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The Expected Economic Impact of an Energy Downturn

Wednesday, 26 Mar, 2008 – 9:00 | No Comment

I have been asked to give a short talk about the expected economic impact of an energy downturn. The talk is to be part of public health program called “Integrating Environmental Dilemmas: A Teach-in on Energy, Climate Change, Water, Agriculture and Population.” I expect that the audience will be university students. The talk will be recorded, and will appear on the internet. This is a draft of the talk.

Good afternoon. My topic today is the expected economic impact of an energy downturn.

Let’s talk a bit first about the energy downturn. As everyone is aware, the price of gasoline and diesel has been rising recently. The reason the price is rising is because the world’s supply of oil cannot keep up with demand.

Figure 1
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I have illustrated the situation we are facing in Figure 1. Demand for oil is rising, and is expected to continue to rise in the future, at least partly because of the growth of economies such as those in China and India. The supply of oil has leveled off. Many people believe that sometime in the next few years, supply may actually begin to fall. Even if the supply remains level, there will be a growing gap between demand and supply.

Earth Is Finite

What is happening is that the earth is finite, and we are starting to reach some of its limitations. At this point, most of the “easy to extract” oil has already been removed. There is still oil in the ground, but what remains is becoming more and more difficult to remove.

When we try to find alternatives, we encounter limitations of other types. In some situations, natural gas might be a substitute, but in North America it is also in relatively short supply. Coal is in better supply, but it has serious climate change issues.

Biofuels might be a substitute, but today’s biofuels use huge amounts of agricultural land and fresh water, and both of these are in limited supply. Biofuels as they are currently produced compete with other uses for land and water, and because of this, drive up the price of food.

Even the minerals that we might use in batteries, and the uranium we might use in nuclear reactors, are becoming increasingly difficult to extract. We have already removed most of the high quality ores of many minerals. What is left is ores of lower concentration. These ores can still be extracted, but it takes more energy resources to process this ore. The energy resources used for processing the ore are often oil and natural gas, and they themselves are in increasingly short supply.

Immediate Economic Impacts

We are all aware that the price of oil is rising, and with it the price of things made from oil, including gasoline, diesel fuel, and asphalt. Since there is some possibility of changing from one fuel to another, the rising cost of oil also causes the price of other fuels, such as natural gas and coal, to rise. Electricity is made from coal and from natural gas, so its price also tends to rise.

Food prices are also rising. In part, this is because of the higher cost of oil used in growing crops and transporting them to market. Food prices are also rising because biofuels are utilizing food crops. The crops used for biofuels compete with other crops for land, fresh water, and fertilizer, driving up costs of production. Also, total production of food crops has not been able to keep up with demand, including biofuel use, and this further adds to price increases.

Impacts of Higher Food and Oil Prices

A major impact of higher food and oil prices is to squeeze out discretionary spending, such as eating out at restaurants and flying overseas on vacation. Some students may have to temporarily drop out of college, if their families can no longer afford to help with tuition. Families will cut back in many different ways to keep their budgets balanced.

Another impact of higher food and oil prices is more defaults on loans. We first heard about higher default rates on subprime mortgages. As prices of food and energy continue to rise, defaults can be expected to spread to other kinds of loans, such as credit card debt, auto loans, and student loans.

As families cut back on spending, financial difficulties can be expected to spread to businesses. Some types of businesses that are particularly vulnerable include restaurants, airlines, auto manufacturers, and home builders. Businesses with high levels of debt are especially vulnerable, since a drop in revenue is likely to make it difficult to make loan payments.

Financial institutions, such as banks, hedge funds, insurance companies, and pension funds are also likely to be affected by rising default rates. When individuals or businesses take out loans, these loans are often held by one of the various types of financial institutions. If there are defaults, it adversely affects these institutions. Banks and hedge funds often borrow money themselves, so may they find themselves squeezed in the middle if default rates rise. Insurance companies and pension funds may find themselves unable to meet their obligations, if defaults become a serious problem.

Higher energy prices in the past have lead to recessions, including the very severe recession that took place in 1973 to 1975. It is likely that higher energy prices are one of the causes of the current recession.

Longer Term Impacts

The graph I showed earlier suggested that the gap between oil supply and demand is likely to get wider, as time goes on. If the shortfall in oil continues to get worse, and it is not possible to offset this shortfall in other ways, this recession may become a permanent. The recession may get worse with time, turning into what we would think of as a long-term depression.

We are now reaching limits of many kinds. One way of representing the economy at various points in time is as disks of various sizes. Each year, society has various resources available to it, in terms of oil, natural gas, fresh water, soil productivity, many types of minerals, good climate, and people available to work with these resources. Based on the investments we have made over the years, society is able to produce a collection of goods and services using these resources. The amount of these goods and services has been growing. Let us look at this graphically.

In the recent past, the economy has been growing:

Figure 2

With a long-term recession, it may change to a no-growth economy:

Figure 3

More likely, the economy will decline as resources deplete:

Figure 4

(TOD readers: In the article The financial crash has a simple cause and a simple solution, Jerome a Paris discusses the fact that since 2002, the US median wage has stagnated. Thus, for a large share of the population, we have already reached the “no growth” scenario. This lack of growth in median wages is likely the reason that the financial services industry developed new forms of loans that made home-buying look more affordable than it really was. The lack of growth in median wage is also a likely reason that those same schemes are now falling apart. To the right is the graph Jerome showed.)

With a declining resource base, the median wage, adjusted for inflation, is likely to decline. This decline in median wage means that default rates on loans are likely to increase, and that discretionary spending will continue to decline.

