“The U.S. Current Natural Gas Situation”

Michael Giberson

What do changes in the domestic U.S. natural gas market have to tell us about the world oil market? Hirsch, Bezdek, and Wendling wrote, “The North American natural gas situation provides some useful lessons relevant to the peaking of conventional world oil production.”

Here is their assessment of the North American natural gas situation:

U.S. natural gas demand is increasing; North American natural gas production is declining or poised for decline as indicated in references 53, 54, and 55. The planned U.S. expansion of LNG imports is experiencing delays. U.S. natural gas supply shows every sign of deteriorating significantly before mitigation provides an adequate supply of low cost natural gas. Because of the time required to make major changes in the U.S. natural gas infrastructure and marketplace, forecasts of a decade of high prices and shortages are credible.

Hirsch, Bezdek, and Wendling, “Peaking of World Oil Production: Impacts, Mitigation, and Risk Management,” (2005) p. 36. (Commonly referred to as the “Hirsch Report.” References 53, 54, and 55 are the US EIA Annual Energy Outlook 2000, a 2004 CERA report on gas supplies, and an Oil and Gas Journal article also from 2004.)

US EIA,

US EIA, “Projected natural gas prices depend on shale gas resource economics,” Today in Energy, August 27, 2012.

Indeed, forecasts of a decade of high gas prices were credible, as many energy experts agreed. But as it has turned out about a year after the report was published U.S. natural gas production began a period of sustained growth, and high gas prices lasted only about 3 years. The planned expansion of LNG imports has turned into a pressing desire to export North American natural gas to Europe and Asia. As of May 17, 2013, two export licenses have been approved and 19 more applications are under review at the US DOE.

Makes me wonder what Hirsch, Bezdek, and Wendling think about the peaking of world oil production now. One clue, from 2010, suggests they no longer draw analogies from the North American gas market when discussion world oil production.

Smil: No imminent danger of peak oil, but will peak oilers admit it?

Michael Giberson

Vaclav Smil wonders, now that 2012 appears to have yielded a new record level of global oil output, will “some catastrophists and peak-oil cultists” have to back off their gloomy outlooks? See Smil, “Memories of Peak Oil,” in The American.

Here is my prediction: No peak oiler will find 2012 oil production data as reason to move away from peak oil gloom.

We can even operationalize my prediction by adding some parameters: I predict that no blogger at The Oil Drum who is on record as believing world oil production peaked sometime between 2004 and 2010 will post on that site within one year an updated claim concluding peak oil will not happen until after 2030.

Before getting too excited about the IEA’s forecast of US oil production leadership…

Michael Giberson

Earlier this week the International Energy Agency released their annual World Energy Outlook, and new is a forecast that the United States would surpass Russian and Saudi Arabia to once-again become the world’s largest oil producer, sometime around 2020. The news set off a wave of happy press, i.e. the Wall Street Journalmore WSJ, Fox Business, Oil and Gas JournalReuters, and this odd warning from OPEC that said the report could lead to higher prices. Mark Mills offers a slightly tempered view of the IEA report at Forbes

Many of the news reports, if you get beyond the headline and first few paragraphs, do provide a bit of context. The projection depends on a host of factors, not the least of which is the price of oil over the next few years. If oil prices drop much below $60 bbl., the U.S. oil boom will slow much more quickly than Saudi or Russian output. U.S. regulatory changes, the pace of pipeline construction, and numerous other factors will also affect how quickly U.S. production can grow.

More generally, such long term forecasting exercises are regularly wrong. Indeed, the news here is exactly the change in the forecast, i.e., the IEA view that their earlier forecasts were wrong. The obvious question is “why we should believe the new view?” Of course changing views when the facts change is a most reasonable thing to do, but we ought not believe that the facts can’t change again.

I recommend we all go read Vaclav Smil on the “Perils of Long-Range Energy Forecasting” (Technological Forecasting and Social Change, 65:3, 2000).

Tedious peak oil claims from the EU Energy Policy Blog

Michael Giberson

Not all peak oil analysis comes across as sloppy, misleading, and a bit tedious, but this one does: “Peak Oil Driving The Global Gas Shift.” Of course sloppy analysis abounds on the internet, and the best approach is usually to ignore it, but this example appears on the somewhat respectable site of the EU Energy Policy Blog.

The introduction to the article is set up as a contrast to the rosy outlook of a Citigroup report that claimed the shale gas boom was set to transform into an oil boom in North America. Not so fast, our author warns. Then, after a few “peak oil-friendly facts” picked from a subsequent US Energy Information Administration report (link), the author gives us the bad news from Iranian production:

The shrinking spare capacity of the OPEC states, of 2.5 Mbd, is almost exactly what Iran was exporting until late 2011, following a year average 2.6 Mbd in 2010, but since 2011 and for reasons only partly related to sanctions, and closer related to depletion, its oil output is falling: Iran’s net exports and export supply capacity may stand at only 2.2 Mbd today. Some sources suggest even less than that. In 1976, Iran could produce 5.75 Mbd and export far more than 4 Mbd to a world market that, at the time, consumed about 62 Mbd compared with 89.7 Mbd today. Explaining this while denying depletion and the impact of oil consumption growth in exporter countries and worldwide is mental gymnastics!

