Peak Oil, or when supply doesn't meet demand

[ostap]

I am always amazed when (mostly) intelligent people discuss economic issues without having the slightest idea of basic economic principles such as supply and demand. A typical example is the Peak Oil discussion, where many highly decorated geologists and other natural scientists usually end up announcing the end of the world because 'supply will not be able to meet demand'. One more example of such a study can be found here (Giant Oil Fields - The Highway to Oil). A peak oil discussion without mention of the price elasticities of demand and supply is worthless. It goes without saying that the above-mentioned study does not once contain the term ‘elasticity'.

What many natural scientists miss is the basic notion that both supply and demand are curves which depend on prices. The market price ensures that current supply equals current demand. Modelling future “supply” and “demand” without taking into account prices is nonsense and disqualifies all conclusions from such studies.

Non-economists usually strongly underestimate the dynamic impact of price changes. High prices do not only temporarily scare off people from buying, but they also set in motion a very powerful process of cutting down on the expensive product and of searching for alternatives. On the supply side, high prices bring online additional sources of supply which were not feasible at lower prices. However, both processes may need some time to take effect.

It is certainly possible that oil production is peaking; however, the relevant question is not when exactly that peak occurs, but what it means for prices. In my view, in the longer run, oil demand is quite sensitive to price. The bogeyman of 100$ per barrel of oil might be conceivable for a short while if oil supply is disrupted, however, it is probably currently far from any long-term equilibrium.

Sheikh Yamani, the former Saudi oil minister, summarized these thoughts appropriately when he said: “The Stone Age came to an end, not because we had a lack of stones, and the oil age will come to an end not because we have a lack of oil.”

Source: www.economicreason.com

[Finster]

Re: Peak Oil, or when supply doesn't meet demand

Peak Oil is real enough, but widely misunderstood. It is a multi-decade, secular phenomenon - having very little to do with soaring oil prices over the past few years.

Peak oil is merely the excuse-du-jour for prices soaring due to inflation. What most people miss when they talk about oil prices is that there is not one, but two, commodities involved. When we quote an oil price in dollars, we are not talking merely about the value of the oil, but also the value of the dollars. "Dollars per barrel" is a ratio - a ratio of the value of the oil to the value of the dollar. Therefore, any analysis that purports to divine the course of that ratio must take into account not merely the supply and demand factors for the oil, but of the dollars as well.

So what has been the main driver of oil prices?

Hint: It's not the oil.

In order to examine the question of the value of oil apart from the value of the dollar, we need to factor the dollar out of the equation. One way is to look at the price of oil denominated in gold. The below chart does just this. It shows the price of a barrel of oil, 1970 to date, not in dollars, but in ounces of gold. Over this entire time frame, the price of oil has barely budged. In dollars, it went from $3.35 to $53.40, up by a factor of 16. In gold, it went from 0.965 ounces to 0.840 ounces - a slight decline.

No, no matter how thorough the analysis of supply and demand trends in oil, if it purports to explain what has happened to oil prices in terms of dollars without just as thoroughly analyzing the dollars, it falls woefully short. Peak oil just doesn't have much to do with it. The vast, overwhelming, factor in oil prices is the shrinking value of the dollar.

[BlackVoid]

Re: Peak Oil, or when supply doesn't meet demand

I disagree. The dollar is part of the problem, but depletion is a bigger issue.

Replacing oil is not so easy as some think. All the economic growth of the last 100 years was due to cheap and abundant energy. All alternatives cost more than oil and all require significant investments. Eventually the problem can be solved, but energy in general will be very expensive in the next few decades while the transition to a new source is made.

[FRED]

Re: Peak Oil, or when supply doesn't meet demand

[QUOTE=ostap]

I am always amazed when (mostly) intelligent people discuss economic issues without having the slightest idea of basic economic principles such as supply and demand. A typical example is the Peak Oil discussion, where many highly decorated geologists and other natural scientists usually end up announcing the end of the world because 'supply will not be able to meet demand'. One more example of such a study can be found here (Giant Oil Fields - The Highway to Oil). A peak oil discussion without mention of the price elasticities of demand and supply is worthless. It goes without saying that the above-mentioned study does not once contain the term ‘elasticity'.