Future Promises

It is not very obvious just looking at an array of discs, but a change from a growing economy, to a flat or declining economy, is really a major change. With a growing economy, future promises are relatively easy to fund:

Figure 5

The reason promises like interest payments and social security payments are relatively easy to fund in a growing economy is because these payments are generally not growing as fast as the economy as a whole. When promises such as these are made, the expectation is that the payments will be less of a burden in the future, because the economy will have grown. With this growth, there should be plenty of funds left over for other things.

With a flat or declining economy, funding for promises becomes almost impossibly difficult. Food and energy costs become a bigger share of the economy, over time, because of energy shortages. Future promises like interest, social security, and Medicare payments also become bigger, relative to the total. I have illustrated this in another graph. The combination of the two types of increases, that is the food and energy costs plus the cost of future promises, becomes a huge problem. There is not enough left over for “everything else”.

Figure 6

Lenders Will Soon Catch on to Decline

If the economy is in long-term decline, it will not be very long before lenders start to catch on. Some creditors may actually figure out that the economy is not growing, and that it is not likely to grow in the future, because of energy shortages and other limits. Other lenders may only figure out that the default rate is very high, and, because of the way the economy is headed, it can only go higher. Regardless of their reasoning, many lenders are likely to come to the same conclusion, namely, that it no longer makes sense to offer loans.

For the United States, the balance of payments deficit is very much like debt. For years, the United States has been importing nearly twice as many goods as it exports. Once trading partners realize that the US economy is in long-term decline, they will realize that it will be almost impossible for the United States to make up for its export shortfall in the future. They are also likely to realize that buying US treasury bonds is not a good substitute for an even trade balance, since the Treasury bonds are likely to decline in value in the future, in terms of the goods they can buy. These issues could lead to a crisis in US imports of all kinds.

World Is Headed for a Credit Unwind

It seems likely that the world is now headed for a major unwind of credit. There has recently been a crisis in the financial markets. This crisis looks very much like the beginning of a major shift toward reduced credit availability. As energy supplies get tighter, economic conditions are likely to get even worse. People will be spending more for food and gasoline, so will be more likely to default on loan payments. If people are out of work, they are more likely to share living spaces. This will reduce demand for houses, and further depress prices.

I expect that the shift toward reduced credit availability will expand in the future. This may even be the “great unwind”, in which debt and financial instruments of all types, including derivatives, become very much less common. The real question now is what form the unwind will take. How major will it be? Will it take place in steps, or will large sections of it occur all at once?

The impact of a credit unwind is very much like cutting up a person’s credit cards. The person (or business or government) still owes as much debt as in the past, but the organization has no way of obtaining new credit. The debtor must now repay the loans out of current income, in addition to paying current expenses out of income. For many, this will not be possible. Bankruptcy seems likely for many, including a large number of businesses and some governments.

It is possible that a correction to the balance of payments situation, mentioned previously, could be part of the unwind. If this happens, imports of all kinds could drop by as much as half, very quickly.

Looking Ahead 20 or 30 Years

If we look ahead 20 or 30 years, it seems likely that the world will be very much poorer. Personal autos may be rare. Electricity may be unreliable. It is likely that we will have much less in the way of goods and services than we have today. A growing population may add to our problems. If the smaller supply of goods and services is divided among more people, living standards are likely to be much lower than they are today.

If the world is much poorer, I would expect social security and Medicare to be drastically scaled back or even eliminated. There will be so little goods and services in total that society cannot afford to set aside much for the disabled and elderly.

I expect that in 20 or 30 years, many business and governments will have failed. Bonds of these businesses and governments will have little value. Stocks of companies that remain in business will continue to have value, but this value may not be high compared to the cost of available goods. Inflation rates are likely to be high, reflecting the lack of goods and services for people to actually buy if they do have money.

Insurance companies and pension plans own stocks and bonds of other companies. When these other companies fail, the insurance companies and pension plans are likely to encounter financial difficulty as well. People who were counting on insurance companies and pension plans for benefits are likely to get nothing, or to receive benefits that are worth very little, because of hyperinflation. I expect most people will choose to continue to work as long as they are physically able to work, because of the poor retirement and pension benefits available.

My expectation is that over the next 20 or 30 years, globalization is likely to be scaled back. A decline in air travel will make it more difficult to manage international businesses. There will be less trust for other countries, because of all the defaults. Countries expecting to import goods are likely to need a corresponding amount of goods to export.

Nature of the Transition

The exact timing and shape of transition from our current economic system to the one that will be in place twenty or thirty years from now is not yet clear. Ideally, the transition will be a slow one, planned by governments. It seems at least equally likely that the transition will involve one or more crashes. Such a crash could be accompanied by bank failures or by hyperinflation.

Health Care Services

Since this talk is part of series of talks related to public health, I will close by making a few comments about changes I expect in the healthcare field.

I expect that over the next 20 or 30 years, health care services are likely to be drastically scaled back. In a poorer world, I expect that services of all kinds are likely to become less important relative to actual physical goods, and medical services will not be an exception. Fees paid to physicians are likely to be scaled back even more than health care services in general, because few will be able to afford the high fees physicians currently charge.

If there is a shortage of oil, transportation is likely to be an issue, for both healthcare employees and for patients. Smaller facilities, within walking distance of patients, may become more important.

Because we are running into limits in so many ways, I expect that electrical interruptions will become more common in the next 20 or 30 years. These may even become a problem early on, for a whole host of reasons, including lack of water for cooling, lack of fuel for power generation, and poor upkeep of the electrical grid. Healthcare providers would be wise to plan for the day when elevators and electronic records may not be available.

Conclusion

I am sorry all of these predictions are very downbeat. As the world reaches it limits, it is clear that the growth paradigm that we are used to will have to end. Decline is in fact quite likely. The economic world does not deal well with economic decline, so economic problems are likely to be among the more severe ones facing the nation and the world, in the years ahead.

Thank you.

