electricity for lighting, and I think this amount of power generation can be maintained for decades to come. Farms had steam tractors and steam-powered threshing machines; construction sites had steam shovels. (When I was a little boy I saw a steam shovel, and it made a big impression on me. Steam rollers were common in the 1940s, as were ice boxes for homes without refrigerators. Outhouses were also quite common in the 1940s, sometimes even in towns and cities.)

          In other words, I don’t think we are going to go back two hundred years in one big collapse. Rather, I see a lot of little collapses ending the way of life of the past seventy or eighty years.

          Agriculture in particular I think will remain mechanized and will function on biodiesel for a long time. Blacksmiths will make a comeback and will make spare parts and also repair much farm machinery for a long time to come. I think artificial fertilizers and pesticides will be around for decades to come, though I also expect to see more and more manure used as fertilizer. If agriculture remains mechanized, food will still be relatively cheap. If we have to go back to labor intensive and draft-animal intensive farming, then food will become much more expensive than it is now.

          The big drop in living standards will come when food costs about half of income–and I hope (and think) we are a long way from that. Much of our current high living standards are based on cheap food and relatively high wages. I expect real wages to fall drastically and also that real food prices will increase somewhat, because biodiesel is more costly than diesel at current prices.

    • I agree that EROEI is important, and that shale oil will likely stay out of reach because of low EROEI.

      With respect to very heavy oil and bitumen, I agree that EROEI is important, but I think there is some chance that technology will improve EROEI enough to make some extraction which is now borderline economically feasible.

  2. Kenneth says:

    Over the past 40 years, when petroleum expenditures as a percent of GDP increased much beyond 5.5%, the economy tended towards recessions — Oil Drum

    forecast US GDP June 2011 – $15.06 trillion
    5.5% = 828.3 billion
    forecast (EIA) US liquid fuels consumption 2011 – 19.250 million bbl/d
    19.25 x 365 days = 7.026 billion bbls
    $828.3 billion (5.5% GDP) / 7.026 billion bbls = $117.88 barrel of oil

    Oil is currently at $90 / barrel and forecast to exceed $100 / barrel in 2011 and $120 / barrel in 2012. – JP Morgan.

    It is very likely that we have another economic downturn 2011-2012.

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