Peak Oilers Now Welcome at the IMF

Taking a short interlude from my recent treatments of technology, I feel the need to do a quick post on Peak Oil’s continued transformation toward respectability. Some months ago, I highlighted the fact that the IMF had openly recognised the Peak Oil argument in even its most prestigious publication, the World Economic Outlook (see my post here). In particular, IMF staffers now appear to be thoroughly acquainted with the work of Steve Sorrell, who has provided us with some of the most in-depth reviews of the Peak Oil literature (see my post here).

Now, when I say ‘recognised’ that did not mean ‘accepted’. Rather, the IMF acknowledged in the World Economic Outlook that price alone had not brought forth sufficient supply or substitutability over a multi-year time frame, as had previously been predicted. Economists at the IMF, therefore, seem to have decided to widen their intellectual net to bring in some fresh ideas.

Technology: Singularity or Collapse? (Part 1: For Ever Exponential)

In the opening chapter of Ray Kurzweil‘s “The Singularity Is Near” we are presented with the following parable:

A lake owner wants to stay at home to tend to the lake’s fish and make certain that the lake itself will not become covered with lily pads, which are said to double their number every few days. Month after month, he patiently waits, yet only tiny patches of lily pads can be discerned, and they don’t seem to be expanding in any noticeable way. With the lily pads covering less than 1 percent of the lake, the owner figures that it’s safe to take a vacation and leaves with his family. When he returns a few weeks later, he’s shocked to discover that the entire lake has become covered with the pads, and his fish have perished. By doubling their number every few days, the last seven doublings were sufficient to extend the pads’ coverage to the entire lake. (Seven doublings extended their reach 128-fold.) This is the nature of exponential growth.

While ‘the water lily and the lake’ appears a strange choice of metaphor since if nothing else it highlights the importance of boundaries to growth, what Kurzweil was trying to communicate was how technology has barely begun to transform our lives.

By contrast, consider the 1972 report to the Club of Rome published under the title “The Limits to Growth.” Much maligned and mostly misrepresented, The Limits to Growth (LTG) was nothing more than a mathematical analysis of linear and exponential growth rates and ultimate constraints. According to the authors, the tyranny of exponential growth rates would eventually lead population and industrial production to explode, setting off a negative feedback in terms of burgeoning pollution and the eventual exhaustion of food and resources. The report never provided specific dates for the depletion of individual materials, although nine our of ten commentaries on the report claim it did (for a post I did on this particular urban legend, see here). Nonetheless, what the report did do was suggest that the idea of inevitable constant human progress was a dangerous myth.

Shale Gas (Part II): Tooth Fairy Economics

In my last post, I noted how a whole host of reports have been trumpeting shale gas as the ultimate ‘get out of jail free’ card from any kind of energy constraint and, indeed, the need to invest in renewables to protect the planet from climate change. Here is Mortimer Zuckerman talking of a shale gas ‘revolution’ in the Wall Street Journal.

America’s soaring natural-gas production has already helped cut our share of oil consumption met by imports to 47% last year from 60% in 2005, according to the Energy Information Administration. The shale-gas revolution, with proper safety practices, can be expected to continue this trend while addressing three longstanding concerns of the energy business: energy scarcity, energy security, and environmental risks. In a word, we have a chance to remake our energy future.

Note that an awful lot is being asked of shale gas if it going to help solve scarcity, security and environmental risks all at once. We are in effect asking it to do three things: 1) allow total energy consumption from all energy sources to grow in order to solve the problem of scarcity, 2) enable us to switch away from coal in the generation of electricity in order to blunt (but not stop) CO2 emission growth and so ameliorate environmental risks, and 3) facilitate a transport revolution that allows us to stop importing oil from geopolitical hotspots.

Shale Gas (Part I): Energy Cornucopia’s Great Fight Back?

The idea that resource constraints pose a limit to growth (one version of which is Peak Oil thoery) is subject to constant attack, with economists of a neo-classical persuassion frequently leading the charge. As such, those who believe in resource cornucopia, or at least that resources pose no impediment to economic growth, deserve a close reading since the victors of this debate will define how our world evolves over the next 50 years.

