How the Peak Oil story could be “close,” but not quite right

A few years ago, especially in the 2005-2008 period, many people were concerned that the oil supply would run out. They were concerned about high oil prices and a possible need for rationing. The story was often called “Peak Oil.” Peak Oil theorists have also branched out into providing calculations that might be used to determine which substitutes for fossil fuels seem to have the most promise. What is right about the Peak Oil story, and what is misleading or wrong? Let’s look at a few of the pieces.

[1] What Is the Role of Energy in the Economy?

The real story is that the operation of the economy depends on the supply of  affordable energy. Without this energy supply, we could not make goods and services of any kind. The world’s GDP would be zero. Everything we have, from the food on our dinner table, to the pixels on our computer, to the roads we drive on is only possible because the economy “dissipates” energy. Even our jobs depend on energy dissipation. Some of this energy is human energy. The vast majority of it is the energy of fossil fuels and of other supplements to human energy.

Peak Oilers generally have gotten this story right, but they often miss the “affordable” part of the story. Economists have been in denial of this story. A big part of the problem is that it would be problematic to admit that the economy is tied to fossil fuels and to other energy sources whose supply seems to be limited. It would be impossible to talk about growth forever, if economic growth were directly tied to the consumption of limited energy resources.

[2] What Happens When Oil and Other Energy Supplies Become Increasingly Difficult to Extract? Continue reading

The real oil limits story; what other researchers missed

For a long time, a common assumption has been that the world will eventually “run out” of oil and other non-renewable resources. Instead, we seem to be running into surpluses and low prices. What is going on that was missed by M. King Hubbert, Harold Hotelling, and by the popular understanding of supply and demand?

The underlying assumption in these models is that scarcity would appear before the final cutoff of consumption. Hubbert looked at the situation from a geologist’s point of view in the 1950s to 1980s, without an understanding of the extent to which geological availability could change with higher price and improved technology. Harold Hotelling’s work came out of the conservationist movement of 1890 to 1920, which was concerned about running out of non-renewable resources. Those using supply and demand models have equivalent concerns–too little fossil fuel supply relative to demand, especially when environmental considerations are included.

Virtually no one realizes that the economy is a self-organized networked system. There are many interconnections within the system. The real situation is that as prices rise, supply tends to rise as well, because new sources of production become available at the higher price. At the same time, demand tends to fall for a variety of reasons:

  • Lower affordability
  • Lower productivity growth
  • Falling relative wages of non-elite workers

The potential mismatch between amount of supply and demand is exacerbated by the oversized role that debt plays in determining the level of commodity prices. Because the oil problem is one of diminishing returns, adding debt becomes less and less profitable over time. There is a potential for a sharp decrease in debt from a combination of defaults and planned debt reductions, leading to very much lower oil prices, and severe problems for oil producers. Financial institutions tend to be badly affected as well. If a person looks at only past history, the situation looks secure, but it really is not.

Figure 1. By Merzperson at English Wikipedia - Transferred from en.wikipedia to Commons, Public Domain, https://commons.wikimedia.org/w/index.php?curid=2570936

Figure 1. By Merzperson at English Wikipedia – Transferred from en.wikipedia to Commons, Public Domain, https://commons.wikimedia.org/w/index.php?curid=2570936

Substitutes aren’t really helpful; they tend to be high-priced and dependent on the use of fossil fuels, including oil. They cannot possibly operate on their own. They add to the “oversupply at high prices” problem, but don’t really fix the need for low-priced supply.

Why supply tends to rise as prices rise

Continue reading

Reasons for our Energy Predicament – An Overview

Quiz: What will cause world oil supply to fall?

  1. Too little oil in the ground
  2. Oil prices are too low for oil producers
  3. Oil prices are too high for oil consumers leading to recession, debt defaults, and ultimately a cut back in credit availability and very low oil prices
  4. Oil exporters are subject to civil unrest and overthrow of governments, due to low prices and/or depleting reserves
  5. Lack of money (and physical resources that might be purchased with this money) to pull oil out of the ground.
  6. Pollution related issues–too much smog in China; too many problems with fracking; too many problems with CO2.
  7. The financial current system fails, and can only be replaced by one that allows much less debt. Oil prices remain too low under such a system. 

In my view, any answer other that the first one is likely to be at least partially right. Ultimately, the issue is that to extract oil or any fossil fuel, we have to keep the financial and political systems together. These systems can be expected to fail, far before we run out of oil in the ground. Most oil in the ground (as well as most other fossil fuels in the ground) will be left in the ground, in my view.