Peak Oil Overview – March 2008 (Pdf and Powerpoint available)

Thursday, 13 Mar, 2008 – 9:57 | No Comment

Preliminary data regarding oil production through December 2007 is now available from the US Energy Information Administration, so it is a good time to put together an updated summary of where we are now with respect to peak oil. The major themes of this presentation are

â€¢ The US oil story
â€¢ The world oil story
â€¢ Five myths

I have put this summary together in the format of a PowerPoint presentation plus notes. In this format, it is a multi-purpose document. You can

1. Read the post yourself, with or without my comments.

2. Use the presentation (PDF) as a handout, to give to one or two of your friends. My comments are intended to give you some more background, so you can better explain the presentation and answer questions.

3. Use the presentation for a group, using the PowerPoint format.
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The PDF version of this presentation is available here. The PowerPoint version is available here.

Peak Oil Overview – March ’08

Gail Tverberg
TheOilDrum.com

Outline

â€¢ The US oil story
â€¢ The world oil story
â€¢ Five myths
2

The US Oil Story

3

The US Oil Story

4

Comments: US oil production has been declining since 1970, in spite of technology advances and new drilling in the Gulf of Mexico. The recent dip and uptick reflects lower production in 2005 due to hurricane damage, followed by a bounce back in 2006 and 2007, as the damage was repaired.

US Peak in 1970

â€¢ US had been worldâ€™s largest producer

â€¢ Peak came as a surprise to most
—Had been predicted by Hubbert in 1958

â€¢ Precipitated a rush to find oil elsewhere
—Ramp up Saudi and Mexico production
—New production in Alaska and North Sea

5

Comments: We were fortunate in 1970 to find other places in the world where oil was available, but had not yet been developed. There are still a few such sites available (for example, some US sites that have been placed off-limits for development), but they are much smaller in relationship to what was available in 1970.

M. King Hubbert had predicted in 1956 that the US production of oil would peak in 1970, but few believed him.

On page 22 of the same report, he predicts that world oil production will peak “about 2000″. His prediction was made in 1956. As such, it did not reflect significant changes in the 1970s, including the significant recession of the 1973-1975 period, the switch to nuclear and natural gas instead of petroleum for electricity generation, and mileage improvements for cars. If these had been reflected, the predicted peak would have been several years later.

Saudi increases were quickest

â€¢ Saudi oil company was run by Americans
—Able to ramp up quickly

â€¢ OPEC embargo in 1973, however
—Oil shortages
—Huge oil price run-ups
—Lead to major recession 1973 – 75

6

Comments:
According to Wikipedia, Arabian American Oil Company (Aramco) was jointly owned by four US oil companies in 1970. In 1973, the Saudi Arabian government acquired 25% of the company. The percentage ownership was increased to 60% in 1974, and 100% in 1980.

OPEC began operation in 1965, but did not have pricing leverage until the United States could no longer produce the vast majority of its own oil, because of its decline in production. In Octover 1973, OPEC initiated an oil embargo against countries that supported Israel in the Yom Kippur War, particularly targeting the United States and Netherlands. The embargo lasted only a few months, until March 1974.

During this time, there was a sharp rise in oil prices, and a sharp drop in the stock market. In the United States, gasoline was rationed with people able to buy on odd or even days, depending on the last digit in their license plate number. According to Wikipedia, oil consumption in the United States dropped by 6.1% during this period.

The 1973-75 recession was the most severe recession since World War II. Merrill Lynch says it believes the current recession will be similar to that recession.

Other oil online by late 1970s

7

Comments: Even when an oil company wants to start new production quickly, it is difficult to do so. The ramp up in Alaska oil production had to wait until the Trans-Alaskan Pipeline System was completed in 1977.

It was known that oil was available in the North Sea prior to the oil embargo. It was not until the price run-up related to the embargo that it was economically feasible to drill there, however.

Production in all three of the areas shown is now declining. Alaskan production reached its peak in 1988; the North Sea peaked in 1999; and Mexico peaked in 2004. The shapes of the production curves vary for the different locations, depending on where the oil was located, and how it was produced.

Now the US is a major importer of oil
and a tiny user of alternatives

8

Comments: This figure is from Page 166 of the 2008 Economic Report of the President. The data shown are 2006 figures. Percentages for alternatives would be slightly higher for 2007.

The graphs are not as clear as I would like. The larger circle on the left represents consumption. It totals 100 quadrillion Btus. The smaller circle represents production. It totals 71 quadrillion Btus. Renewables are in the section pulled out. In total, renewables amount to 10% of production or 7% of consumption. The vast majority of renewables are hydroelectric and “other biomass” (wood used to heat homes and fuel some electric generating plants).

Reading Slide 8

â€¢ About two thirds of oil is imported

â€¢ Biofuels make up about 1.0% of energy production – a little less of use

â€¢ Wind comprises 0.4% of energy production

â€¢ Solar comprises 0.1% of energy production

9

Comments: We use a huge amount of oil and other fossil fuels. Even with big ramp up in alternatives, they are still tiny. If a cutback is made in fossil fuels, either because of shortages or because of a desire to reduce carbon dioxide, it seems clear that at least part of the response will have to be reduce total energy usage.

The World Oil Story

10

World Oil: Discoveries follow same pattern as US production

11

Comments: The discovery information is based on backdated information – what we now think old discoveries were worth. Some of the big oil fields in the Middle East were discovered about 1960. We are still discovering new fields, but they tend to be smaller and more difficult to extract. The discovery information includes only liquid oil, not oil in the form of tar or other solids.