As I mentioned in my last past, it adds nothing to the debate when many mainstream economists begin their analysis by misconstruing the arguments of their opponents. Take a careful note of three things that modern Peak Oil theorists are not suggesting: they emphatically are not stating that 1) price doesn’t matter, 2) there are no more reserves to be found and 3) technological advances are irrelevant. If you don’t believe this statement, then I urge you to actually read the landmark article by Campbell and Laherrere in Scientific America (here) that brought the topic of Peak Oil back into the public domain. Or, at the very least, read the excellent summation of Peak Oil thought that ends their article:

The world is not running out of oil—at least not yet. What our society does face, and soon, is the end of the abundant and cheap oil on which all industrial nations depend.

The Limits to Growth, Urban Legends, Economists and Dieter Helm

At the heart of economics is the idea of scarcity—or rather scarcity in the face of infinite wants. Yet scarcity is an issue that touches upon us all, and thus draws the interest of different scientific disciplines. So if we take the idea of scarce oil (let’s call it Peak Oil), we should not be surprised that chemists, physicists, engineers and geologists would want to take a view.

Nonetheless, many economists appear to believe that they have a unique and superior understanding of how scarcity evolves through time (using the tools of supply, demand and price); and they often also behave as if no non-economist could ever hope to gain such insights. As such, we may criticize them for being arrogant—but not as necessarily wrong (and at this point I have to declare that I am an economist by training). But wait a minute, if the arguments of mainstream economists are so evidently correct, why do many of them appear to have a pathological need to misconstrue the arguments of their opponents?

Probably the most enduring urban legend (or urban myth if you prefer the term) of them all in the study of resources is the common interpretation of The Limits to Growth report to the Club of Rome published in 1972. Surely, everyone knows that the report’s forecast of resource exhaustion by the year 2000 turned out to be nothing but a huge joke. And if we don’t know this directly ourselves (having not read through the report because frankly who has the time, and where would we find a copy anyway these days), we know because high profile journalists and media pundits have told us of the report’s spectacular failure on TV, in newspapers or over the internet (or someone in a pub or bar said that is what the report said).

The Chief Investment Officer of JP Morgan Comes Out of the Peak Oil Closet

At the heart of the cornucopian view of energy abundance lies the belief that technology will overcome any natural resource constraint. The poster child for this view of the world is Moore’s Law, whereby computing power follows the allegory of a grain of wheat on a chess board (so promising untold riches for us all).  Interestingly, Michael Cembalest the CIO of JP Morgan—surely the antithesis of The Archdruid—displayed a large dose of scepticism over this technological nirvana in a recent report that commenced by highlighting a few famous predictions of our energy future (in so doing, Cembalest makes the point that Moore’s Law is the technological exception—not the rule): 

Could Peak Oil Pose a Near-Term Risk?

In my last post, I noted how even the IMF has come to address the issue of Peak Oil, most explicitly in the April 2011 edition of their flagship publication World Economic World (here). From a risk perspective, the first take-away from the report is that the very inelastic short-term supply and demand curves for oil make the world economy (and individual wealth) highly vulnerable to any geopolitical disturbance in oil supply. The second take-away is that long-term demand is also highly inelastic, suggesting any substitution away from oil is problematic (for example, it would take decades to replace our petrol and diesel based car fleet with an electric-based alternative). However, neither of these conclusions directly address the issue of whether oil production could peak.

On the longer-term supply side, the central scenario in the IMF report is for an annual average growth rate in oil production of 1.5%,  while the the alternative ‘Peak Oil’ scenario (called Scenario 2 in the report) is for a decline of 2% per annum. How exactly these figures have been arrived at is left somewhat vague. The supply growth scenario appears an extrapolation of recent trends, while also being broadly consistent with the forecasts of the International Energy Agency (IEA). For the contraction scenario, a reference is given to a paper by Sorrell et al but no further details are provided. In other words, the IMF deftly avoids going into the peak oil controversy but just plucks out a couple of scenarios: 1) consensus oil cornucopia and 2) a mild oil descent.

