The Real Oil Extraction Limit, and How It Affects the Downslope

There is a lot of confusion about which limit we are reaching with respect to oil supply. There seems to be a huge amount of “reserves,” and oil production seems to be increasing right now, so people can’t imagine that there might be a near term problem. There are at least three different views regarding the nature of the limit:

  1. Climate Change. There is no limit on oil production within the foreseeable future. Oil prices can be expected to keep rising. With higher prices, alternative fuels and higher cost extraction techniques will become available. The main concern is climate change. The only reason that oil production would drop is because we have found a way to use less oil because of  climate change concerns, and choose not to extract oil that seems to be available.
  2. Limit Based on Geology (“Peak Oil”). In each oil field, production tends to rise for a time and then fall. Therefore, in total, world oil production will most likely begin to fall at some point, because of technological limits on extraction. In fact, this limit seems quite close at hand. High oil prices may play a role as well.
  3. Oil Prices Don’t Rise High Enough. We need high oil prices to keep oil extraction up, but as we reach diminishing returns with respect to oil extraction, oil prices don’t rise high enough to keep extraction at the required level. If oil prices do rise very high, there are feedback loops that lead to more recession and job layoffs and less “demand for oil” (really, oil affordability) among potential purchasers of oil. One major cut-off on oil supply is inadequate funds for reinvestment, because of low oil prices.

Why “Oil Prices Don’t Rise High Enough” Is the Real Limit

In my view, our real concern should be the third item above, “Oil Prices Don’t Rise High Enough.” The problem is caused by a mismatch between wages (which are not growing very quickly) and the cost of oil extraction (which is growing quickly). If oil prices rose as fast as extraction costs, they would leave workers with a smaller and smaller percentage of their wages to spend on food, clothing, and other necessities–something that doesn’t work for very long. Let me explain what happens. 

Because of diminishing returns, the cost of oil extraction keeps rising. It is hard for oil prices to increase enough to provide an adequate profit for producers, because if they did, workers would get poorer and poorer. In fact, oil prices already seem to be too low. In years past, oil companies found that the price they sold oil for was sufficient (a) to cover the complete costs of extraction, (b) to pay dividends to stockholders, (c) to pay required governmental taxes, and (d) to provide enough funds for investment in new wells, in order to  keep production level, or even increase it.  Now, because of the rapidly rising cost of new extraction, oil companies are finding that they are coming up short in this process. 

Oil companies have begun returning money to stockholders in increased dividends, rather than investing in projects which are likely to be unprofitable at current oil prices. See Oil companies rein in spending to save cash for dividendsIf our need for investment dollars is escalating because of diminishing returns in oil extraction, but oil companies are reining in spending for investments because they don’t think they can make an adequate return at current oil prices, this does not bode well for future oil extraction.

A related problem is debt limits for oil companies. If cash flow does not provide sufficient funds for investment, increased debt can be used to make up the difference. The problem is that credit limits are soon reached, leading to a need to cut back on new projects. This is particularly a concern where high cost investment is concerned, such as oil from shale formations. A rise in interest rates would also be a problem, because it would raise costs, leading to a higher required oil price for profitability. The debt problem affects high priced oil investments in other countries as well.  OGX, the second largest oil company in Brazil, recently filed for bankruptcy, after it ran up too much debt.

National oil companies don’t explain that they are finding it hard to generate enough cash flow for further investment. They also don’t explain that they are having a hard time finding sites to drill that will be profitable at current prices.  Instead, we are seeing more countries with national oil companies looking for outside investors, including Brazil and Mexico. Brazil received only one bid, and that for the minimum amount, indicating that oil companies making the bids do not have high confidence that investment will be profitable, either. Meanwhile, newspapers spin the story in a totally misleading way, such as, Mexico Gears Up for an Oil Boom of Its Own.

US natural gas is another product with a similar problem: the price is not high enough to justify new production, especially for shale gas producers. The huge resource that some say is there is simply too expensive to extract at current prices. Would-be natural gas producers cannot tell us this. Instead, we find a recent quote in the Wall Street Journal saying:

“We are not dealing with an era of scarcity, we are dealing with a situation of abundance,” Ken Cohen, Exxon’s vice president of public and government affairs, said in an interview. “We need to rethink the regulatory scheme and the statutory scheme on the books.”

Cohen could explain that without natural gas exports, there is no way the natural gas price will rise high enough for Exxon-Mobil to extract the resource at a profit. Without exports, Exxon Mobil will lose money on the extraction, or more likely, will have to leave the natural gas in the ground. With low prices, the huge resource that Obama has talked about is simply a myth–the prices need to be higher. Of course, no one tells us the real story–it seems better to let people think that the issue is too much natural gas, not that it can’t be extracted at the current price. The stories offered to the news media are simply ways to convince us that exports make sense. Readers are not aware how much stories can be “spun” to make the current situation sound quite different from what it really is.