What many natural scientists miss is the basic notion that both supply and demand are curves which depend on prices. The market price ensures that current supply equals current demand. Modelling future “supply” and “demand” without taking into account prices is nonsense and disqualifies all conclusions from such studies.

/QUOTE]

Interesting post. See here for iTulip's editorial position on Peak Oil.

[Spartacus]

Re: Peak Oil, or when supply doesn't meet demand

In one panel discussion I heard one of the geologists say "oil will not end, prices will rise" and the economist, 10 seconds later said "the geologists don't take price into account". hmmmmm .... professional deafness?

Are you reading an economist saying "the peak oilers say this and that and the other thing"?

In one speech, Ken Deffeys talks about the new price volatility and says "one of my colleagues' wife works in telecom capacity provisioning and she says that this oil price action is mathematically exactly what happens when there is very little slack in the system - little excess capacity. Prices move jerkily".

How could one possibly conclude that he's not taking pricing into account?

I don't know who you're reading (maybe an economist who mis-represents the arguments?), and whether you're reading whole pieces (rather than select quotes) but IMHO, this is a straw man argument.

All the stuff I've read - if you read the whole piece, leaving everything in context - says "the end of cheap, easily extracted oil". Not "the end of oil".

The geologists' so called "disaster" predictions (of the people I've read) mostly boil down to "if we don't prepare we'll suddenly have sharply higher prices, if we prepare we won't be shocked and may be able to have a gradual price rise".

In fact, most go out of their way to say "we will be getting petroleum out of the ground for 500 years, the petroleum is not going to suddenly end - the question is how much will it cost?" - which brings me back to my opening paragraph above.

[Harry Pottery]

Re: Peak Oil, or when supply doesn't meet demand

Personally, I find your original post both condescending and completely off the mark.

You state that these "(mostly) intelligent" people do not well-enough comprehend the "laws of supply and demand" to rationally assess the peak oil dillemma. And so begins the lecture from "right thinking", "soundly scientific" economists regarding the magical laws of supply and demand and their inherent ability to solve all the worlds problems...

The problem is that oil, like most commodities, is NOT SOLD ACCORDING TO THE LAWS OF SUPPLY AND DEMAND ON A FREE MARKET. There is no such thing as "free market" oil. From OPEC to the military "securitization" of "private" oil fields and transport, ALL OIL PRODUCTION AND TRANSPORT IS STATE SUBSIDIZED AND CONTROLLED. Prices are controlled, distribution is controlled, refining is controlled...all the way to the pump. Supply and demand have nothing to do with the price of oil. Profits of the oil industry are, in fact, "privatized" to "multi-national companies" (i.e. organizational structures that exist across international borders, which are owned by individuals called "shareholders"). However, the expenses of the oil industry are "socialized"--the militaries of the U.S., France, Britain, etc. (funded by the taxpayers of these various "industrialized" countries) are used to enforce and maintain the operation of the "private contracts" held by the aforementioned "private companies".

To paraphrase Noam Chomsky, "free markets" make perfect sense when you accurately describe what a "free market" is...namely, a "free market" is a euphemism for "highly managed system of administration". There is nothing "free" about it, and there certainly is no supply/demand "market" at work.

As for peak oil specifically, the point is that the world's oil supply is finite. This is not debatable. Its also true that oil becomes harder to extract the farther it is from the surface. This means that the current rates of usage simply can't continue indefinitely. Maybe we have 20 years left...maybe we have 100 years left. But the alarming point is that we have no plan in place to make a conversion to a different system before the expiration. That's the problem, and there is no supply/demand curve in the world that is going to create one for us.