The lack of an explicit treatment of the long-term supply side is somewhat puzzling, given that the IMF’s study feels able to put numbers onto the demand side (albeit with large caveats). In short, no light is shed on how price can introduce more capital expenditure and thus call forth more oil supply over the longer term and no information is given on how the supply curve moves through time due to the impact of technology.

Nonetheless, if you access the paper led by Steve Sorrell that is referenced by the IMF (here) you can find a treasure trove of information about a range of possible long-term oil supply outcomes, both optimistic and pessimistic. Unfortunately, the article is behind a pay wall (and costs $19.95 through the Science Direct website) but most of the contents are freely available in other publications Steve Sorrell has co-authored—particularly the The Global Oil Depletion Report from the UK Energy Centre—and in video and powerpoint presentations.

If you want to understand the main points Sorrell wishes to communicate directly, then I suggest you watch the video below (as the powerpoint charts are barely visible in the video, it is worth running this Powerpoint presentation concurrently as most of the slides overlap). For those time constrained, I have pulled out the most interesting points and charts in the rest of the post.

http://blip.tv/ruw-/steve-sorrell-peak-oil-a-review-of-global-oil-depletion-2999895

If I had to sum up Sorrell’s key messages, they would be these:

• Consensus reserve estimates of oil reserves may be accurate (thus falsifying the claims of high profile Peak Oil exponents such as Colin Campbell), however this makes only a relatively small difference to the timing of a peak in production.
• The critical issue is how easily (and cheaply) we can access resources rather than their ultimate size.
• There is a significant risk that oil production will peak before 2020.
• The assumption of a peak beyond 2030 appears at best optimistic and at worst implausible.

Sorrell starts his analysis by defining conventional oil as a combination of crude oil, condensates and natural gas liquids.

Sorrell notes that true unconventional oil currently accounts for only 3% of total ‘all liquids’ production and is projected by the IEA to only be a little over 10% by 2030 (the IEA’s Current Policies scenario sees 11.3 million barrels per day of unconventional oil production in 2030 out of a total of 103.9 mbd in their 2011 World Energy Outlook report). The IEA defines unconventional liquids to include biofuels plus unconventional oil which includes oil sands, extra heavy oil, gas to liquids (which is different from natural gas liquids), coal to liquids and kerogen oil.

Against this background, Sorrell stresses that if conventional oil depletes more quickly than expected, non-conventional oil will not be able to make up the difference over a 20 year time span. He then focuses on the supply dynamics of conventional oil, particularly on the physical constraints on production, and notes the following points:

• Each individual oil fields follows a pattern of rise, peak, plateau and fall
• Most production in a region originates from larger fields
• Larger fields are relatively easy to find than smaller ones and are thus generally found first

The UK oil industry is used by Sorrell as a typical example. The largest fields such as Brent and Forties were found in the early stages of exploration. Further, the much smaller fields most recently discovered both peak earlier and decline quicker as well as produce less oil overall. Note that the recent numbers from the latest BP Statistical View of World Energy show UK oil production at 1.3 mb/d in 2010, down from 2.7 mb/d in 2000.

Economists please note (and I am one by training): during the period of UK oil production decline, the oil price has risen radically and deep sea drilling and extraction techniques have continued to improve. Nonetheless, the decline in production has been impervious to both price and technological trends. What is more, numerous other countries are now in the position of recording relentless output declines.

Sorrell then looks at the concept of ultimately recoverable resource (URR). In his words

The URR is the sum of cumulative discoveries, future reserve growth at known fields and the volume of oil estimated to be economically recoverable from undiscovered fields—commonly termed the yet-to-find (YTF).