What Goes Wrong with “Climate Change” and “Limit Based on Geology” Views

The Illusion of Reserves. Oil and gas reserves may seem to be “be there,” but a lot of conditions need to be in place for them to actually be extracted. Clearly, the price needs to be high enough, both for current extraction and to fund new investment. Other conditions need to be in place as well: Debt needs to be available, and it needs to be available at a sufficiently low rate of interest to keep costs down. There needs to be political stability in the country in question. Something as simple as a continuation of the uprisings associated with the Arab Spring of 2010 could lead to the inability to extract reserves that seem to be present. Other requirements include availability of water for fracking and the availability of skilled workers and drilling rigs.

In the past, we have been far enough away from limits that issues such as these have not been a big problem. But as we get closer to limits and stretch our capabilities, these become more of a problem. Right now, availability of debt at low interest rates is a particularly important issue, as is the need for adequate oil company profitability–things that are easy to overlook.

Wrong Economic Views Leading to Wrong Oil Views. Economists have put together economic models based on a world without limits. A world without limits is the easy approach, because mathematical relationships are much simpler in a world without limits: a relationship which held in 1800 is expected to hold in 1970 or in 2050.  A world without limits never offends politicians, because growth always seems to be possible, meaning a never-ending supply of jobs and of goods and services for constituents. A model without limits produces the simple relationships that we are accustomed to, such as “Inadequate supply will lead to a rise in price, and this in turn will tend to create greater supply or substitutes.” Unfortunately, these models omit many important variables and thus are inadequate representations of the world we live in today.

In a world with limits, there are feedback loops that cause high oil prices to lead to lower wages and more unemployment in oil importing countries. Thus “demand” can’t keep rising, because workers can’t afford the higher oil prices. Oil prices stagnate at a level that is too low to maintain adequate investment. High oil prices also feed back into slower economic growth and a need for ultra-low interest rates to raise demand for high-priced goods such as cars and homes. 

When prices remain in the $100 barrel range, they are still high enough to damage the economy. Businesses are not much damaged, because they have ways they can work around higher oil prices, especially if interest rates are low.  Most of the ways businesses can work around high oil prices involve reducing wages to US workers–for example, outsourcing production to a lower cost country, or cutting the pay of workers, or laying off workers to match lower demand for goods. (Lower demand for goods tends to occur when oil prices rise, and businesses raise their prices to reflect the higher oil costs.)

Workers are still affected by costs in the $100 barrel range, and so are governments. Governments must pay out higher benefits than in the past, to keep the economy afloat. They must also keep interest rates very low, to try to keep demand for homes and cars as high as possible. The situation becomes very unstable, however, because very low interest rates depend on Quantitative Easing, and it does not appear to be possible to continue Quantitative Easing forever. Thus, interest rates will need to rise. Such a rise in interest rates is likely to push the country back into recession, because taxes will need to be higher (to cover the government’s higher debt costs) and because monthly payments on homes and new car purchases will tend to rise. The limit on oil production then becomes something very remote from geology–something like, “How long can interest rates remain low?” or “How long can we make our current economy function?”

The Interconnected Nature of the Economy. In my last post, I talked about the economy being a complex adaptive system. It is built from many parts (many businesses, laws, consumers, traditions, built infrastructure). It can operate within a range of conditions, but beyond that range it is subject to collapse. An ecosystem is a complex adaptive system. So is a human being, or any other kind of animal. Animals die when their complex adaptive system moves out of its range.

It is this interconnectedness of the economy that leads to the strange situation where something very remote from the real problem (oil limits) can lead to a collapse. Thus, it can be a rise in interest rates or a political collapse that ultimately brings the system down. The path of the downslope can be very different from what a person might expect, based on the naive view that the problems will simply relate to reduced supply of oil.

A Case Study of the Collapse of the Former Soviet Union 

The Soviet Union was major oil exporter and a military rival of the United States in the 1950s through 1980s. It also was the center of a huge economic system, involving many other countries. One thing that bound the countries together was the use of communism as its method of government; another was trade among countries. In effect, the group of communist countries had their own complex adaptive system. Things seemed to go fine for many years, but then in December 1991, the central government of the Soviet Union was dissolved, leaving the individual republics that made up the Former Soviet Union (FSU) on their own.

While there are many theories as to what all caused the collapse, it seems to me that low prices of oil played a major role. The reason why low oil prices are important is because in an oil exporting country, such as the FSU, oil export revenues represent a major part of government funding. If oil prices drop too low, there is a double problem: (1) it becomes unprofitable to drill new wells, so production drops and, (2) the revenue that is collected on existing wells drops too low. The problem is then a huge financial problem–not too different from the financial problem the US and many of the big oil importing countries are experiencing today.  

Figure 1. Oil production and price of the Former Soviet Union, based on BP Statistical Review of World Energy 2013.

Figure 1. Oil production and price of the Former Soviet Union, based on BP Statistical Review of World Energy 2013.

In this particular situation, oil prices (in inflation adjusted prices) hit a peak in 1980. Once oil prices hit a peak, FSU oil production very much flattened. There was a continued small rise until 1983, but without the very high prices available until 1980, aggressive investment in new oil extraction dropped back.

