November 14, 2005
Peak Oil at the American Enterprise Institute
Posted by James Hamilton at November 14, 2005 12:20 PMdigg this | reddit
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Tracked on November 14, 2005 11:10 PM
So we are in peak oil now. I've been planning to buy a Mazda Rx-8 now that I have graduated and have a nice cushy job. Should I buy it ? or the price of oil is going to rise so much that it would be too expensive to run in say 4 yrs ?
Posted by: ASD at November 14, 2005 02:08 PM
Peak oil really depends on two things and two things alone at this point, neither clearly knowable: 1) Is al Ghawar in Saudi Arabia going to decline soon? and 2) Will Russian production decline soon?
The latter is more likely than the former as most reports suggest that the Russians have been way overpumping their fields for short-term gains. OTOH, despite all the efforts of Matthew Simpson in his interesting book, _Twilight in the Desert_, the bottom line is that al Ghawar is so complicated and large that nobody really knows what is going to happen with it. It really is the ball game at over 5% of world output and more than three times the output from the next most productive field in the world (Burgan in Kuwait).
Posted by: Barkley Rosser at November 14, 2005 02:23 PM
I'm not sure where oil prices will go over the next 4 years-- they could go up or down. For reasons I expressed in the talk, my best guess is that if they go down, they won't go down too far or stay there too long. But 4 years is a fairly short horizon.
Posted by: JDH at November 14, 2005 03:42 PM
Here are Charles Maxwell's price predictions:
Year WTI price
As reported to the Denver ASPO-USA conference:
He's a braver man than me to commit to numbers. Knowing the price requires knowing supply (influenced by unpredictable delays in new projects and unpredictable declines in existing oilfields), and then figuring how much the extremely inelastic demand will respond to that supply. He did say he thought his projections would be wrong, he just didn't know which way.
Incidentally JDH: great speech.
Posted by: Stuart Staniford at November 14, 2005 04:26 PM
I agree with Stuart. I think it's an excellent look at peak oil. I will be passing the link on to my friends.
As far as the price predictions, what I'm hearing (ok, seeing) in the comments from JDH and Stuart are alongs the lines of what my quasi-educated guess tells me. I moved money into oil and the industry at $30 and $50 but I'm hanging now, with the assumption that (a) profits will continue to be good--unless congress trips all over its three left feet to mess this up and (b) investment will make the service companies quite profitable as well.
I mentioned this before, but my personal financial prediction was increased earnings with the oil companies with some of the earnings come back to shareholders, and some to the service companies, which also comes back to the shareholders in one form or another.
This is another reason I've not been happy with Simmons "predictions." I'm not sure if others have noticed that in some recent speeches he's said that the numbers were meant to get attention. Attenion yes, but also ammunition for those who want to create talking points.
But I think if we see prices such as posted by Stuart, people will still get it. The price isn't doing down much, it will look to be increasingly (with upward/downward fits and starts) and will influence vehicle purchase decisions.
Posted by: T.R. Elliott at November 14, 2005 06:09 PM
Just a question in regards to calculating inflation adjusted numbers for the price of oil circa 1981:
Wouldn't it be more correct to adjust the price by CPI ex-energy? I may be in error, but it seems to be a case of using a compounding rate that incorporates changes in the price being adjusted.
Also, I noticed the absence of discussion about the other major fossil fuels, coal -- and more importantly -- natural gas. I believe that it is warranted to look at all the major sources of non-renewal energy rather than just oil. Perhaps the issue should have been from the start phrased differently: Peak Fossil rather than Peak Oil.
Posted by: JMM at November 14, 2005 07:42 PM
JMM, if the object were to calculate how much oil costs in terms of potatoes you would be correct. But if the object is to calculate how much the 1985 cost of oil would amount to in terms of 2005 dollars, we want to use the CPI. One of the reasons that a dollar doesn't buy as much today is, as you correctly point out, because energy prices have gone up. The CPI calculation therefore does exactly what we want in this case.
Posted by: JDH at November 14, 2005 08:40 PM
JDH,your speech at AEI was good, one of the better ones I have seen on this topic.
JMM, I agree with you. Natural gas is the most critical fuel at present in the US. Gas is depleting fast and it is not possible to increase imports quickly enough. The first oil crisis caused a lot of substitution of oil with gas and nuclear. This is not possible now. On the other hand it is very difficult to substitute natural gas with any other fuel. The prospects for increasing domestic US coal production are crucial here. This has direct impact on the US trade deficit. If the energy problems continue it is not really possible to correct the deficit by exporting more - at any currency rate. The double natural gas and oil problem will only increase the deficit. The volumes here are so huge that energy becomes an important factor.