Current estimates for URR are between 2,000 and 4,300 giga barrels (Gb), with giga meaning billion. If we take out what has already been produced, that leaves us with between 870 Gb and 3,170 Gb left to recover. (The IEA in its 2011 WEO report puts recoverable conventional oil resource at 2,800 Gb, and thus a URR of around 4,000 Gb.) Sorrel then goes on to make the critical observation that the year of peaking is remarkably insensitive to the actual URR:

Now you can alter the shape of the curve to delay the peak, principally by a) decelerating your oil production ramp up, or b) putting your peak off but at the expense of having oil production fall off a cliff at some point in the future. But neither action is a free lunch economically.

Sorrell then went on to analyse 14 forecasts of oil production out to 2030. Of these 14, five forecast no peak before 2030; these forecasts came from the IEA, OPEC, US Energy Information Administration (EIA), ExxonMobil and Meling (Statoil-hydro). The non-peak forecasts arrived at their conclusions through a combination of having higher URR estimates and assuming larger post peak declines:

The next critical question then is how realistic are the no-peak-before-2030 forecasts? Sorrell implies that such forecasts should not be judged as central scenarios but rather as at the edge of all possible outcomes for a number of reasons.

First, historical experience suggests that production curves are asymmetric—but not to the right of the peak but rather to the left. In other words, we see a fast ramp-up and then slow decline. Sorrell notes that of the 37 countries that have already experienced a peak, the peak took place at 26% (production weighted) of their URR (ultimate recoverable reserves). The more optimistic forecasts—like those of the IEA, EIA and OPEC—are implicitly looking for a peak at a much higher percentage of URR.

Second, the more optimistic studies assume that discovery trends will remain in place despite the fact that they have been on a long-term downward decline (although the IMF’s New Policies Scenario has quite conservative discovery rates of 8 Gb per year through 2035).

Third, many forecasts such as those by the IEA suggest that oil can be extracted from the newly discovered fields at a rate that has no historical precedent.

Following on from this analysis, Sorrell and his co-authors ended the paper cited by the IMF with this statement:

Given these complexities, we suggest that there is a significant risk of a peak in conventional oil production before 2020. At present, most OECD governments are failing to give serious consideration to this risk, despite its potentially far-reaching consequences.

From a risk perspective, this appears very sensible. We just don’t know when the actual conventional oil peak will take place and attaching a single point estimate appears a futile exercise. However, we do know that it could appear early or late. If early, this would imply that we have very little time to put in pace either non-conventional supplies or renewables. The result of a supply side conventional oil shock could thus inflict a major blow to global GDP (and, potentially, global political institutions).

Sex, Violence, the Amish and the IMF

If you like your Peak Oil raw, the blogosphere provides plenty of sustenance. At sites such as The Archdruid Report, Casaubon’s Book and The Automatic Earth, we see a small section of society actively preparing for a major discontinuity in the type of lives we lead. One of my favourite representations of this meme is provided at Clusterf**k Nation, a blog run by the author James Howard Kunstler. Kunstler jumps the divide between hard analysis of the perceived problem and fictional representations of how things could unfold. You may not agree with Kunstler, but you will not be bored.

In the non-fiction book The Long Emergency, Kunstler gives an explanation of how the global economy could reverse as oil production peaks. But for me, Kunstler’s fiction leaves a more enduring memory. In the World Made by Hand series we see society shrinking in upon itself. The death of distance lauded in the 1990s has become a cruel joke:  the principal means of transport are reduced to foot, horse or boat (bicycles even fall by the wayside through a  lack of tires). And political relationships relapse to those existing in the pre-modern period. We are faced with feudalism: medieval free towns, lords of the manor (or their scrap-yard equivalents), serfs, self-contained religious sects and marauding bands of muggers.

At its best, life appears to resemble an Amish country idyll but with a lot more sex. At its worst, the break-down in social order and frequent bouts of extreme violence place us in the pages of Cormac McCarthy’s ‘The Road’.