Not only did FSU oil production flatten, but FSU oil consumption also flattened, not long after oil production stopped rising (Figure 2). This flattening helped maintain exports and the taxes that could be collected on these exports.

Figure 2. Former Soviet Union Oil Production and Consumption, based on BP Statistical Review of World Energy, 2013.

Figure 2. Former Soviet Union Oil Production and Consumption, based on BP Statistical Review of World Energy, 2013.

Even though total exports were close to flat in the 1980s (difference between consumption and production), there were some countries where exports that were rising–for example North Korea, shown in Figure 4. This mean that oil exports for some allies needed to be cut back as early as 1981. Figure 3 shows the trend in oil consumption for some of FSU’s allies.

Figure 3. Oil consumption as a percentage of 1980 consumption for Hungary, Romania, and Bulgaria, based on EIA data.

Figure 3. Oil consumption as a percentage of 1980 consumption for Hungary, Romania, and Bulgaria, based on EIA data.

A person can see that oil consumption dropped off slowly at first, and increased around 1990. All of these countries saw their oil consumption drop by at least 40% by 2000. Bulgaria saw is oil consumption drop by 65% to 70%.

The FSU exported oil to other countries as well.  Two countries that we often hear about, Cuba and North Korea, were not affected in the 1980s (Figure 4). In fact, Cuba’s oil consumption never seems to have been severely affected. (It is possible that exports of manufactured goods from the FSU dropped, however.) Cuba’s drop-off in oil consumption since 2005 may be price-related.

Figure 4. Oil consumption as a percentage of 1980 oil consumption for Cuba and North Korea, based on EIA data.

Figure 4. Oil consumption as a percentage of 1980 oil consumption for Cuba and North Korea, based on EIA data.

North Korea’s oil consumption continued growing until 1991. Its drop-off was then very severe–a total of an 83% reduction between 1991 and 2010. In most of the countries where oil consumption dropped, consumption of other fossil fuels dropped as well, but generally not by as large percentages. North Korea experienced nearly a 50% drop in other fuel (mostly coal) consumption by 1998, but this has since somewhat reversed.

By 1991, the FSU was in poor financial condition, partly because of the low oil prices, and partly because its oil exports had started dropping. FSU’s oil production left its plateau and started dropping about 1988 (Figure 2).  The actual drop in FSU oil production meant that oil consumption for the FSU needed to drop as well–a big problem because industry depended upon this oil. The break-up of the FSU was a solution to these problems because (1) it eliminated the cost of the extra layer of government and (2) it made it easier to shift oil consumption among the member republics, so that those republics that produced more oil could keep it for their own use, rather than sending it to republics which did not produce oil. This shortchanged non-oil producing republics, such as the Ukraine and Belarus.

If we look at oil consumption for a few of the republics that were previously part of the FSU, we see that oil consumption was fairly flat, then dropped off quickly, after 1991.

Figure 5. Oil consumption as a percentage of 1985 oil production for Russia, the Ukraine, and Belarus, based on BP Statistical Review of World Energy 2013.

Figure 5. Oil consumption as a percentage of 1985 oil production for Russia, the Ukraine, and Belarus, based on BP Statistical Review of World Energy 2013.

By 1996 (only 5 years after 1991), oil consumption had dropped by 78% for the Ukraine, by 61%  for Belarus, and by “only” 47% for Russia, which is an oil-producing state. At least part of the reason for the fast drop off was the fact that in the years immediately after 1991, oil production for the FSU dropped by about 10% per year, necessitating a quick drop off in consumption, especially if the country was to continue to make some money from exports. The 10% drop-off in oil production suggests that the decline in oil production was more than would be expected from geological decline alone. If the decline were for geological reasons only, without new drilling, one might the expect the drop off to be in the 4% to 6% range.

When oil consumption dropped greatly, population tended to decline (Figure 6). The decline started earliest in the countries where the oil consumption drop was earliest (Hungary, Romania, and Bulgaria). The steepest drop-offs in population occur in the Ukraine and Bulgaria–the  countries with the largest percentage drops in oil consumption.

Figure 6. Population as percent of 1985 population, for selected countries, based on EIA data.

Figure 6. Population as percent of 1985 population, for selected countries, based on EIA data.

Some of the population drop is from emigration. Some of it is from poorer health conditions. For example, Russia used to provide potable water for its citizens, but it no longer does. Some is from conditions such as alcoholism. I haven’t shown the population change for North Korea. It actually continued to increase, but at a much lower rate of growth than previously. Cuba’s population has begun to fall since 2005.

GDP growth for the countries shown has tended to lag behind world economic growth (Figure 7).

Figure 7. GDP compared to world GDP - Change since 1985, based on USDA Real GDP data.

Figure 7. GDP compared to world GDP – Change since 1985, based on USDA Real GDP data.

Nearly all of the countries listed above have had financial problems, at different times.