The only practical solution would be to intoduce a heavy gasoline tax - enough to get $4 gasoline. This would force the oil imports down and patch the fiscal deficit. This is not much - the European level would be $6. This would hurt a lot - but won't kill. Most of the other alternatives are far worse - and might really kill the economy.
In the world scale the Chinese coal is all important. It makes 70% of the Chinese energy consumption and is the basis for its industrial growth - and hence for the global growth. There are some symptoms of slowing coal production growth in China. Chinese oil production is near or at peak. Significant, and rapidly growing domestic oil supply has also been important for the Chinese economic miracle. Oil imports will rise considerably when the domestic production starts declining. So here we have real energy-related risks. No wonder the Chinese like to have some cushion in the form of currency reserves.
Considering the effects of an oil crisis it is important to see that it is no more possible to diminish the share of oil in total energy consumption like it was done in the '70s and '80s. I am inclined to predict volatile oil prices but not sky high ones. A severe recession and demand destruction will be the most likely scenario. If the global economic growth would continue supported by other fuels, the oil demand would remain high and so the prices. Otherwise we would have a recession and lower demand. We might have 1 - 2 years of growth at the present level or little lower but probably no more.
Posted by: TI at November 15, 2005 12:17 AM
Is it possible to get a copy of the charts that you presented? They sound fascinating.
Posted by: Rob at November 15, 2005 05:10 AM
Good economics says, in life, hedge. Protect yourself against future worst cases as best you can.
If you have lots of oil assets you can afford an oil burning car or energy intensive house. If you do not, then you want to lean towards a car which is cheap to run (total cost of ownership).
AFAIK, Honda, Nissan and Toyota have the lowest total cost of ownership of any cars in North America: repairs, fuel, insurance and depreciation (the latter the single largest cost). Especially Toyota. I believe people like COnsumer's Reports publish this information. Sports cars have high Total cost of ownership (they tend to have high depreciation and poor fuel economy).
You want to think through the scenario where say $3.50 gas is a long term reality, and how you would live within your current income on that scenario. Because even the experts cannot predict the price of gas: it could be $5, it could be $1.50 (but is more likely to be between $2 and $3).
Even more important is avoiding debt as much as you can (exception: a reasonable mortgage to buy a tax free principle residence, with the caveat that on both coasts of the US right now, most new mortgages are not reasonable in size). Most people forget you have to *repay* debt, it's not just about the interest. And interest *compounds*. You can pay back more in a loan in interest payments than you do in principal.
The less debt the more hedged you are against losing your job or paying more to fill a tank of gas at $5.
Posted by: John at November 15, 2005 07:10 AM
Let me add to that something quite sexist for which I apologise in advance. You are from what you imply, single, male and in your 20s. If you think a swish Mazda will help you pull women, then it might be worth doing. (my own experience was that nice clothes were far more important in this regard than a nice car).
Time waits for no man. When you are 43, say, you will be married, have 3 kids and a people mover. Impressive cars will simply be a distraction.
In life you regret what you *didn't* do, in the long run, not what you did do. My biggest regret of my 20s is I spent less time than I should have with wild, dangerous women ;-).
At least I haven't bought the people mover yet ;-).
Posted by: John at November 15, 2005 07:18 AM
This may be a stupid question, but what about the tar sands in Canada? I keep hearing that if the price of oil is anywhere near $50 a barrel that it becomes cost efective to mine, transport, and refine the sands. The estimates for production capacity seem large even considering the technical hurdles. Is it just hype?
Posted by: Rick at November 15, 2005 08:03 AM
The slides can be downloaded here.
Posted by: JDH at November 15, 2005 09:21 AM
Many people are assuming that tar sands will be making a significant contribution that's already factored in to many of the estimates. Bubba has some discussion.
Posted by: JDH at November 15, 2005 09:27 AM
Just one minor critque on the speech, but a critical point that economists should understand. If crude oil futures for December 2005 are at $60 and December 2006 is trading $61, that is emphatically NOT a forecast of where oil will be a year from now. It is ONLY the price of where the market values delivery for that period today. Think about it -- when nearby crude oil was $12 in early 1999 and the market was in backwardation with forward prices even lower, it was hardly a forecast of the future and even if it had been, it was dead wrong. What a higher forward price reflects is really only some or all of the cost of financing and storing oil for a year. Otherwise, as always, the peak oil hypothesis is long on theory and speculation and short on hard data. Proven reserve estimates, production capacity and production itself continues to trend higher. Production costs lag far far behind the price. The price advance is not cost push inflation, in my view, but demand pull inflation of a particularly speculative variety. It is not the 5% growth in world physical demand over the past two years that has driven price, but the 75% expansion of the paper market in the form of NYMEX crude oil futures open interest that has really propelled the price. I know, I know, that's the contrarian view of the peak oil crowd and this forum in general, but it is actually the more conservative and traditional economic view. The result has been a bubble which is only just beginning to burst.