For the majority of neoclassical economists, such visions are nothing but dystopian fantasies: doomer porn for those with a disposition toward the depressive. Nonetheless, the historical record gives one pause f0r thought: economies do suffer from shocks, which can in turn lead to political dislocations. Within living memory, we saw an economic discontinuity in the 1930s lead to social mayhem throughout Europe and the death of around six million Jews. People still living became unwilling participants in adaptations of Schindler’s Ark and Sophie’s Choice.

So is there any way to get from the existing economic consensus to the type of economic breakdown that Kunstler professes to see?

In my last post, I argued that there was no inherent contradiction between Peak Oil and neoclassical economic thought from a theoretical perspective. The argument was purely over the shape and dynamics of supply and demand curves. To take us into Kunstler’s ‘World Made by Hand’ would require a massive economic contraction sufficient to fracture our global political institutions, in turn setting off a second round of economic deterioration that demolishes our domestic political and social structures. Can Peak Oil take us into the first stage of this process? To do so, a neoclassical economic analysis would be looking for three things: 1) highly inelastic supply and demand curves for oil, both in the short and long term, 2) a supply curve that moves to the left and 3) a key role for oil in economic growth.

Surprisingly, the IMF published a section (entitled “Oil Scarcity, Growth, and Global Imbalances“) within its flagship Word Economic Outlook back in April 2011 that set out some scenarios that indirectly dealt with all these three things.

As regards the elasticity of oil demand to price, the IMF was not the first international organisation to warn of the world’s vulnerability to an oil price shock. In the International Energy Agency’s flagship 2010 World Energy Outlook report, the Executive Summary had a section entitled “Will peak oil be a guest or the spectre at the feast?” which led off with the following paragraph:

The oil price needed to balance oil markets is set to rise, reflecting the growing insensitivity of both demand and supply to price. The growing concentration of oil use in transport and a shift of demand towards subsidised markets are limiting the scope for higher prices to choke off demand through switching to alternative fuels. And constraints on investment mean that higher prices lead to only modest increases in production.

What this statement means is that the oil supply and demand curves are looking highly inelastic. In other words, when the oil price goes up there is not that much room to either substitute out of oil into alternative sources of energy or bring more oil into production.

For the demand elasticity, the IMF went further and applied some numbers to the problem. Over the short term, the IMF sees the demand curve as almost vertical. In their words “a 10 percent increase in oil prices leads to a reduction in oil demand of only 0.2 percent”. This is a pretty frightening statement: it says we have almost no ability to adapt to an oil price shock over the short term. So god help us if a) Iraq plummets into an internecine civil war, b) Israel attacks Iran or c) Nigeria descends into internal chaos. The short-term supply elasticity is also seen as very low at between 1 and 10 percent, and mostly consists of the production buffer held by Saudi Arabia. Should this buffer go, the short-term supply curve becomes in effect vertical (no increase in supply at any price).

Nonetheless, this is not the core of the peak oil doomer scenario; for us to approach collapse, we must see viciously steep long-term supply and demand curves, against which both substitution and technological invention appear ineffectual. And this, in effect, is what the IMF at least suggests on the demand side. It calculates a long-term price elasticity of oil demand (long term defined as a 20-year time horizon) of 7%. This again appears incredibly small. You can double the price but you can hardly make a dent in demand. How could this happen?

For this, we must understand the unique attributes of oil: energy density and transportability. These characteristics are incredibly difficult to replicate. Accordingly, where it has been possible to substitute out of oil, much of the transformation has already taken place. In other words, the shift to gas and coal for electrification previously provided price elasticity for oil, but that has now gone.

Now the IMF’s  baseline scenario for oil production is for 1.5% annual growth. However, in Scenario 2 of the report a contraction in supply of 2% per annum is also considered. The 2% decline number is taken from a paper by Sorrell et al in Energy Policy (that is unfortunately behind a pay wall). In this scenario, we move into a world where the supply curve is moving to the left as opposed to a cornucopian view of the world where technology always pushes the supply curve to the right.