Belarus’s GDP seems to be doing better than the rest on Figure 7. Belarus, like the Ukraine, is a pipeline transit country for Russia. In Belarus, natural gas consumption has increased, even as oil consumption has decreased. This increase is likely helping the  country industrialize. Inflation occurred at the rate of 51.9% in 2012 according to the CIA World Fact Book. This high inflation rate may be distorting indications.


We can’t know exactly what path our economy will follow in the future. I expect, though, that the path of the FSU and its trading partners is closer to the path we will be following than most forecasts we hear today. Most of us haven’t followed the FSU story closely, because we wrote off most of their problems to deficiencies of communism, without realizing that there was a major oil component as well.

The FSU situation may, in fact, be better that what the Industrialized West is facing in the next few years. The FSU had the rest of the world to support it, offering investment capital and new models for development. Oil production for Russia was able to rebound when oil prices rose again in the early 2000s. As situations around the world decline, it will be harder to “bootstrap.”

One of the things that hampered the recovery of the FSU was the fact that the communist economic model proved not to be competitive with the capitalistic model. In a way, the situation we are facing today is not all that different, except that our challenge this time is competition from Asian economies that we have not had to compete with until the early 2000s.

Asian economies have several cost advantages relative to the Industrialized West:

(1) Asian competitor countries are generally warmer than the industrialized West. Because of this, Asian workers can live more comfortably in flimsy homes. They also don’t need much salary to cover heating and can more easily commute by bicycle. It is often possible to produce two crops a year, making productivity of land and of farmers higher than it otherwise would be. In other words, Asian competitor countries have an energy subsidy from the sun that the Industrialized West does not.

(2) Asian competitors are often willing to ignore pollution problems, reducing their costs relative to the West.

(3) Asian competitors generally depend on coal to a greater extent than we do, keeping their costs down, relative to countries that use higher-priced fuels.

(4) Asian competitors are less generous with employee benefits such as health care and pensions, also holding costs down.

Economists, through their wholehearted endorsement of globalization, have pushed industrialized countries into a competitive situation which we are certain to lose. While oil prices tend to push wages down, competition with Asian countries makes the downward push on wages even greater. These lower wages are part of what are pushing us toward collapse.

To solve our problems, economists have proposed a shift toward renewable energy and the implementation of carbon taxes. Unless these changes are done in a way that actually reduces costs, these “solutions” are likely to make us even less competitive with low-cost competitors such as those in Asia. Thus, they are likely to push us toward collapse more quickly.

To support this position, economists point to climate change models based on the view that the burning of fossil fuels will increase greatly in the decades again. In fact, if collapse occurs in the next few years in the Industrialized West, carbon emissions are likely to fall quickly. Because of the interconnectedness of the world system, the rest of the world will likely also encounter collapse in not many more years, and their carbon emissions are likely to fall quickly, as well. Even the “Peak Oil” emissions that are used in climate change models are way too high, relative to what seems likely to be the case.

If I am right about collapse being a possibility for the Industrialized West, then our problem will be that we as nations become so poor that we can no longer find goods to trade with Asian countries. Most of our goods will not be competitive as exports, and we won’t be able to simply add more debt to rectify the situation. Thus, we will become unable to buy many goods we depend on, including computers and replacement parts for wind turbines.

Breakups of many types are possible. The European Union may cease to operate in the way it does today. The International Monetary Fund is likely to cease operating in the way it does today, because of the collapse of many of its members who provide funding. The US will be subject to strains of the type that lead to break up. If nothing else, oil producing states will want to withdraw, so that they are not, in effect, subsidizing the rest of the US economy.

It is unfortunate that economists are tied to their hopelessly out-of-date economic models.  Part of the problem is that the story of “collapse around the corner” doesn’t sell well. The alternate story economists have come up with really isn’t right, but it is pleasing to the many who benefit from subsidies for renewables, and it makes politicians look like they are doing something. The specter of climate change in the distance gives an excuse to cut back oil use, among other things, so has at least some theoretical benefit.

It is unfortunate, however, that we cannot look at the real problem. Unless we can understand the problem as it really is, it is impossible to find solutions that might actually be helpful.

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 financial problems for oil producers and for oil exporting countries. We are really dealing with a physics problem that affects many parts of the economy at once, including wages and the financial system. I try to look at the overall problem.
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347 Responses to The Real Oil Extraction Limit, and How It Affects the Downslope

  1. nonplused says:

    I worked until recently for a company that did an extensive analysis of gas supply in North America. Our results were as follows, and anyone can come up with this from the publically available information but it takes a fair amount of doing.

    Natural gas production is rising in some areas where the cost is essentially zero, like the Bakken and the Eagleford. This gas is associated gas from oil production and is essentially free, the oil pays for the well. In the Bakken they are still flaring something like 200 million mmcf/d, you can see it from space (Google Bakken gas flaring from space.)

    The Marcellous is also growing rapidly. Production costs can be as low as $2/mmbtu and they are very close to major markets, so transport costs are low.