Posted by: Tim at November 15, 2005 10:20 AM
Thanks for posting the excellent speech prof hamilton !
The reason I don't buy those 10yr oil futures is two-fold. I think technology will advance some, and I think that consumer spending on energy will simply hit a wall (over a period of years anyway). If people are faced with doing without comforts to put gas in a car or heat a home I believe there will be fast changes in consumer habits and technology.
The production side has a lot of information and discussion but I'm interested to read more on the above. I fully agree with JDH in that the market is going to address peak oil but it will be very interesting to see how.
One of the last things I saw (in the WSJ some months ago) talked about cheap non-hybrid mid-size sedans reaching 60mpg in 10yrs by having more efficient engines.
Posted by: biker at November 15, 2005 11:22 AM
That was a very well formed speech. Too many people who discuss peak oil have further extrapolated about the inevitable collapse of society. They are then summarily dismissed by both the public and politicians as extremists. And they should be, no one can say what alternatives will be feasible as oil and natural gas become scarcer and more expensive. The point is to motivate additional resources in that direction.
Posted by: Rick at November 15, 2005 02:46 PM
Economic theory (the Hotelling Model) says that the price of an exhaustible resource rises over time towards infinity, as that resource is exhausted.
If oil is indeed being exhausted, good solid economic theory says its price should rise, at least until the price of economic substitutes is reached.
As to reserves, net new reserve additions have been lower than annual consumption for 20 years. Every major oil company has flagged the difficulty of replacing reserves. Exhaustion rates on existing fields have risen-- the UK North Sea production profile is a case in point and an excellent example.
If we are not at peak oil, the onus is on the optimists to show where that oil is going to come from. This is what Matt Simmons is saying.
I agree with you financial market speculation has driven the price of oil up (another asset bubble) but my guess is by $10-$15, not by $40.
Someone else asks about Canada. The raw facts are at $50/bl, we can expect as much as 3m barrels/day by 2015 pace less than 1m b/d now. 4-4.5m b/d at a push. There is not the capacity up there to build it any faster-- in skilled manpower, infrastructure, water, natural gas etc.
Posted by: John at November 16, 2005 10:44 AM
It should be kept in mind that the Hotelling model has several important simplifying assumptions in it, including 1) no technological change, 2) complete knowledge of the availability of the non-renewable, depletable resource, 3) a competitive market for the resource, and in the simplest original version 4) constant marginal cost of extraction. Those assumptions in an infinite horizon optimization give the nice, neat result of a real price that steadily increases at the real rate of interest. Alter any of those assumptions, none of which are correct, of course, and you alter that result. That in the real world we see some rather extreme volatility of the price of oil is not all that surprising.
Posted by: Barkley Rosser at November 17, 2005 07:23 AM
I have a small question.
You point out in your presentation what the market predicts as the future oil price. And from the numbers you show, it looks like the oil price is going to stay more or less level.
However, that is because of the intertemporal arbitrage: The market does not allow large fluctuations in the future.
But I don't understand why this should be a good prediction for the price of oil. 3 years ago, the market did not say oil would be 55$ for dec 2005, exactly because of intertemporal arbitrage.
I don't have access to the numbers, but it would be interesting to see how the 'future' price of oil has fluctuated over the last 5 years or so. Because I would suggest that the market prices these contracts more or less like 'oil will be about the same next year as this year'.
If you look at it this way, then the market MUST ignore peak oil. Because if it didn't, it would be subject to this mechanism.
Just my 2c's, ignore it if it makes you laugh.
Posted by: Anonymous at November 22, 2005 05:02 AM
The other solution is an import tax that effectively puts a floor under domestic oil at $60. Right now that would not be too painful - a windfall foregone - but it would not only guarantee a minimum price paid by consumers but also a minimum price received by producers. This would make it worth developing American sources of oil eg Canada and US oil shale, effectively solving both the import issue and the strategic dependence on the middle east and Russia. Moreover it would be counter cyclical in that a global slowdown would produce a low world oil price but a bigger import duty for the US treasury. Windfall gains for oil companies could be dealt with via taxes and allowances for investing in alternative energy.
Posted by: Mark T at November 22, 2005 07:07 AM
Anonymous, I think of the futures price not as telling us what will happen (nobody knows that), but rather as telling us what many market participants regard as the expected outcome.
Posted by: JDH at November 23, 2005 04:52 AM