Moreover, if you take this Peak Oil decline scenario and combine it with the IMF’s previously calculated demand and income elasticities, global capitalism suffers a significant shock. In their words:

The most striking aspect of this scenario is, however, that supply reductions of this magnitude would require an increase of more than 200 percent in the oil price on impact and an 800 percent increase over 20 years. Relative price changes of this magnitude would be unprecedented and would likely have nonlinear effects on activity that the model does not adequately capture. Furthermore, the increase in world savings implied by this scenario is so large that several regions could, after the first few years, experience nominal interest rates that approach zero, which could make it difficult to carry out monetary policy.

It should be noted that ‘several regions’ are already experiencing nominal interest rates approaching zero. Thus if we are already entering the foothills of a Peak Oil shock, monetary policy is already incapably of easing the blow over large swathes of the globe including the United States.

Unfortunately, the IMF’s Scenario 3 paints an even bleaker picture since it recognises some of the more recent work on energy’s role in GDP growth. Under traditional approaches, the contribution of oil to economic output has been pegged at around 5% for the tradeables sector and 2% for the non-tradeables based on the cost of oil within the economy. New methodology suggests that these figures could be as high as 25% and 20%, respectively. The argument runs thus: certain technologies are premised on access to energy. Reduce the access to energy and the technology becomes defunct.

As an example, take the first Newcomen steam engine, developed around 1710, that allowed water to be pumped out of coal mines; in so doing, mines were opened up to exploitation at a hitherto unprecedented scale. But the Newcomen engine relied on a bountiful supply of coal. If the coal hadn’t been there, the steam engine could not be operated. The machine technology and the energy can therefore be thought of as a single package: remove one and you cease to have the other.

In a more up-to-date context, think of a sophisticated airline routing algorithm that minimises the number of empty aircraft seats and reduces ticket prices. Doubling the price of jet aircraft fuel not only reduces the number of planes in the air but also reduces the optimisation potential of the algorithm, so setting off second round effects. Oil scarcity can therefore lead to what is, in effect, the disinventing of technology.

Overall, a neoclassical framework built on a slightly more pessimistic premise can have some quite alarming implications. In the words of the IMF:

But if the reductions in oil output were in line with the more pessimistic studies of peak oil proponents or if the contribution of oil to output proved much larger than its cost share, the effects could be dramatic, suggesting a need for urgent policy action.

Nonetheless, even if we pile an oil supply contraction (IMF Scenario 2) on top of a greater role for oil in the economy (IMF Scenario 3), we still are not reduced to the existence of Kunstler’s post apocalypse Amish. The IMF does not give a compound figure for one scenario placed on top of another, but for the US we are probably looking at a 20-25% decline in GDP over a 20 year period against trend and a lot steeper drop for emerging Asia. Assuming trend is for modest growth, this type of oil shock would flat line growth overall.

The relatively benign worst-case outcome of no growth (but no descent), however, assumes that massive price and income shocks can be smoothly absorbed both within and between societies. Unfortunately, we have already seen financial systems struggle with shocks an order of magnitude smaller.

In conclusion, the IMF’s formal neoclassical analysis could easily take us to the brink of Kunstler’s descent, but we would still need something beyond a traditional economic shock to push us over. For that we would need to turn to the science of complex systems or to geopolitics, topics that I intend to return to in future posts.

Of Straw Men and Peak Oil

Now here’s a task for you. Click on the link here to Economist’s View, probably the most widely visited economics blog and aggregator of all things economics-related on the web. Go to the Google Search function at the top and type in  ‘Peak Oil’ restricting the search to ‘This Site’. What do you get? The answer: very little (relatively speaking). Around 98o results, compared with a total of 9,500 for the word ‘Greece’.

Glance a couple of results down and you will see one headline titled “Peak Oil is Stupid”. If you follow the link, you will end up at a post by Tim Haab, blogger at Environmental Economics and an economics professor at Ohio State University. What does he have to say about Peak Oil:

Must be time to update my semi-regular ‘peak oil is stupid’ rant.  So here goes…

I don’t care when oil (OR COAL) peaks, I care when we run out, which we won’t because, as production declines, prices WILL rise. As prices rise, people WILL figure out alternatives. They might not be happy alternatives. They might not be as productive alternatives. They might not support the same lifestyle to which we are accustomed. But there WILL be alternatives, forced by higher prices–and no other mechanism is that powerful.