    But all 3 of these plays will soon reach physical limits to production. They can only drill so many wells a year and decline rates are high. So that, combined with gas exports and coal plant retirements will eventually bring supply and demand into a balance that requires more expensive fields to be developed. There are a lot of them out there, but the price will have to be substantially higher than it is now. But it will still be significantly below the current cost of oil on an energy equivalent basis.

    If and when gas prices rise to a level that funds the marginal fields, producers with a large footprint in the Bakken, Eagleford, and Marcellous are going to make a mint.

    The major risk to this analysis is a reversal of anti-coal policies once gas and thus electricity prices start to rise. Put coal back on the agenda and it could be a while before gas prices rise above what we now call “the coal stack”. I also think that Thorium derived electrical power should be explored but right now we just don’t seem to have the money or will to do anything but keep our heads above water.

    Uranium derived electricity has probably seen it’s heyday, we don’t need anymore plutonium to wipe out the world and the process is way to messy, as the public will come to understand probably quite soon due to the continuing deterioration of the situation at Fukashima. Actually Fukashima is way more scary than people understand, because a loss of control of this situation has major implications beyond the release of the thousands of tons of spent fuel at just that one site. If they lose a spent fuel pool at Fukashima, the resulting exclusion zone could include other nuclear reactors, and without human intervention what’s to stop those sites from releasing materials? I’m taking about a domino affect here that might eventually wipe out Japan and have far reaching implications for the entire northern hemisphere.

    • Leo Smith says:

      Oh dear. Uranium fuel has had its day? – more reactors being built than ever.
      Plutonium not needed? – its better reactor fuel than uranium. All modern reactors can burn it.
      Thousands of tonnes of used fuel at Fukushima? Hardly. A typical reactor gets through less than a hundred tonnes a year.

      Stick to oil gas an coal, where your expertise and knowledge lies….

    • You talk about “if and when gas prices rise to a level that funds the marginal fields”. The problem I keep pointing out is that salaries don’t rise with higher energy prices. In fact, they tend to stagnate or fall, except perhaps in the immediate area where the production is taking place.

      If we spend more on energy costs, we have less to spend on discretionary spending. The economy tends to shrink. So the high natural gas prices don’t last for very long, and the companies will again have a problem making money, because the price drops below the marginal cost of production. The government tries to keep interest rates low to cover up this problem, but it is not clear this approach can continue. It is not a realistic long-term strategy.

      I agree that natural gas prices are way below oil prices, on a heat-equivalent basis. It has been this way quite a while. Oil is much more portable than natural gas, because it is a liquid, so it is much more in demand. Transportation could be switched somewhat toward gas, but it would take quite a while to make a very big transition.

  2. jrwakefield says:

    I really wish you people would end this climate change connection to CO2 nonsense. It diminishes the credibility of the over all message of this. 16 years now of no increase in world average temps in spite of ever increasing CO2 emissions. Record cold in the US this winter. Even the IPCC is backing off in their final version of their recent report. They claim that it is LIKELY that we are causing MOST of climate change. That means they are 50.1% sure we are causing 50.1% of the world’s climate. Yet in the real world there is nothing happening which is beyond normal variation. Nothing. If you think there is, then please I’d be more than happy to see a SCIENCE paper published which measures that abnormal change. But you wont find it because it doesnt exist. Human caused climate change is dead, just the supporters are too wrapped up in their ideology to see it.

    • Leo Smith says:

      Well you will enjoy this. Climate Believers should look away. Its blasphemous.

    • For what it is worth, Euan Mearns (formerly of The Oil Drum) has a post up called, The Ice Man Cometh. There were several Climate Change nonbelievers at The Oil Drum.

      • jrwakefield says:

        I was booted out from commenting at TOD for my skeptical views of AGW. Oh, and please get it right. EVERYONE understands that the climate changes. It as done for 4.5 billion years, and will do for billions more. We are skeptical of the THEORY that the ONLY cause of current change in the climate is only because of our emissions of CO2.

        • There were sharp divisions in views on climate change at TOD. Leanan was seriously concerned about climate change, and pushed her views on Drumbeat. There were so many conflicts otherwise that climate change posts, per se, rarely appeared on TOD.

  3. Chris Johnson says:

    How should we reconcile the apparent contradictions between the reports of declining oil production worldwide, and newly discovered fields that promise almost unlimited opportunities? Here are two to look at:

  4. Paul says:

    I just read this on the Financial Times web site —- and quite frankly — I am feeling a bit nauseous…..

    Toil for oil means industry sums do not add up

    Rising costs are being met only by ever smaller increases in supply

    The most interesting message in this year’s World Energy Outlook from the International Energy Agency is also its most disturbing.

    Over the past decade, the oil and gas industry’s upstream investments have registered an astronomical increase, but these ever higher levels of capital expenditure have yielded ever smaller increases in the global oil supply. Even these have only been made possible by record high oil prices. This should be a reality check for those now hyping a new age of global oil abundance.