The combination of discoveries which peaked many years ago, and oil extraction which tends to peak in individual areas, leads one to believe the eventually world oil production will peak. There will still be oil in the ground, but it will be difficult to extract. Eventually, we simply won’t be able to keep extracting as much as we would like:

â€¢ As oil fields get older, the percentage of water extracted with the oil tends to increase. In some cases the water percentage exceeds 99%. Once an oil field’s water production exceeds the installed water handling capability, production will need to be reduced. When the cost of additional water handling capability exceeds the cost of oil extracted, it stops making economic sense to extract the oil.

â€¢ Some of the oil will be mixed with toxic chemicals like poisonous hydrogen sulfide gas. Special techniques will be required to safely extract this oil. This process will be expensive and time consuming. A giant oil field discovered in Kazakhstan in 2000 has this problem and isn’t expected to come on line until at least 2011.

â€¢ Some of the oil is found extremely deep beneath the sea. Special techniques need to be developed to deal with the high pressures and the temperature differentials encountered when drilling in these locations. Developing these new techniques takes time and is expensive. At some point, we will reach our limit on deep sea drilling.

â€¢ Some of the oil is very viscous, akin to tar. It can only be extracted by digging. Production requires inputs of fresh water and natural gas. Once limits on either of these are reached, production must stop. In some cases nuclear may be substituted for the natural gas, but this takes time, money, and agreement of the local population.

World oil production has stalled

12

Comments: Oil production on an “all liquids” basis was flat for the years 2005, 2006, and 2007. On an energy available basis, production actually declined. There are several reasons for this:

â€¢ The “All Liquids” summary includes lower energy products like ethanol and natural gas liquids. These have been growing, while crude oil production has tended to slightly decline since 2005.

â€¢ The oil produced requires more and more energy in extraction, because it is mixed with more and more water, and is found in deeper and deeper locations. More energy is required for extraction, leaving less for end users.

â€¢ If we look at oil available for imports, this has been declining since 2005. Part of the reason is the greater amount of oil used in extraction; part of the reason is that the standard of living in oil exporting nations is rising, so these nations are using more of the oil themselves, leaving less to export.

And prices are spiking

13

Comment: The fact that oil prices have been spiking since 2005 should come as no surprise. I show an estimated partial 2008 price on this graph, too, since we know the price spike has continued into 2008.

Given the shrinking supply and rising demand, the rise in prices was close to inevitable. Some of the poorer countries are being priced out of the market, and the use of coal is rising, particularly in China.

The higher prices have stimulated work on fields that were known, but not fully developed. Recent data compiled on oil megaprojects indicates that oil companies are now making a concerted effort to develop sites that may be available but have not yet been developed. Many of these projects are expected to begin production in 2008 and 2009.

OPEC, particularly Saudi Arabia, has had
reduced oil production recently

14

Comment: The oil production of Saudi Arabia and OPEC has been sufficiently variable over time that it is difficult to make predictions, simply based on trends. OPEC’s production, and in particular Saudi Arabia’s production, is down in both 2006 and 2007. It is hard to know exactly what this means.

According to the US Energy Information Administration, Saudi Arabia’s highest oil production was in 1980, when it produced 9.9 million barrels a day. Its recent peak was in 2005, when it produced 9.6 million barrels a day. In 2006, Saudi production dropped to an average of 9.2 million barrels a day. In 2007, production from February to August was only 8.6 million barrels a day.

When OPEC agreed to raise quotas near the end of 2007, Saudi Arabia did in fact raise its production. Its highest single month of production in 2007 was 9.1 million barrels a day, in December 2007. This represented a 500,000 barrel a day increase over its earlier low production of 8.6 million barrels a day, but still left production below both the 2006 average of 9.2 million barrels a day and the 2005 average of 9.6 million barrels a day.

One question too is whether this increase will continue, or if it is just temporary. It is sometimes possible to squeeze out a little extra production for a while, but then production drops back to a more normal level. Saudi Arabia originally planned to have an upgraded field (Khursaniyah) on line by late 2007, which was expected to produce an extra 500,000 barrels a day of oil. It may have thought it could make a spurt of extra production until this field came on line. Now the Khursaniyah field upgrade has been delayed until late 2008. Will Saudi Arabia be able to continue the increase, without the assistance of the Khursaniyah field?

Another question is why OPEC refused to raise its quota further on March 5, 2008. Is Saudi Arabia now really at the peak of what it can produce? It claims to have more production available in reserve. We know that Saudi Arabia has some poor quality oil off-line because the oil requires special processing which is not yet available in any refinery. Is this the only Saudi production off-line? Are other OPEC countries also unable to produce more?

OPECâ€™s true reserves are unknown

â€¢ Published reserves are unaudited

â€¢ Last Saudi reserve while US involved was 110 Gb in 1979 (perhaps 168 at â€œexpectedâ€)
—Production to date 81 Gb, implying 29 to 87 Gb remaining; Saudi claims 264 Gb remaining

â€¢ Kuwait published 96.5 Gb – Audit 24Gb

â€¢ GW Bush says regarding asking Saudi Arabia for more oil
—â€œIt is hard to ask them to do something they may not be able to do.â€

15

Comment: If one analyzes the reserves for OPEC countries, one very quickly comes to the conclusion that the published numbers are unreasonably high.

This is the story: In the early 1980s, OPEC oil countries were all vying for high quotas. To get those high quotas, they believed that publishing high reserves would be helpful. One by one, OPEC oil countries raised their reserve estimates, in an attempt to make it look like they had more oil, so deserved higher quotas. To further this illusion, they kept the reserve numbers at the new high level, even when oil had been pumped out, and no new oil had been found.

The practice has continued for years. OPEC leaders found that by overstating their reserves, they gained new respect, both within their own countries and abroad. They also found that the practice was very easy to do, since no one is auditing the reserve numbers they provide.