Well that has put the Peak Oilers in their place then! But just in case, let’s see what two of the most famous Peak Oil advocates, Colin Campbell and Jean H. Laherrere, had to say back in March 1998 when  they wrote a a high profile article (here) for Scientific American (when oil cost $12 a barrel):

The world is not running out of oil – at least not yet. What our society does face, and soon, is the end of the abundant and cheap oil on which all industrial nations depend.

Furthermore:

From an economic perspective, when the world runs completely out of oil is thus not directly relevant: what matters is when production begins to taper off. Beyond that point, prices will rise unless demand declines commensurately.

Thus from a theoretical standpoint, there is in reality not much difference between Campbell and Laherrere, on the one hand, and Haab on the other.

And now a plea from me: could everyone please keep their straw men in the barn. If we only seek out the views  within the opposing camp of the extremists, or the outdated, it is relatively easy to knock down their arguments—but it doesn’t further the debate. Few Peak Oilers now say that one day there will be oil and the next it will be gone; most prescribe, like Campbell and Laherrere, to the idea of peak ‘cheap’ oil and the theory that an oil production growth constraint could increasingly impact on wider economic growth and human welfare.

More broadly, I mentioned in my last post that Peak Oil theory would need to overturn the neoclassical economics consensus. Actually, this claim needs refining somewhat, since I wasn’t referring to the theory of neoclassical economics but rather the empirical world view of most neoclassical economists. Mark that these are two very different concepts. Advocates of a biophysical economic view of the world do look at the world differently (look at the graphic below  from Question Everything). However, I would argue that the viewpoints are not contradictory; rather they are more like very different artistic interpretations of the same object: the earth system.

The critical point here is that biophysical approaches to economics warn of the tyranny of the second law of thermodynamics: energy and matter will tend to entropy (disorder). From a neoclassical perspective, this, translates into increased scarcity and an upwardly sloping supply curve that moves continually to the left. This contrasts starkly with the neoclassical cornucopian paradigm that as technology advances the supply curve moves inexorably to the right.

Put bluntly, the peak resource advocates see stuff getting progressively more scarce and thus more expensive; traditional neoclassical economists see stuff getting ever more accessible (through the magic of technology) and thus cheaper.

And so back to oil. A strong proponent of the magic of markets and technology over the years has been Daniel Yergin the cofounder of Cambridge Energy Research Associates and the author of a number of highly influential books on the oil industry, the most recent of which—”The Quest”—was a mainstay of my Christmas reading. If you don’t want to read the book, then I recommend an Op-Ed piece he wrote for the Wall Street Journal here.

The article, again, is built around a straw man, in this particular case the ideas of the earth scientist Marion King Hubbert, the father of Peak Oil:

Hubbert insisted that price didn’t matter. Economics—the forces of supply and demand—were, he maintained, irrelevant to the finite physical cache of oil in the earth. But why would price—with all the messages that it sends to people about allocating resources and developing new technologies—apply in so many other realms but not in oil and gas production? Activity goes up when prices go up; activity goes down when prices go down. Higher prices stimulate innovation and encourage people to figure out ingenious new ways to increase supply.

Hubbert is certainly a towering figure in the Peak Oil movement, and Campbell and Leherrere likely built on his intellectual foundations. But schools of thought (at least good ones) evolve, and it is no different with the advocates of peak oil. Thus, if one is to criticise Campbell, it cannot be because he ignores price (even though M. King Hubbert certainly held the market system in little esteem).