    According to the 2013 WEO, the total world oil supply in 2012 was 87.1m barrels a day, an increase of 11.9mbd over the 75.2mbd produced in 2000.

    However, less than one-third of this increase was in the form of conventional crude oil, and more than two-thirds was therefore either what the IEA calls unconventional crude (light-tight oil, oil sands, and deep/ultra-deepwater oil) or natural-gas liquids (NGLs).
    This distinction matters because unconventional crude has a higher cost than conventional crude, while NGLs have a lower energy density.

    The IEA’s long-run cost curve has conventional crude in a range of $10-$70 a barrel, whereas for unconventional crude the ranges are higher: $50-$90 a barrel for oil sands, $50-$100 for light-tight oil, and $70-$90 for ultra-deep water. Meanwhile, in terms of energy content, a barrel of crude oil is worth 1.4 barrels of NGLs.
    Threefold rise

    The much higher cost of developing unconventional crude resources and the lower energy density of NGLs explain why, as these sources have increased their share of supply, the industry’s upstream capex has increased. But the sheer scale of the increase is staggering: upstream outlays have risen more than threefold in real terms over the past 12 years, reaching nearly $700bn in 2012 compared with only $250bn in 2000 (both figures in constant 2012 dollars).

    Coinciding with the rise in US tight-oil production, most of this increase in upstream capex has occurred since 2005, as investments have effectively doubled from $350bn in that year to nearly $700bn in 2012 (again in 2012 dollars).

    All of which means the 2013 WEO has the oil industry’s upstream capex rising by nearly 180 per cent since 2000, but the global oil supply (adjusted for energy content) by only 14 per cent. The most straightforward interpretation of this data is that the economics of oil have become completely dislocated from historic norms since 2000 (and especially since 2005), with the industry investing at exponentially higher rates for increasingly small incremental yields of energy.

    The industry has been able and willing to finance such a dramatic increase in its capital investment since 2000 owing to the similarly dramatic increase in prices. BP data show that the average price of Brent crude in real terms increased from $38 a barrel in 2000 to $112 in 2012 (in constant 2011 dollars), which represents a 195 per cent increase, slightly greater in fact than the increase in industry capex over the same period.

    However, looking only at the period since 2005, capital outlays have risen faster than prices (90 per cent and 75 per cent respectively), while in the past two years capex has risen by a further 20 per cent (the IEA estimates 2013 upstream capex at $710bn versus $590bn in 2011), while Brent prices have actually averaged about $5 a barrel less this year than in 2011.
    Iran not a game changer

    That prices have fallen slightly since 2011 while capex has risen by a further 20 per cent is a flashing light on the industry’s dashboard indicating that its upstream growth engine may finally be overheating.

    Without a significant technological breakthrough reversing the geological forces that have driven the unprecedented increase in upstream investment over the past decade, prices will have to rise further in real terms from here or else capex – and with it future oil production – will fall.

    It should also be emphasised that this vast increase in capex has occurred during a prolonged period of record-low interest rates. Once interest rates start rising again, this will put further pressure on the industry’s ability to make the massive capital outlays required to keep supply growing.

    Of course, the diplomatic breakthrough achieved with Iran over the weekend could provide some much needed short-term relief to the market, as Iran’s exports could ultimately increase by up to 1.5m barrels a day if and when western sanctions were to be fully lifted. But this would not change the dynamics of the industry’s capex treadmill in any fundamental sense.

    Even if global oil demand only grows at 1 per cent a cent a year, those extra barrels would be would be fully absorbed by the market within about 18 months. And that is probably how long it would take for Iran’s production and exports to return to pre-sanctions levels in any case.
    Alternatively, if we take the IEA’s estimate that global production of conventional crude oil from all currently producing fields will decline by 41m barrels a day by 2035 (that is, by an average of 1.9m barrels a day per year), then Iran’s potential increase of 1.5m barrels a day would compensate for just 10 months of natural decline in global conventional-crude output.
    In short, behind the hubbub of market hype about a new age of oil abundance, the toil for oil is in fact now more arduous and back-breaking than ever.

    This should worry everybody, because with the evidence suggesting that consumers are reluctant to pay much above $110 a barrel, it is an open question what happens next to the industry’s investment plans and hence, over time, to the supply of oil.

    Mark Lewis is an independent energy analyst and former head of energy research in commodities at Deutsche Bank; Daniel L Davis, a lieutenant colonel in the US Army, is co-author

  5. Aleh Kaliada says:

    BTW sorry for spelling, non-native english and no time for verification. Also big thanks for your great blog, which i always enjoy reading.

  6. Aleh Kaliada says:

    Hi, Gail.
    While i generally agree with most of your analysis, the thesis about oil’s major contribution to the fall of USSR is questionable imo.