A graph of OPEC oil reserves over time is as follows:

(Not in Presentation)

There are many other ways this problem can be seen. For example, OPEC’s oil production is unreasonably low in relationship to its reserves, unless the countries are inept at production or are misstating their reserve amounts. I discuss this issue further in my post The Disconnect Between Oil Reserves and Production. “Ace” has calculated some much lower reserve estimates, based on industry estimated recovery percentages.

Another insight can be gained by looking at Saudi oil reserves, when Americans were involved in setting reserves. According to Matt Simmons’ “Twilight in the Desert”, Saudi oil reserves were 110 Gigabarrels (Gb or billion barrels in US terminology) in 1979, back when Americans were still partial owners of Aramco. If we subtract the 81 Gb pumped out since then, this suggests remaining reserves of 29 Gb.

If is possible (even likely) that the 1979 American estimate was low. If, instead, we use the Saudi published estimate of 168 Gb in 1980, and subtract from it production of 81 Gb to date, we get an estimate of 87 Gb. This is less than a third of the 264.3 Gb that Saudi Arabia is currently reporting as reserves!

Kuwait is another country where we have an alternate estimate of the proven reserves available. An analysis by the Kuwait Oil Company as of December 31, 2001, showed proven reserves for the country of 24 Gb. Their published reserves were 96.5 as of December 31, 2001, moving up to 101.5 as of December 31, 2006!

President George W. Bush seems to be aware of Saudi Arabia’s production/reserve problems. In an interview on ABC’s Nightline, when asked why he didn’t pressure the king for more oil, George Bush said

If they don’t have a lot of additional oil to put on the market, it is hard to ask somebody to do something they may not be able to do.

Somehow, US textbooks and newspapers have not figured out the problem with OPEC reserves. They continue to quote huge “proven reserves” for most of the OPEC countries. The word proven adds credibility to the numbers, suggesting that somehow, the reserves have been proven to some authority, when nothing could be further from the truth.

The United States Geological Service (USGS) has added further to the confusion. It has taken the absurd reserves published by OPEC, and made calculations based on US development patterns suggesting that OPEC reserves may, in fact, be low. USGS publishes its even higher estimates, confusing the situation further.

Fortunately, FSU production has increased recently

16

Comment: The Former Soviet Union saw a sharp decline in oil production in the late 1980s and early 1990s. With the adoption of modern extraction methods, they have been able to increase production again. There have even been some more recent discoveries brought on line.

Production going forward is uncertain

â€¢ OPEC refuses to increase quotas

â€¢ Numerous reports say Russian production is likely to begin decreasing soon

â€¢ Little hope for US, North Sea, Mexico

â€¢ Canadian oil sands contribution is very small

â€¢ Recent discoveries have been small, relative to what is needed

â€¢ New production techniques can lead to sudden drop-offs
—Followed by small dribble for years from EOR

17

Comments:We have problems almost everywhere we look. OPEC doesn’t look like it is willing/able to increase production; Russia, which is the biggest part of the Former Soviet Union, looks like it is about to begin to decline; and there are a huge number of countries already post-peak, like the United States, Mexico, and the countries that make up North Sea production.

Even Canada, apart from the oil sands, is post peak. Canada depends on imports–heavily from Saudi Arabia–for its oil. While Canada has been exporting oil from the oil sands to the US, there are really two issues involved:

(1) The amount of oil from the oil sands is not likely to ramp up quickly.

(2) Canada is likely to need the oil itself, as its other production declines. This is especially the case if Saudi oil which it imports continues to decline. Under NAFTA, Canada is obligated to export a proportional share of its oil to the US, but this may be subject to renegotiation in the next few years.

There are really a couple of issues with newer technologies that are being used. One is that fancier and fancier extraction tools (such as horizontal wells and maximum reservoir contact wells) have been developed. These are able to suck out a greater percentage of the available oil, before production suddenly “hits a wall” when the layer of oil has been extracted, and the remaining oil is mixed with a huge amount of water and under little pressure. If this should happen on an enormous field like Ghawar in Saudi Arabia, we could very quickly see production drop by 2 million barrels a day, or more.

In recent years, quite a few “enhanced oil recovery” methods have been developed. Much of the impact of these methods is already reflected in the production data graphed. In some cases, like Mexico, it has permitted production to continue longer before the inevitable drop in oil production came. In others, it helps wells to continue to produce at a very low level after the vast majority of production is completed. It is doubtful that oil production will ever stop – a dribble that is nearly all water will continue indefinitely.

Projections of Future Production Vary Widely

18

Comment: The highest estimate in slide 18 is from the US Energy Information Administration. It is based solely on demand, under the assumption that OPEC can always provide additional oil if needed.

The next highest forecast is from the newsletter of the Association for the Study Peak Oil and Gas-Ireland, prepared by Colin Campbell. A link to it can be found here. It assumes that production will rise from its current level of 85 million barrels a day to a peak of 88 million barrels a day in 2010. After that, production will decline.

The next highest forecast is that of “Ace” of The Oil Drum staff. A link to his forecast can be found here. In this forecast, Ace considers the various Megaprojects, and when they are expected to go on line. He also considers expected decline rates on existing fields. He believes that we are on a plateau now that may last a few years. After that production will decline.

The remaining estimate is by Matt Simmons. In this interview, he mentions that he expects crude oil (not “total liquids”) to drop to 65 million barrels a day by 2013. I have attempted to translate this comment into an equivalent projection, on a total liquids basis. It ends up being just a bit below Ace’s projection.

World â€œAll Liquidsâ€ Forecasts

â€¢ â€œAll Liquidsâ€ – Includes biofuels and â€œcoal to liquidâ€ fuels

â€¢ US EIA forecast – Based solely on demand

â€¢ ASPO Newsletter – Assoc. for the Study of Peak Oil and Gas Ireland, March â€˜08

â€¢ â€œAceâ€- Tony Eriksen, on The Oil Drum

â€¢ Simmons – Matt Simmons, recent interview on evworld.com

19

EIA expects biofuels, CTL,
and oil sands to remain small

20

Comment: The US Energy Information Administration’s current projections suggest that it does not expect any of these fuels to grow to be significant between now and 2030.