[Spartacus]

Re: Peak Oil, or when supply doesn't meet demand

This is what I find interesting about ONE particular "libertarian" or "Mises-ian" site.

They would rather post articles supporting Thomas Gold's theories than post articles about businessmen who see an opportunity in peak oil and are starting businesses or inventing products to minimize the effect.

They apparently are irony-sensing-deficient (but irony-creating geniuses).

Personally, I find your original post both condescending and completely off the mark.

You state that these "(mostly) intelligent" people do not well-enough comprehend the "laws of supply and demand" to rationally assess the peak oil dillemma. And so begins the lecture from "right thinking", "soundly scientific" economists regarding the magical laws of supply and demand

What, the same economists who, to a man, missed the popping of the Internet bubble?

Who missed the development of the housing bubble?

IT CAN'T BE!!!!!!!
SAY IT AIN'T SO !!!!!!

[BlackVoid]

Re: Peak Oil, or when supply doesn't meet demand

Gold price usually follows closely the price of oil. When oil goes up, so does gold. Oil goes down, gold goes down.
It is no wonder that pricing oil in gold results in stable prices. It is like pricing butter with milk.

[jk]

Re: Peak Oil, or when supply doesn't meet demand

Gold price usually follows closely the price of oil. When oil goes up, so does gold. Oil goes down, gold goes down.
It is no wonder that pricing oil in gold results in stable prices. It is like pricing butter with milk.

not quite:




from
http://stockcharts.com/def/servlet/F...71940&cmd=show[s99887335]&disp=O

[Finster]

Re: Peak Oil, or when supply doesn't meet demand

I disagree. The dollar is part of the problem, but depletion is a bigger issue.

Please note I have supplied hard evidence in support of my claim that most of the rise in oil prices is due to dollar depreciation. Specifically, I have shown that when priced in real money, oil prices have gone virtually nowhere in decades, while they have risen manifold in dollars. You claim "depletion is a bigger issue", but have not mustered any supporting data.

[fourthirtysix]

Re: Peak Oil, or when supply doesn't meet demand

I'm starting from a view that peak oil is real, and will slowly but gradually decline over the coming decades, here is my question:

Since most of the world's oil is controlled by state-owned oil companies, what is the best way to invest in oil going forward? To me, this question lies at the very heart of how to defend yourself against inflation in the future.

If their is a smaller supply of oil, wouldn't that hurt revenues for oil services, refiners and transport since their is less oil to process? Who, other than the state-owned companies, stands to do well from declining supply and increasing prices over the next 50 years?

Thanks

[Spartacus]

Re: Peak Oil, or when supply doesn't meet demand

If their is a smaller supply of oil, wouldn't that hurt revenues for oil services, refiners and transport since their is less oil to process? Who, other than the state-owned companies, stands to do well from declining supply and increasing prices over the next 50 years?

Thanks

Quite the opposite.

The major empirical foundation for peak oil is the simple observation that in any oil province one first finds a few small fields, then the major elephants. Producing from these is easy. Stick a hole in the ground and let 'er rip. As the production from these accelerates and a few more elephants are found (all the elephants are usually found early in a province's life) the oil province's production rises then stabilizes for a short time and then declines.

The decline used to be slow because as the pressure in a field declines the oil comes out slower. That USED to be the case. New technologies now let the producers get the oil out quicker (pressurized injection of steam, water or Carbon Dioxide or Nitrogen, horizontal drilling, and so on), so going forward the individual field decline curves may be quite steep.

That's for individual fields - for entire provinces, new discoveries bolster later production a bit, so again, the decline tails off whereas the initial rise was usually pretty quick.

Later in the oil province's life discovery falls off. Discovery of large fields just about disappears. Note that worldwide, the last of the elephants were found in the late 1960s and early 1970s (the Cantarell field in Mexico I think was the last one).

