A Discussion of Peak Oil

A couple of days ago the Wall Street Journal ran an opinion piece stating essentially that all the hype over peak oil is wasted air.  Yergin writes with a clear distaste for anything and anyone who has cautioned the world that oil may not last forever or that we ought to be thinking about what to do about that now.  Let me right away state my first issue with the article: it is filled with flashy, attention-getting language that is mixed with a fair share of hyperbole and grandstanding.  For any of my students out there reading this, when you see language like this, you know one thing: you aren't going to get an analysis that is carefully reasoned, looks fairly at all sides of an issue, and reaches a balanced judgement on the topic at hand.  That doesn't mean it doesn't have some good points to make, but it does mean we need to take a careful look at what it has to say.

The idea of "peak oil" is pretty simple - it is the idea that at some point the world will no longer be able to keep up oil production and over the years global production of oil will begin to decline.   Pretty much everyone believes this; the debate is always about when that time will come and what a post-peak oil world will look like.  The Wikipedia site for Peak Oil is in my opinion quite good on this subject, and another excellent site is The Oil Drum.  The idea was put forward by a geologist named Hubbert, who made some calculations about how much oil is possibly recoverable and then made some predictions about how U.S. national oil supplies will trend in the coming decades.  He began with the idea of small oil fields, and noticed that in many cases the production of oil from oil fields tends to follow something like a bell-shaped curve (technically it isn't a true bell-shaped curve, but it resembles one).  Production is low at first, rises quickly, eventually hits a maximum, and then begins to decline.  Within a larger region, the total amount of oil is higher, so the curve has a very similar shape with the difference being that the curve is larger and the peak comes later.  Hubbert speculated that since fields of oil and regions of oil fields tend to proceed in this manner, then so will the total amount of oil in a larger area - such as a nation, and eventually the whole planet if we continue to extrapolate.  So really it is a matter of scale - small oil fields tend to follow a small bell-shaped curve, larger regions follow a similarly shaped but slightly larger bell-shaped curve, nations and the planet as a whole will likewise follow a similarly shaped but much larger bell-shaped curve.  But in each case, a peak in production is reached and production decreases after that.

In the mid-1950's, Hubbert predicted a curve for the United States and stated that the U.S. would achieve peak oil production ~1965-1970, and decline from that point.  His prediction has been impressively accurate for actual U.S. oil production. Yergin attempts to downplay this in the WSJ article, focusing on the trees and arguing against the existence of the forest.  But it is a simple thing to compare Hubbert's prediction of the U.S. peak with now historical data and see an impressive similarity.  U.S. oil production peaked in 1970, and has been in decline since.  It has also been applied to numerous other regions and again the fit is often pretty good.  In other words, Hubbert's peak is an important concept for us to understand.

In some ways, Yergin is right to critique Hubbert.  Hubbert's idea was a simple, starting model.  It was a model based primarily on geologic volume of available oil.  But the availability of natural resources is not simply due to geologic factors, but also to technological, economic, and political factors.  Hubbert didn't include any wiggle room for advancements in technology, which have increased the total amount of recoverable oil from the world's oil fields by a significant percentage.  There is no doubt that new technologies have allowed us to find more oil than initially anticipated for various oil fields and regions.  These improvements have changed the back end of the curve, so that it doesn't fall as quickly.  What this tells us is that the model needs to be updated and improved, not that the model needs to be ridiculed.

Hubbert's idea applied to the planet as a whole also doesn't incorporate economic factors well (really, at all).  But neither does Yergin's analysis seem complete here.  One problem with applying Hubbert's peak to global oil production is that there is a difference in the relationship between production and price at these different scales.  For a small field, when production begins to decline, there is no affect on the price of oil in the global market.  Production falls and price is unaffected.  This simply cannot translate, however, to the global scale, where decreasing production will have a tremendous impact on price.  As global production begins to decline, price generally will increase.  As the price increases, demand may decrease and cause the price to fall again, but eventually price & demand will find a new equilibrium as the total supply continues to decrease.  The net result generally is that price will rise, but it is buffered by decreasing demand.  But a brief history lesson is in order here.    

Oil prices, production, and reserves have at times followed a pattern such as this: oil reserves begin to get low, decreased supply causes prices to begin to rise, increased prices lead to increased profits, a portion of profits are re-invested into exploration for new oil fields, new oil fields are discovered, reserves & production increase, and prices then drop again.  This scenario played out on a large scale in the 1970's & '80's, when oil jumped from $3/bbl to over $30/bbl in a short decade.  But as the price rose, oil companies began spending their money on finding new sources of oil.  And they were successful, especially in the North Sea (UK & Norway) and in Mexico, both also important for being non-OPEC nations.  As these new discoveries were put into production, reserves and production increased, and price began to fall.

Hence, at times we might think we have reached a global peak in oil production, but the factors surrounding that may lead to new discoveries that in turn cause production to rise again.  So that what we thought was the peak, wasn't.  And this could certainly happen again.  Anyone who's climbed a mountain is familiar with this - often times you think you can see the peak ahead of you, but then you get there and you realize it isn't.

But another point needs to be made that is completely avoided by Yergin: cheap oil is found first, expensive oil is found later.  Yergin states that the world has 1.4 trillion bbl of reserves, and another ~3.5 trillion bbls of reserve base, material that is either not economically viable at the present time (i.e., too expensive to get out right now) or material that is not precisely known from a geological standpoint.  That 3.5 trillion number by the way is highly controversial.  Most of that 3.5 trillion is tied up in very non-conventional sources of oil - tar sands and oil shales.  While these do exist, the problem is two-fold:  1) they will require very high prices for oil in order to be possible; and 2) they will require significantly higher impact on the environment in order to extract them.  Focusing on #1, what this means is that as we continue to move forward in time, the next oil fields are going to require higher oil prices.  As oil production declines and remaining production moves to more and more expensive areas of extraction, price is going to go up.  The days of $2/gal gasoline are very likely long gone and aren't coming back, a point that Yergin doesn't bring up.  Yes there is potentially still a lot of oil out there, but fewer and fewer people will be able to afford to buy it.

In the end, we must also realize that in such a complex global system involving geology, economics, engineering, technology, & politics, no one is ever going to be able to correctly predict the peak of oil in such a way that all of the rest of us will find it absolutely convincing.  There will always be differing opinions on when peak oil will occur.  One thing is clear - we aren't going to know when peak oil happens until after it does, and perhaps not even until a decade or more has passed.  Only in hindsight will we be able to say when peak oil occurs.  The prudent thing then is to make preparations for it earlier rather than later, but currently too few understand the concept and there is no consensus yet on what should be done about it.