If one reads Daniel Yergin after reading the Campbell and Laherrere article, what jumps out at me is how little new is in “The Quest”, despite 12 years elapsing between the two publications. (Is that why Yergin had to reach back decades earlier for his straw man?) For example, Campbell and Laherrere recognised that technology is having an impact:

A second common rejoinder is that new technologies have steadily increased the fraction of oil that can be recovered from fields in a basin—the so-called recovery factor. In the 1960s oil companies assumed as a rule of thumb that only 30 percent of the oil in a field was typically recoverable; now they bank on an average of 40 or 50 percent. That progress will continue and will extend global reserves for many years to come, the argument runs.

They go on to argue, however, that such technological progress is already factored into oil company forecasts of reserves to a high degree. Moreover, their paper accepts the existence of large reserves of unconventional oil such as the Orinoco oil belt in Venezuela, and tar sands and shale in Canada. They also perceived the potential for natural gas liquids. They hardly come across as Luddite technophobes:

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Theoretically, these unconventional oil reserves could quench the world’s thirst for  liquid fuels as conventional oil passes its prime. But the industry will be hard-pressed for the time and money needed to ramp up production of unconventional oil quickly enough.

If advanced methods of producing liquid fuels from natural gas can be made profitable and scaled up quickly, gas could become the next source of transportation fuel.

At this point, let me have a little rant of my own echoing that of of Professor Haab who kicked off this post. Peak Oil thought does not automatically contradict the underlying philosophy of market economics. Most of it can be encompassed in the idea that the oil supply curve is inelastic over the short term and will tend to move to the left over the long term as resources run dry, thus leading to permanently high prices.

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Put differently, the argument is not one of whether supply and demand curves exist, but rather what shape they are and how they move through time.

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Critically, the massive global oil market, consisting of numerous buyers and sellers and highly visible price, proves a wonderful free market test. So let us see what the oil price has done since Campbell and Laherrere wrote their paper back in March 1998 (chart is Brent oil):

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The market speaks—and it is stunning reaffirmation of Campbell and Laharrere. Yergin’s book “The Quest” is a paean to technology: data processing on an unheard of scale, horizontal drilling, CAD/CAM oil field design, deep water drilling, new technology to extract oil from tar sands and shale—the list goes on. In other words, the modern world oil industry is a tribute to science, as well as man’s endeavour unleashed by free markets. Yet over that period the oil price has risen tenfold in nominal terms and over fivefold in real, inflation-adjusted terms. And here is the supply response (taken from the BP Statistical Review). Lacklustre at best.

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In short, when the market price of an item rises, it should cause people to substitute away from the good and cause more investment in the production of the good: this is Economics 101. Taken together, the market should produce countervailing forces that ameliorate the rise. Over the last decade, this has not been happening. Mr Market has spoken, and it has been on the side of Peak Oil. It would be nice, therefore, if Economist’s View could give the issue a little more respect—despite the undoubted importance of Greece.

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The Conjoined Twins: Peak Oil and Climate Change

Of modern-day dystopias, the conjoined twins of climate change and peak oil energy (or rather peak energy) are poor dance partners, forever out of tune and stepping on one another’s toes. Despite being conjoined through carbon, the interaction between the two is complex and, at times, contradictory. Accordingly, while most of the environmental movement has embraced both issues, it is a somewhat awkward clinch.  At the most extreme, the thesis of one negates the other: a peak energy carbon constraint caps warming; while a carbon concucopia allows economies to grow head long into a climate crunch (that they may or may not have the wealth to cope with).

Peak oil’s path to respectability has been a little more convoluted than that of climate change.  Indeed, it is still quite far from becoming the consensus. Indeed, for peak oil theorists to emerge victorious they need to slay an even more entrenched existing consensus, that of neoclassical economics. Laurence Summers—a feted economist whose resume includes an academic professorship at Harvard, the role of Chief Economist at the World Bank and stints with both the Clinton and Obama administrations—had this to say about resource constraints back in 1991:

“There are no limits to the carrying capacity of the earth that are likely to bind any time in the foreseeable future. There isn’t a risk of an apocalypse due to global warming or anything else. The idea that we should put limits on growth because of some natural limit, is a profound error and one that, were it ever to prove influential, would have staggering social costs.”