    Firstly, unlike today’s Russian Federation, oil exports never were a big part of the soviet budget. Until 70s oil exports revenues were close to zero at all – and USSR felt not bad at that time dispite this inconvinience.
    After that oil exports started to rise. But even at the (short) peak prices time hard currency revenue was modest.
    Let us look into numbers. I did this calculations several years ago. Historical prices were taken from worldbank, export volumes – according to BP Stat Review.
    1st column is year. 2d is price of oil in constant 2005 year dollars. 3d is total exports, bill USD. 4d column is appr export in hard currency, bill USD (it is important, cause hard currency oil export was about 1/3 of total soviet oil export, the rest went to soviet block countries and was more like donation than profit to budget)
    1965 6,08 3,3 1,1
    1966 5,62 3,4 1,1
    1967 5,45 3,6 1,2
    1968 5,45 4,0 1,3
    1969 4,98 3,8 1,3
    1970 4,46 3,5 1,2
    1971 5,92 5,0 1,7
    1972 5,85 4,9 1,6
    1973 7,78 7,0 2,3

    As we can see, until 1973 hard currency oil revenues were about 1-2 $ billions 2005 year. Negligible. Remember, SU felt not bad in 1973 actually.

    1974 24,95 22,3 7,4
    1975 21,36 21,7 7,2
    1976 23,52 27,2 9,0
    1977 23,51 29,3 9,8
    1978 20,79 27,0 9,0

    These are 1st oil shock years. OPEc so called embargo, Nixon’s oil racioning laws, Israel-Arab war… Soviet hurd currency revenues from oil rise to $ 7-9 billions in 2005 dollars.

    1979 43,03 58,2 19,4
    1980 48,37 64,6 21,5
    1981 46,51 62,6 21,0
    1982 44,1 61,5 20,5
    1983 41,15 60,3 20,1
    1984 40,52 58,2 19,4
    1985 38,98 51,5 17,2

    These are 2d oil shock years. Iran revolution and Iran-Irak war. The revenues of USSR from oil rise to appr $20 billions of 2005 year dollars a year. This is the time of the most dependance on oil revenues – at least it is usually said so.
    Divide that $20 bill a year on the population of the SU – 300 millions ppl – and that is $65/year or $5/month (dollars of 2005 year). Not too bad. But hardly something that could be critical actually.
    In total we have 12 years of relatively big hard currency flows to soviets. Relatively – because they were small actually comparatively to the total sovet budget.

    1986 17,89 25,9 8,6
    1987 20,64 31,0 10,4
    1988 15,72 24,1 ?12
    1989 19,17 27,2 ?14
    1990 23,66 26,3 ?14
    1991 20,09 17,4 ?10

    These are drop in prices years until the fall of the soviet union… More than 1/3 of total oil exports is sold for hard currency that years, so ?? at the 4d column. Now it is around $10 bill a year, instead of $20 bill previous 7 years, and exactly similar to the 5 years before that (1974-1978).

    Just for comparison. Russian Federation.

    1991 20,09 32,2
    1992 19,48 24,9
    1993 17,09 20,8
    1994 16.1 18,3
    1995 15,95 19,3
    1996 19,56 24,8
    1997 19,58 25,6
    1998 14,03 18,6
    1999 19,84 26,0

    These are nasty 90s. People of the ex-USSR live very bad that years. Life expectancy drops an astounding 7 years. Thanks to reforms. Old people begging and undernourished are common – which was unthinkable before. Pay attencion,
    that hard currency revenues are actually higher that years than any time before that, and that should be divided for just a half of the population (soviet 300 million against russian 145 millions people). Paradox? Not at all…

    2000 31,60 46,3
    2001 28,71 47,5
    2002 29,57 55,5
    2003 32,04 69,7
    2004 38,85 93,5
    2005 53,39 133,1
    2006 62,93 159,0
    2007 65,51 170,8
    2008 82,86 210,8
    2009 56,50 148,7
    2010 69,99 183,4

    These are 2000’s years. Yes. 10-20 fold rise. That is contemprorary Russia’s foundation. And yes – for contemprorary Russia this is vital, and a major part of the budget. Unlike USSR.

    Drop in oil prices had some role in USSR falling. But not main at all. There were much more important drivers.

  7. Wishing everyone a Happy New Year! I should be around for a while, until a short trip to Sweden February 8 – 12.

  8. Don Stewart says:

    Dear All

    There has been some discussion here about three problems, or perhaps three aspects of essentially the same problem:
    1. The ‘oil is too expensive’ problem (Gail)
    2. The ‘debt is too high’ problem (Nicole Foss)
    3. The ‘climate change is a 400 pound gorilla’ problem (James Hansen)

    Many of the advocates for each position maintain that their particular viewpoint is the important one, while the remaining two viewpoints are not important. I would like to consider the relationship between the three viewpoints in terms of human psychology. I will refer to a study described in Scarcity.

    Tunneling means that we focus on something to the exclusion of other important things. For example, a deadline focuses us on the urgent need to finish a job, which makes us neglect things which are not the job we are focused on. Firemen are rather frequently killed because they failed to fasten their seat belts in the fire truck and the fire truck has an accident on the way to the fire. The firemen always fasten their seat belts in their private automobiles, but while racing to a fire they are tunneling on many other things and do not think about the seat belt.