Five Myths

21

Myth #1: OPEC could produce more if it used current techniques

â€¢ International oil companies use same service companies US companies do

â€¢ Most are using up-to-date techniques

â€¢ Expenditures often are high

â€¢ Problem is very old fields

â€¢ Overstated reserves raise expectations

22

Comment: It is easy to see how this myth might arise, if people believe published reserves.

Myth #2: Drilling in Arctic National Wildlife Refuge will save us

23

Comment: This slide is from a presentation of Dr. Sam Shelton of Georgia Tech. The oil from ANWR is expected to provide only a small upward “bump” to US production.

Quite a few of the other much-hyped solutions are expected to provide equivalently little benefit. We will likely need to reduce consumption to better match supply.

Myth #3: A small downturn can easily be made up with energy efficiency

â€¢ The quickest impacts are financial
—Recession or depression
—Serious recession in 1973 – 75

â€¢ Use of biofuels raises food prices
—Further increases recession risk

â€¢ Donâ€™t need peak for recession
—Only need supply/demand shortfall
—Likely what we are experiencing now

24

Comment: The connection between oil supply and the economy is not well understood by most. A shortage of oil very quickly leads to an increase in prices, and a cutback in the demand for other goods and services. The combination of these events tends to cause a recession. Cutting back on usage tends not to be sufficient to prevent the problem, because there are so many other users around the world, including in China and the developing world. They are likely to cause an increasing demand for oil, even if we try to cut back.

Myth #4: Canadian oil sands will save us

â€¢ Hard to see this with current technology
—Technology known since 1920s
—Production slow and expensive

â€¢ Requires huge amount of natural gas
—In limited supply

â€¢ Most optimistic forecasts equal 5% of current world oil by 2030
—Even this exceeds available natural gas
25

Comment: There has been commercial development of the Canadian Oil Sands since 1967. Huge amounts have been spent, and there has been great damage to the environment. Even with this, production has remained small–only a little over 1% of world supply. Natural gas limitations suggest that we will never be able to greatly ramp up production.

Myth #5: Biofuels will save us

â€¢ Corn-based ethanol has many problems
—Raises food prices, not scalable, CO2 issues, depletes water supply

â€¢ Cellulosic ethanol theoretically is better
—Still does not scale to more than 20% of need
—Competes with biomass for electric, home heat

â€¢ Biofuel from algae might work
—Not perfected yet
26

Comment: Every study that has been done recently with respect to corn ethanol seems to come out with worse indications. Corn ethanol has virtually no benefits over petroleum. It uses huge amounts of fossil fuels as inputs, so it has most of the drawbacks of fossil fuels. It also has its own drawbacks, including raising prices, damage to the environment, high water usage, and possible CO2 and other global warming gas increases because of land use changes and nitrogen fertilizer use.

At this point, there aren’t good alternatives to gasoline commercially available, however. Since there is great political appeal to growing our own fuel, corn ethanol is supported by most politicians, even if any reasonable analysis would say its benefit is very limited.

Longer term cellulosic ethanol may be a better solution, but at this time it is not commercially available. Even if we use wood and switchgrass as inputs, cellulosic ethanol will be difficult to scale up to provide more than a small share of the needed fuel.

Biofuel from algae looks to some like it might work. At this point, we do not have a commercial way of doing this and the cost would be extremely high.

The Disconnect Between Oil Reserves and Production

Thursday, 6 Mar, 2008 – 10:00 | No Comment

This post includes some ideas of Matt Mushalik, plus some of my analysis. Matt is a retired civil engineer and regional planner from Sydney, Australia.

If a person looks at published oil reserves, it is easy to get the idea that there are huge amounts of oil left to be extracted. One would think that there is no way that peak oil should be a concern. Once we look at the situation a more closely, we discover that published oil reserves really aren’t all that helpful in telling us about future production. In fact, the evidence suggests that oil shortages may not be many years away.

1. How much oil reserves are shown in published reports?

Figure 1
[break]
Most reports show reserves similar to those shown above, which were compiled by British Petroleum (BP). The major categories shown on Figure 1 are

â€¢ Canadian oil or tar sands. Generally considered a resource, rather than a reserve. (Shown separately by BP.) Oil sands resource was first listed by BP in 1999, even though commercial production began in 1967.

â€¢ OPEC 11. Excludes Angola (added to OPEC in 2007), and Ecuador (added recently).

â€¢ FSU. Former Soviet Union.

â€¢ USA, Europe, etc. Everything else other than Canadian oil sands, OPEC 11, and FSU. Includes Australia, Canada, China, Mexico, and many other counties.

In this analysis, the term “gigabarrels” (abbreviated Gb) is used to mean 1,000 million barrels, or 1 billion barrels in USA terminology.

2. How does the distribution of actual oil production compare with the distribution of published reserves?

It is very different:

Figure 2

Production from the Canadian oil sands is just a thin ribbon, year after year, in spite of the apparently large size of the available resources. OPEC 11 has far less production than might be expected by their “proven reserves.” USA, Europe, etc. has much higher production than might be expected based on the size of their reserves. If one graphs the ratio of production to reserves, one obtains the following:

Figure 3

It is clear from this graph that the ratio of production to reserves varies considerably from group to group. It can also vary over time, as shown by the fact that the ratio for FSU is shifting downward over time.