Finally production form the the elephants peaks and start declining. Individual fields rise to a certain level, and production stays at a flat plateau for a long time, but sum all the production for a province, some production already peaked, other production coming on line, and you get a short lived peak, no long flat plateau.

Discoveries are now (in the history of this hypothetical oil province whose elephants are declining, not "now, April 2007") of tiny fields, in difficult to produce areas.

At this stage, if the province is to keep producing, many smaller fields need to be found to replace the reduced output from the elephants.

From this one must conclude that the smaller post-peak supply (post-peak of both individual provinces and later world post-peak) must come out of smaller and smaller fields, and more of them, and usually fields in difficult areas(which is why they are not found earlier), or fields that are technically difficult to produce from.

This suggests more services, and more expensive services, not less. More exploration rigs, more rigs dispersed to more (but smaller) fields, higher-capability (more expensive) rigs to search deeper, and so on.

Refineries now need to be more agile, or perhaps entirely new refineries need to be built to process more widely-varying types and grades of crude. You need more transportation from many smaller fields instead of a small number of larger fields.

As an example, the North Sea's major fields are on the downside of their production profile, but to date, as a whole, the North Sea's output has only dropped a little as many smaller resevoirs are being tapped.

Also, as more difficult operations like shale oil and tar sands become profitable at higher prices, service company revenues are likely to rise because these reserves require more difficult technologies, more of them, and slightly different technologies.

final edit: So the cost of discovering each new drop of oil rises. Lots of this money will be wasted, as exploration wells come up with no petroleum. The extra money of course will ONLY be spent (and the service companies will do well) as long as the price of oil gets high enough to support spending this money, if the price is high enough to risk drilling empty wells.

[Jim Nickerson]

Re: Peak Oil, or when supply doesn't meet demand

Matthew Simmons is scheduled to be on financialsense.com broadcast tomorrow. http://www.financialsense.com/index.html actually it is available now.

It says the Feb. 2007 GAO report on Crude Oil will be discussed.
http://www.gao.gov/new.items/d07283.pdf

[Spartacus]

Re: Peak Oil, or when supply doesn't meet demand

Thanks - I caught this.

Apropos the question that was asked earlier, whether the service companies will make less money on the downside of peak - Simmons notes that on the rise to its peak,

(timestamp 8:16) Cantarell had 40 wells producing from 1981 - 1996 1 million bbl per day, then they did Nitrogen injection, production shot up to 2.2 million bbl per day peak around 2 years ago, and now on the down side, 440 rigs are producing 20% down from Cantarell's peak, which was .

timestamp 11:20 the largest fields being found these days produce 40,000 bbl per day for a few years before going into terminal decline.

So you figure it out - 40 wells before peak, now 440 wells - the drillers and rig makers will be doing a lot of business.

Matthew Simmons is scheduled to be on financialsense.com broadcast tomorrow. http://www.financialsense.com/index.html actually it is available now.

It says the Feb. 2007 GAO report on Crude Oil will be discussed.
http://www.gao.gov/new.items/d07283.pdf

[BlackVoid]

Re: Peak Oil, or when supply doesn't meet demand

Peak Oil links:
http://www.theoildrum.com/
http://www.peakoil.net/
http://en.wikipedia.org/wiki/Peak_oil

Most countries now have declining production. Mexico, GBR, Norway, Kuwait, Iran are all in decline, to name just a few. The US is in decline since 1970. Where is the new technology that is supposed to reverse this trend? Hubbert predicted in 1956 that the USA will peak ariund 1970. This proved to be very accurate. No new technology could do anything about it.
Saudi Arabian production also fell 8% last year, this is allegedly a voluntary cut, but they are producing way below their OPEC quota now - quite unusual for them. The Oildrum has a lot of details on this, check it out.

Oil and gold both have a much higher price now. The price of oil has trippled in five years, did the US really have 300% inflation in 5 years? No. Oil and gold are both going up.
Why not compare the price of oil with uranium? You could do that and prove that the price of oil is falling. ;)