Saturday, September 17, 2011

Why Hubbert’s Peak May Not Happen, and Why That Misses the Point

I was asked by one of the executives at Idealab to comment on today's Wall Street Journal essay by Daniel Yergin, entitled "There Will Be Oil". I'm currently reading his book, The Prize now; unfortunately, I thought very little of his essay. Here's what I wrote:

What a disgraceful, sensationalist, condescending, collection of half-truths! The first half was inexcusable, and the second half was simply bad. The author is partially correct in some areas, but for all the wrong reasons, and his final conclusion is simultaneously wrong, and irrelevant.

Why Hubbert’s Peak May Not Happen, and Why That Misses the Point

Let’s keep something in the forefront of our minds – we care about the future price of oil. Hubbert’s analysis matters because it predicts rapidly escalating oil prices. Any conclusion which claims that massively increasing oil prices will prevent Hubbert’s peak, misses the point entirely, and is so bafflingly daft as to border upon willful intellectual fraud. We’ll be saved from skyrocketing oil prices as soon as the skyrocketing oil prices arrive and are here permanently. Hooray!

It's true that Hubbert's analysis ignored economics. He took his analysis simply from the geophysics of extraction. However, the economic analysis results in some curious results - literally the physical manifestation of the philosophical argument of "what happens when an immovable object meets an unstoppable force?". In this case, the immovable object is the oil supply and an unstoppable force is the demand for oil.

In both cases, neither force is truly unstoppable. Better technology, especially spurred by higher prices, will shift the oil supply curve. As oil gets more expensive, other means of supply become feasible. We can drill deeper and deeper (and expose ourselves to more Deepwater Horizon type accidents). We can turn a frozen mixture of tar and sand into oil by injecting steam and scrubbing like crazy (not too far removed from recovering oil from a Walmart parking lot in Wisconsin in January – see, two can play the sensationalist game). In the mid-90's I've worked in the oil fields in Canada doing what's called "tertiary recovery". Primary recovery is when the oil flows out of the ground. Secondary recovery is when water is injected into an oil field to push up the remaining oil. Tertiary recovery is when solvent (ie, soap) is injected into the field in hopes of scrubbing the last few drops of oil from the rock walls. Tertiary recovery is done when the value of oil recovered exceeds the cost of scrubbing. But let's not kid ourselves on what the value of oil needs to be for these processes to be economic.

On the other side is demand. People have been arguing strongly for conservation since Carter. Here too, we see oil prices at work. As oil prices rise there is a greater and greater incentive to implement conservation and efficiency efforts. These are now becoming fashionable and practical, but during the Reagan administration (and many times since), it was considered downright "un-American" to even consider conservation. However, the article makes the hilarious claim that increased efficiency, which has barely made a dent in the inexorable growth of oil consumption, will actual cause demand to "slacken" by 2020 - in light of booming growth from BRIC (Brazil, Russia, India, China) countries as well as existing first-world countries.

However, before I address the many fallacies in the article, let's examine what we've discovered. Skyrocketing oil prices will increase supply. Huge leaps in the price of oil will spur efficiency savings, "reducing" demand. So, as soon as we see massive increases in the price of oil, and we'll be saved!

Now, back to the argument that we will all be saved from the calamities of skyrocketing oil prices due to Hubbert’s peak through the benevolent gift of skyrocketing oil prices. What actually happens to oil production, and Hubbert's global peak, depends on the relative elasticity of oil supply and demand, relative to oil prices. Which immovable object and which unstoppable force is truly unstoppable? Which of these global titans will win - is it the Earth's relentless difficulty in providing oil, our our insatiable thirst of consumption?

If the supply-side proves to be stronger - if the Earth absolutely will not provide more oil, regardless of price, then we shall see Hubbert's peak occur. We will see oil production decline regardless of demand. Each new day of decreased production will see further escalating prices. Now, if the demand-side proves to be stronger. If people absolutely will not reduce oil consumption regardless of price. If people will pay any price for oil, then we will not see Hubbert's peak. We will see continued oil production, straining to match the daily rise of oil consumption. This oil production will come from further and further fields, and processes, which only become economic through increased oil prices (as we are seeing with the tar-sands, and tertiary recovery, and some other things the author mentions). We could see a production "plateau" that the author mentions.

So, let’s quickly examine the elasticity of oil supply and the elasticity of oil demand in order to determine which is more likely to bend. As a fun example of oil demand elasticiy, let’s look at one indicator of how strong our demand for oil is. Shown below is the total vehicle-miles driven on all US roads (data from DOT). It shows steady growth, almost doubling in amount, from 1985. The only remote dip occurs due to the greatest economic collapse this country has seen since the Great Depression. The consequences of this collapse? It set us back about 2~3 years. Oh, and we’re back to climbing again. So, we can conclude that oil demand is very inelastic, and unlikely to change much.

So, now we turn to our analysis of the elasticity of oil supply, and at the same time, let’s addess one of the author’s more heinous misdirections. Hubbert's analysis was done with the assumption that oil prices would be reasonably stable. This is why he neglected improved technological means of discovery. Since oil prices have been reasonably stable since the 1950’s the analysis has proven robust. However, with extremely high oil prices will come the economic pressure that drives further expansion. The author claims that

“Overall U.S. oil production has increased more than 10% since 2008. Net oil imports reached a high point of 60% in 2005, but today, thanks to increased production and greater energy efficiency (plus the use of ethanol), imports are down to 47%.”

Ignoring the hint that ethanol could save the day (the economic and thermodynamic policy disaster that corn ethanol has been), let’s examine this glorious increase in US production in historical context:

Excellent. So after West Texas Intermediate hit a record high of more than $130/bbl in 2007, the US managed to increase its production to match that of 2003. If only oil prices would hit $2000/bbl, then we’ll be back to the go-go times of the 1960’s and we can all drive cars with fins and big-block V8 engines! It’s pretty safe to conclude that oil supply is very inelastic and huge changes in price are needed to move the needle on oil production.

So, let's look at what has happened - in both cases we see that any increase in oil production, or any decrease in oil consumption require astronomical increases in oil prices, and that's all anyone cares about. I suppose there is a sense of smugness in watching Hubbert's peak not arrive while witnessing $200/bbl oil. But nobody cares about the shape of the curve, we care about oil prices and that's what the author has failed to address.


Ok, I was planning on going through the article, paragraph by paragraph, and point out the half-truths, the misstatements, and the childish name-calling, but I’ve got pancakes to make. The only point of this article is, as I see it, to take regulatory pressure off of the oil industry, and to remove pressure (policy or otherwise) from developing alternative energy sources, because we can all realize that “everything will be just fine”. My advice? Buy oil futures. And invest in renewable energy.