There seems to be an anomaly in the BP data in 1998, which was the year production for FSU was shown by country for the first time. In 1998, there was a 23Gb increase in FSU reserves, and corresponding decrease in reserves for the USA, Europe, etc. group. Apparently, reserves for one or two countries got shifted between the two groups at that time. This anomaly causes the jump in the 1998 production to reserve ratios in Figure 3.

3. Aren’t published reserves a leading indicator for future production?

One might expect reserves to be a leading indicator, but when one looks at historical data on an aggregate basis, it is difficult to see much evidence that this is in fact the case.

â€¢ USA, Europe, etc. Oil reserves are essentially flat from 1980 to 2006, while oil production first rose, then peaked and began to decline. One would never guess the rise and fall in oil production from the reserves.

â€¢ USA by itself Both oil production and oil reserves have been falling since prior to 1980. Oil production has tended to fall more quickly than oil reserves, as evidenced by the decline in the production to reserve ratio over time. If reserves were a leading indicator of depletion, one might expect this ratio to rise rather than fall over time.

Figure 4

â€¢ OPEC 11 Several OPEC members publish very high reserve numbers, but have never offered production at the level one might expect from the quoted reserves.

â€¢ FSU Russia quotes its reserves at “P3″ level, a level that is quite a bit higher than the level mandated by the US Securities and Exchange Commission (SEC). Besides P1 or proved reserves, which are all the SEC permits, it includes amounts that are expected with improvements in technology and economics, and even amounts that may be possible in the future, with future technology. The big drop in the ratio of production to reserves in recent years may indicate a more aggressive view of what may be possible in the future.

â€¢ Oil sands The hot water extraction process similar to that used todaywas patented in 1928, and the first large-scale commercial extraction began in 1967. While a huge amount of the resource is present and there has been a great deal of investment ($10.4 billion in 2005), production remains low — currently a little over 1% of world oil supply. According to Statistics Canada, 2007 production is expected to increase by 2.2% over 2006 production.

4. Does everyone use the same rules in determining oil reserves?

No. Companies which follow the US SEC rules are required to set reserves at the P1 level — the amount that is clearly available with current technology and current economic conditions. Availability must be demonstrated by actual production or commercial formation tests. Some countries use P2 reserves — reserves that are at the “expected” level. Others use P3 reserves, incorporating amounts that may be possible with future technology and higher oil prices. I am not aware of aggregate data regarding the difference in these reserve levels, but some company level data suggests that at times they can be very large (for example, here and here).

Now that companies are having increasing difficulty replacing their SEC reserves due to depletion, the SEC is considering modernizing its rules. The changes are expected to increase the amount of reserves companies can record.

Reserve amounts reported by countries to statistical organizations are generally not audited. BP reports whatever countries report to it, without adjustment. When these amounts are published in newspapers and books, they are often referred to as “proven reserves,” even though they use different definitions and are not audited.

Based on US data, the data BP publishes appears to be on a crude + condensate + natural gas liquids basis. Biofuels are excluded, as are processing gains.

5. Is there any evidence that the oil reserves for OPEC are overstated?

There is a great deal of evidence that this is the case.

â€¢ Matt Simmons obtained copies of more than 200 scientific papers published by scientists working on Saudi Arabian oil production. Based on his review of these papers, Simmons came to the conclusion that reservoirs in Saudi Arabia were at an advanced stage of depletion, and that the reserves were significantly overstated. His findings were published in the book Twilight in the Desert in 2005.

â€¢ Several of the OPEC countries adjusted their reserves upward in the 1980s, without any new oil discoveries, at a time when there was discussion about how production quotas should be allocated. It was believed that having higher reserves would be beneficial when quotas were assigned, so each country in turn raised its reserves. Logically, reserves should be declining in recent years, as oil is pumped out, and virtually no new fields are added, but this is not happening.

Figure 5

â€¢ Dr. Sadad I. Al Husseini, former Executive Vice President of Aramco (Saudi Arabia’s national oil company), gave a presentation last October in which he stated that OPEC oil reserves are overstated by more than 300 Gb. If the amount is 300 Gb, it would correspond to about one-third of current reserves. His presentation says more than, so this is a floor, not a best estimate.

â€¢ A report by the reserves committee of the Kuwait oil company shows only 24.2 Gb of proven reserves (48.1 Gb if non-proven reserves are included) at the end of 2001, while published reserves as of the same date were 96.5 Gb. This was only 25% of the published level.

â€¢ The amount of oil produced by OPEC, relative to the amount of stated reserves, is very low. Some of this may be the result of very heavy oil that cannot be produced very quickly, such as that found in Venezuela (similar to the Canadian oil sands). Some other oil may be bypassed, because of war and sanctions, as in Iraq. Even allowing for this, the reserves would be much more reasonable in relationship to production if they were half of their stated amount, or even less.

â€¢ While OPEC claims extra capacity, its actions are not consistent with having much extra capacity. It seems likely that much of the claimed extra capacity relates to oil that is difficult to refine. No buyers are available, because no refineries can handle the particular impurities of the oil.

6. Is there a way of representing the disproportionate nature of the reserves and production graphically?

Matt Mushalik has prepared a graph showing the disproportionate nature of reserves and production. According to his calculations, 45% of oil production comes from only 190 GB of reserves. If these should deplete, there will be very serious implications for world production.

Figure 6

Matt’s groupings are a little different from mine. He shows several of the OPEC countries separately and groups the remaining countries by whether their reserves are increasing over time or decreasing over time. Matt has written about the disconnect between reserves and production in World’s Fragile Oil Flows From Declining Reserve Base.

7. Doesn’t the US Geological Service (USGS) say that huge amounts of oil are yet to be discovered, and that current reserves will prove to be too low, rather than too high?

Yes. The latest USGS study does show 649 Gb of undiscovered oil and 612 Gb of “reserve growth”. The methodology of this analysis is seriously in doubt, according to a report by Jean Laherrere. In this report, USGS does not adequately reflect the fact that the rate of discoveries has been falling.

