Tuesday, January 12, 2010

Nonsense, Peak Oil, and Oil Prices

Nonsense, Peak Oil, and Oil Prices....?

Peak Oil: By Seth Myers

After the oil price collapse of 2008, the subsequent rise to $80 this year convinced many that people that oil traders were anticipating a tight oil market with the economic recovery. Meanwhile, others felt that speculators were reacting to financial factors like the weak dollar rather than market fundamentals. The former were very much encouraged by the many advocates of “peak oil” who perceived a long chain of negative news and predictions as heralding the end of the oil age.

Here’s the reality: we are nowhere close to the end of the oil age. A careful examination of the facts shows that most arguments about peak oil are based on anecdotal information, vague references and ignorance of how the oil industry goes about finding fields and extracting petroleum. In fact, today’s oil market is similar to what we saw back in the 1980s, which saw an oil price spike, followed by a price collapse that persisted for years.

Let’s consider the arguments of the peak oil promoters. The more alarmist of these people claim that oil production peaked sometime in the past few years, and that helps explain the triple-digit prices that occurred last year. But blaming peak oil for the price spike requires two rather extraordinary beliefs. One is that the May 2005 peak in crude-plus-condensate production is irreversible, even though such peaks have occurred in the past. The other is that last year’s 3-million-barrel-per-day reduction in OPEC production was due to a decline in OPEC capacity that just coincidentally happened as prices were collapsing and OPEC reduced quotas by 3.5 MMbbl/d.

The recent round of warnings began in the 1990s, when some geologists used so-called Hubbert curves to estimate resources and predict production around the world. This resembles the fallacy many economists fall prey to, namely believing the model over reality. Hubbert curves are not the norm in the real world, nor have they successfully predicted production except in rare cases. In 1980, Hubbert himself used the curve to estimate remaining US gas resources at 270 to 400 trillion cubic feet; US gas production since 1980 has totaled 500 Tcf, and gas reserves have increased.

Most (but not all) peak oil advocates have abandoned this theory, along with the corollary that a peak in production represents the point at which half of the resource has been produced. Since many countries have had multiple peaks, this is obviously false. Instead, these analysts rely on estimates of resources using creaming curves, made up of discovered fields by size, which tend to flatten out as an area is depleted.

Unfortunately, in doing so, two shortcomings have been ignored. First, field size estimates are not fixed, but tend to grow over time as better recovery methods are applied and new investment adds to oil-in-place. Peak oil advocates argue that new methods do not improve recovery, pointing to occasional field examples to support their claim, despite the overwhelming evidence to the contrary. Again, reality trumps models.

Additionally, creaming curves are only reliable if there are no serious constraints on drilling. Witness the interpretation (by Jean Laherrere) of the sharp drop-off in field size in the Middle East as evidence of resource scarcity in the region, when in fact it merely represents the shift in drilling after 1980 from the major countries (Iran, Iraq, etc.) to Oman, Syria and Yemen. Policy, not geology, is the explanation.

Finally, there are the recent efforts to predict production by categorizing fields and/or countries into rising, plateau or declining categories. Like other efforts, this ignores all variables (politics, economics, infrastructure, technology) in favor of a time-element, presumed to represent geology. Again, this flies in the face of the historical data, where many countries have seen production decline, only to recover upon tax reduction, the welcoming of new foreign investment, or by the simple expedient of investing more money.

And the emphasis on depletion rates, found to be increasing lately, raises a valid concern but is lacking. While new technologies allow fields to be produced more quickly, this is an input rather than an output. Drilling more wells will offset that decline rate, as witness countries like Iran, said to have an 8% depletion rate, yet whose production has not fallen—until its quota was reduced last year. Differential levels of investment explain why some countries’ production is stable or rising rather than falling, and the countries whose production is falling are often those that have a xenophobic or confiscatory investment environment.

Moving beyond the data which peak oil advocates emphasize, there is ample evidence that the petroleum resource remains abundant. In the 1990s, it was correctly noted by some peak oil advocates that there was a rough consensus (reached in the 1970s) that the recoverable petroleum resource (not the total, or in-ground, resource) was about 2 trillion barrels. Since then, however, most analysts have produced estimates of around 3.5 trillion barrels of recoverable petroleum. With a global recovery rate of about 35%, this implies approximately 10 trillion barrels of oil in place. (I personally consider that conservative, based on experience with resource estimates.) And this is conventional oil, with easily that much unconventional, mostly shale, oil around. The sky may not be the limit for production, but clearly there is no resource constraint.

Certainly, resource nationalism is a concern, since it forces the industry to exploit more expensive resources than otherwise, but it is also two-edged knife. Recall that the last major price collapse, in 1998, followed the decision by the Venezuelan government to reform its upstream sector, leading to an increase of 1 MMbbl/d in six years, mostly conventional oil. There are a number of countries that have the potential to increase production by significant amounts in the next few years, including non-OPEC countries like Brazil, Mexico, and Russia, as well as many small countries that are likely to reverse their recent declines and raise production, implying that the peak is nowhere in sight.

And while some analysts, such as CERA and Total, argue that they can’t see production rising for more than another decade or two, this is more an acceptance of the limits of their foreknowledge: we can’t see where new automobile capacity will come from in two decades, but that doesn’t mean production will peak.

The current market resembles that of the early 1980s, when, after a peak, prices moderated somewhat. Analysts warned that weak oil demand was due to slow economic growth, not conservation, and non-OPEC costs were much too high to allow any significant new supplies to come on line. As late as 1985, when OPEC production had dropped by nearly 50% in five years, almost no one anticipated the subsequent price collapse. This time around, many in the industry are more wary of predictions of tightening markets, but the likelihood of much lower prices in the next five years will almost certainly mean another major round of industry consolidation.

Michael Lynch, the former director for Asian energy and security at the Center for International Studies at the Massachusetts Institute of Technology, is an energy consultant.

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