    Page 34 in Scarcity
    ‘To measure the cost of tunneling, we added a wrinkle. We had participants play two games side by side. They were given two pictures to memorize and to reconstruct. And we made them poor (few guesses) in one game and rich (many guesses) in the other. So they experienced scarcity in trying to reconstruct one picture but not the other. Their total earnings depended on their performance in both games: they had to maximize total points earned. Think of it as having two projects, one with a deadline tomorrow and the other a week later. If people were to tunnel, then what they gain in one picture would be offset by worse performance on the other.

    Consistent with the focus dividend, people were more effective guessers on the picture they were poor on. But they also tunneled: they neglected the other picture. And this was not efficient. They performed so much worse on the neglected picture that they earned, overall, fewer points than subjects who were poor on both pictures. They earned less even though they had more total guesses.’

    It seems to me that expensive oil, excessive debt, and climate change are all very serious issues. We should not be trying to solve any one of them while neglecting the other two, else we will suffer the same fate as the study participants..

    Of course, quite a few people think that there simply are no solutions and humanity, and perhaps a whole lot of other creatures, are going to become extinct. As I have said here many times, I tend to side with Toby Hemenway’s talk ‘How to Save Humanity, But Not Civilization’. Saving humanity, I think, requires a simultaneous solution to all three aspects of what I see as one large problem. We have to recognize the deadlines, but not sub-optimize by focusing on only one aspect.

    Don Stewart

    • I would put excessive debt right up with the high cost of oil, in terms of what brings the economy down. Debt can’t keep growing, and an increase in interest rates may very will be the final straw, ultimately circling around to bring down both oil production and the economy.

      What happens to climate is interesting, but if most of us are dead, really doesn’t matter a whole lot. The earth will save itself; it will cycle to a new climate state. The point behind all of the climate change hysteria is a need to save humans from climate change. Climate change is not really anything we can do anything about, except allowing the collapse which we are already facing happen. The collapse from energy/ debt will bring the system down as effectively as anything we could engineer, to prevent climate change. I don’t know whether the collapse will make any difference, but there is really nothing more we can do. Worrying about climate change won’t help. We may have to go back to being hunter-gatherers, but that is a possibility regardless.

      • Don Stewart says:

        I disagree that collapse is the only thing we can do about climate change. As both Jim Hansen and Albert Bates and others make clear, we can also do reforestation and carbon farming. Hansen gives estimates for the potential carbon sequestration, and Albert gives his own estimates. Choosing NOT to do carbon farming and reforestation is a vote FOR climate change.

        One might argue that high priced oil or excessive debt is going to crash the economy in 2014, so it is a moot question. Old timers like David Holmgren and Albert Bates have been saying that industrial civilization is doomed now for 30 years. It is still chugging along. You can expect David and Albert to be more circumspect about their forecasts than newcomers who haven’t been serious wrong…yet.

        So a little humility is certainly in order from all of us. In any event, if civilization DOESN’T crash in 2014, then the issue of climate change and whether we do something positive (carbon farming and reforestation) is still on the table. Hansen notes that both positive actions make it easier for humans to make it through a crunch.

        Don Stewart

      • Joy says:

        It doesn’t matter what any of us say here, those that can see the writing on the wall and the cataclysm looming will lay out a case for change and those that buy into all well funded conspiracy theories, like the $ 1 billion spent per year to fight cap and trade will toe the corporate paid for line, people who can’t even comprehend that we are leaving a toxic junk pile in our wake as we exploit our way through this age.

        It’s a pity that disaster will unfold equally on the sane and rational as much as on the irrational and non thinkers but we might have to come to a point where much of the world is a desert including the US and over 1/3 of what was dry land sits under water as sea levels rise. Before sanity prevails

        I’ve been fighting this battle on the streets, through the media and face to face for more than 40 years and every year the outlook has become grimmer while denials have become louder, less sane and full of rote learned catchphrases that have even eliminated individual thought on the denial side.

        I’m OK, I’m in my sixties and won’t be around to witness much of the destruction but the same people who hyperventilate over an easily fixable debt problem are in full support of leaving an unviable ecosystem for the grandkids, and I’m sure they’d rather be left with some debt than planetary devastation.

        It takes a special type of ignorance to see a fiscal problem as being far more severe than the end of life as we know it but people are people, some study and learn and through learning grow and change while others are told what to think, how to repeat what they were told, stagnate and then slip into ignorance induced entropy.

        All I am thankful for is when the final tally is taken, I and many of us stood up for the planet and future while too many were bought by shiny, glitzy advertising paid for by big pollution.

        It’s a crying shame that all will be punished by the willfully induced ignorance that has held back any progress in fixing an ever more severe problem.

        Oh and Happy New Year and enjoy them while they last.

      • Actually, I should say cost of oil that is too low for producers to make a profit, even as it still is on the high side for consumers, who are increasingly without jobs.

  9. Pingback: … and into 2014 | Brain Noise

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