Basing estimates of future oil production on oil reserves is likely to give far too high an indication with respect to actual future production. Even more absurd numbers come from using “resource” numbers (which are higher than reserve numbers) to make estimates of future oil production. Coal and natural gas production is likely to fall at exactly the same time as oil, because the problems are likely to be financial and political ones, not “resources in the ground” problems.

Direct Application of M. King Hubbert Theory is Incorrect

M. King Hubbert is known for his estimates of future oil production  (195619621976) based on reserve amounts. There are two things of importance to notice about his estimates:

(a) The oil reserve estimates used are of free flowing oil reserves of the type that geologists currently were looking at. Thus, they were restricted to “cheap to extract” reserves, and

(b) When Hubbert showed graphs of world oil production following a generally symmetric curve (so downslope looks like a mirror image of upslope), Hubbert showed some other source of energy supply (nuclear in his early papers, solar in later ones) rising to high levels, before world oil production ever dropped. He even talked about making liquid fuels using a huge amount of energy plus carbon dioxide and water–in other words, reversing combustion (1962). In order to ramp nuclear or solar up to these very high levels, they would need to be  extremely cheap.

The assumptions that M. King Hubbert makes are effectively ones that would allow the economy to continue to grow and the financial system to “hang together.” If a person looks at today’s situation, it is quite different. We do not have an alternate fuel supply that will  allow the economy to continue to grow, regardless of fossil fuel consumption. The published reserves include large amounts of oil in the ground that are not of the very cheap to extract type. Extracting such oil will be impossible if oil prices are very low, or if credit availability is lacking. It is tempting for observers to look at oil reserves and assume that all is well, but this is definitely not the case.

Continue reading

An Economic Theory of Limited Oil Supply

We seem to hear two versions of the story of limited oil supply:

1. The economists’ view, saying that the issue is a simple problem of supply and demand. Substitution, higher prices, demand destruction, greater efficiency, and increased production of oil at higher prices will save the day.

2. A version of Hubbert’s peak oil theory, saying that world oil production will rise and at some point reach a plateau and begin to decline, because of geological depletion. The common belief is that the rate of decline will be determined by geological considerations, and will roughly match the rate at which production increased.

In my view, neither of these views is correct. My view is a third view:

3. An adequate supply of cheap ($20 or $30 barrel) oil is no longer available, because most of the “easy to extract” oil is gone. The cost of extracting oil keeps rising, but the ability of oil-importing economies to pay for this oil does not. There are no good low-cost substitutes for oil, so substitution is very limited and will continue to be very limited. The big oil-importing economies are already finding themselves in poor financial condition, as higher oil prices lead to cutbacks in discretionary spending and layoffs in discretionary industries.

The government is caught up in this, as layoffs lead to more need for stimulus funds and for payments to unemployed workers, at the same time that tax revenue is reduced. There can be a temporary drop in oil prices (as there was in late 2008), as recession worsens, but eventually demand rises again, oil prices rise again, and the pattern of layoffs and increased governments financial problems occurs again.

Without substitutes at a price that the economy can afford, economies will adapt to lower amounts of oil they can afford by worsening recession, debt defaults, and reduced international trade. There may be tendency for international alliances (such as the Euro) to fall apart, and for countries to break into smaller units (Catalonia secede from Spain, or countries break up the way the Soviet Union and Yugoslavia did).

At some point, probably not too many years in the future, the amount of oil extracted from the ground will drop, reflecting a combination of geological and economic factors. The fall may very well be quite steep. While we can’t expect to extract more than geology will allow, there is nothing to say that political and economic factors will allow extraction of this amount. If civil war breaks out in an oil producer, production may drop quickly. Or if oil prices drop because of severe recession, drilling of new fields and wells may drop off quickly, leading to lower production as existing wells deplete, and not enough new supply as added. There may also be disruption in international sales of oil. Continue reading

The Context of Hubbert’s Peak in World Oil Forecast

(Note: This is a post I wrote which is published in today’s ASPO-USA newsletter.)

Recently when I was reading some of the papers M. King Hubbert wrote, one thing struck me was the context in which he made his forecast regarding how world oil supply would peak and decline. He made this forecast in the context of having plenty of other fuel supply from other sources already developed, to offset this decline.

The three graphs shown in this paper are from Hubbert’s 1956 paper, Nuclear Energy and the Fossil Fuels. Based on Figure 30, it is clear that he expected nuclear energy to raise total energy production to a very high level, even before fossil fuels began to decline.

In his 1962 report, Energy Resources – A Report to the Committee on Natural Resources, Hubbert writes about the possibility of having so much cheap energy that it would be possible to essentially reverse combustion–-combine energy plus carbon dioxide and water to produce new types of fuel plus water. If we could do this, it would be possible to fix our high CO2 levels and produce lots of fuel for our current vehicles, even without fossil fuels. Continue reading