Figure 7

The USGS also determines expected reserve growth in an inappropriate manner. They determine reserve growth based on historical experience for companies using SEC reserves. They apply this approach world-wide, without considering the type of reserves reported by other countries. In countries where reserves are inflated, this adjustment has the effect of inflating them further. If the ratio of US production to reserves has been declining over time, it is likely this approach will even overstate future US reserve growth.

8. Which of the groups “USA, Europe, etc.”, FSU, and OPEC are past peak production?

â€¢ USA, Europe, etc. The grouping USA, Europe, etc. is fairly clearly past peak production. The USA, the North Sea, and Mexico are all past peak, as are Canadian conventional production and Australia. The only other major producer that is not past peak is China, and its production is increasing very little. Angola and Ecuador, which have recently joined OPEC, are shown in this group, but even with their inclusion, production is dropping.

Figure 8

It is logical that this group should peak first, because it includes most of the heavy users of oil, and they generally extracted their own oil first.

EIA data through November 2007 is shown because it gives nearly the full 2007 year, while BP does not yet include 2007. The reason BP data is consistently higher than EIA data is because it includes natural gas liquids, while EIA data includes only crude and condensate. Since EIA does not show a subtotal for FSU, it was necessary to estimate this amount by combining data for the available countries, and adding an estimate for countries not shown separately, based on BP data for this segment.

â€¢ Former Soviet Union Oil production for the FSU does not yet appear to have peaked.

Figure 9

Production dropped in the early 1990′s, and is now getting back to the level it was previously. It is not clear that it will ever exceed its previous peak. There are frequent reports that Russian production is expected to level off or decline in the future; the smaller countries are limited in their production capability by infrastructure limitations. Thus, increases in the future are likely to be small, at least in relationship to declines in production of the USA, Europe, etc. group. Thus, this group is not likely by itself to save us from peak oil.

â€¢ OPEC 11 It is possible that OPEC-11 is past peak, but this is not yet certain. BP indicates a small up-tick in OPEC 11 production in 2006, but EIA data shows a decrease in both 2006 and 2007 production.

Figure 10

If one looks more closely at OPEC 11 production using Matt Mushalik’s graph of incremental EIA production (showing just recent changes in production), one can see that that while Saudi Arabian oil production is not as low as it was in early 2007, it is nowhere near where it was in mid-2005.

Figure 11

The lower Saudi production raises questions about OPEC 11′s ability to raise its production. This is one to watch–once OPEC 11 is past peak, it is very likely that the world is past peak. We know so little about “real” OPEC reserves that reserve levels cannot be used to eliminate this possibility.

9. Can the Canadian oil sands save us from peak oil?

Can the perpetual sliver ever be anything else? It is difficult to see how Canadian oil sands production will expand very much, very quickly. According to the Master’s thesis of Bengt SÃ¶derbergh, natural gas availability is likely to limit oil sands production in the long term. With or without the natural gas limitation, there are many other concerns, including environmental impact, greenhouse gas emissions, and very high continuing investment. Optimistic estimates of production are about four times current production by 2030. This would be about 5% of current world production–still not very much.

It is possible that one of the new production techniques, such as Toe to Heel Air Injection, will prove to be effective. If this happens, oil sands production may increase by even more than that forecast in the current optimistic target. If such an increase does occur, much of the benefit is likely to be after 2020. Such an increase could theoretically help mitigate the downslope after the peak in world oil production. The increase, should it occur, is likely be too late and too small to prevent the peak.

10. Does this type of analysis say anything about depletion rates?

Possibly. Cambridge Energy Research Associates (CERA) published an analysis indicating that if one looks at a mixture of fields that are increasing and decreasing, the overall decline rate is 4.5%.

If CERA looks at the decline rate for a mixture of increasing and decreasing fields, it sounds like CERA is looking at the depletion rate with respect to reserves at a point in time. This is in contrast to a decline rate, which one generally thinks about as occurring after individual field’s peak or plateau.

While CERA made its calculation with individual field data, another approach would be to start with aggregate data relating to the (production / reserves) ratio, such as BP data. A person would then make adjustments to the aggregate data. One adjustment would be to remove reserves relating to fields that are not yet in production from the total reserve amount. Another adjustment might be to put reserves on a P2 (that is expected) basis, if companies report them on a P1 or P3 basis. Another adjustment is a small timing adjustment – the payments during one year should relate to reserves at the end of the previous year, instead of the end of the current year. Ratios before adjustment are shown in Figure 3.

The ratio before adjustment for the USA, Europe, etc. group is 7.1% (Figure 3). It seems likely that even after adjustment, it would be higher than 4.5%.

The ratio before adjustment for the FSU group is 3.5%. Two adjustments are needed:

1 .To reduce the reserves because reserves are on a P3 basis, and thus are higher than the expected or P2 level.

2. To reduce the reserves by the amount relating to fields not yet in production.

Both of these adjustments would tend to reduce the denominator of this ratio, and thus increase the ratio. With these adjustments, it is likely that the FSU ratio would also be over 4.5%.

OPEC reserves, as published, are too unreliable for this approach to work. If a person had a better analysis of reserve figures for OPEC, it could perhaps be applied.

11. What should we do now?

Given the likely shortage of oil in the future, and the likely environmental impacts whether or not there is an oil shortage, it would be best to start taking action now to reduce usage of oil and other fossil fuels.

Figure 12

We are now running out of time to implement urban rail solutions as is being done in the Australian City of Perth. In Perth, rail lines run alongside the freeways. Rail stations have bus terminuses on top the rail stations, and kiss & ride and park & ride facilities nearby. This is ideal for getting to the station in various ways and a quick train-ride to the city.