Allow me to attempt the “mental gymnastics,” which in this case seems to be the mental equivalent of sitting on a balance beam and swinging my legs: to wit, the internet search! Yielding an EIA country report on Iran and this chart:

Iranian Total Oil Production and Consumption, 1977-2010

EIA, Iranian Total Oil Production and Consumption, 1977-2010

The International Energy Agency’s numbers on Iranian oil production look much the same. Admittedly, our author is making claims about 2011, and especially about changes since 2011 (i.e. production over the first month or two this year), while the chart about only shows data through 2010. So imagine a slight drop for 2011 and a sharper drop for early 2012, perhaps like the drop seen in 2002. The IEA’s more recent analysis of Iranian oil suggests that production fell by 1.5 percent in February 2012, to the lowest rate in three years.

But can we call this a Peak Oil omen? Obviously, as the chart shows, Iranian oil production is down from the high levels of the 1970s. But, with the helpful labels inserted by the U.S. EIA “Iranian Revolution” and “Iran-Iraq War,” it is easy to see that the so-called above-ground factor of politics and war have driven the most significant swings in production. In addition, the chart makes clear that net exports (and most of the numbers cited in the paragraph quoted are net export numbers) depend on production and domestic Iranian consumption.

So far as I know, peak oil is a theory about production rate limits enforced by physical realities, not a theory about international trade. Net export data is at most suggestive. And especially when the trade data cited comes from a period of explicit trade sanctions imposed by nations who previously were significant trading partners, it seems all to easy to believe that the above-ground factors of politics are dominating the export data changes, and not the physical limits of depletion.

The author follows the Iran discussion with a wide-ranging sketch of gas market shifts, global energy policies toward renewables, and hopes for electric vehicles – the sort of view of the world you can have from reading many government reports on energy policies. Ultimately the author asserts a global move from oil, despite its high value, to natural gas, despite its lower value.

To me, the economics of the conclusion seems less than well worked out.

 

 

Hotelling takedown

Michael Giberson

One of the classics of resource economics is Harold Hotelling’s “The economics of exhaustible resources,” Journal of Political Economy (1931). The article gave us what is now called “Hotelling’s rule,” which links resource prices and extraction rates for resources in finite supply. The article was simple, logical, and pathbreaking.

It also, by the way, appears to be not very significant to the world we actually live in according to a recently published article by Rob Hart and Daniel Spiro, “The elephant in Hotelling’s room,” Energy Policy (2011).

ABSTRACT: This paper questions the assumption, commonly used in theoretical and policy research, that scarcity rents make up a large proportion of market prices for oil and coal. We show that the empirical literature, simple calculations of historical and future scarcity rent shares, and possible theoretical explanations all imply the same overall conclusions: that scarcity rents seem to have been marginal or non-existent historically; that they almost certainly do not dominate fossil resource prices today; and that there will be other factors shaping the prices in the upcoming decades. We therefore argue that using the scarcity rent as the main or only basis for policy or for explaining empirical outcomes is ill-advised.

Don’t Peak: On ill-considered peak oil debates

Michael Giberson

Daniel Yergin’s peak oil commentary in last Saturday’s Wall Street Journal has set the econoblogosphere to chattering, or at least those of us in the energy corner. In addition to the clash of the titans, i.e. James Hamilton’s “More thoughts on peak oil” rejoinder to Yergin, the mere mortals are going at it, too.

Michael Levi did a quick round-up of reactions at his Council on Foreign Relations-based blog, then added his views. He expressed some exasperation about the “muddled, often faith based” arguing that goes on when peak oil is the topic.

I think he’s right: ideas often get muddled when peak oil is the topic. A big part of the problem is how the term “peak oil” frames the debate.

The problem with peaks

The term “peak oil” draws attention to the wrong issue. Try an analogy: During any given football game, there will be a point at which the football reaches its maximum height. Call it “peak ball.” Two things are obvious: first, after peak ball, the football will never again be that high; and second, the peak ball moment has almost nothing to do with the overall game. If you want to understand the football game, don’t worry about peak ball. People who frame the discussion in terms of peak ball will miss the point; the game’s real action is elsewhere.

Even experienced analysts get thrown off track. Consider Hamilton’s “More thoughts” rejoinder to Yergin.  Hamilton begins by trying to clarify just what he wants to discuss, stating three propositions as the “core claims that need to be evaluated.” Oddly, he then dismisses the first two propositions as so obvious as to not require additional thought (so what was it about the first two “core claims” that needed evaluation?) In any case, he thinks he is going to evaluate his third core claim: “This peak in global production will be reached relatively soon.”

But look at what he actually writes about in the rest of his essay. Beyond some swipes at Yergin’s peak oil discussion, Hamilton’s evaluation focuses on the slow supply response to increasing world demand for oil over the last few years, what economists’ call the price elasticity of supply. Hamilton said:

I was not among those who claimed that the peak would arrive by Thanksgiving 2005, nor 2007, nor 2011. But I am among those who did claim, and still believe, that the slow rate of increase in annual oil production over the last 5 years has caused significant economic problems for countries like the United States.

And he concluded:

I submit that meeting the growing global demand for crude oil over the last five years has posed significant challenges for the world economy. And those who worry that the next 5-10 years might be like the last should not be dismissed as crackpots.

In both claims, Hamilton draws attention to the slow rate of the supply response relative to demand growth. He is right, this is where the action is with respect to understanding recent oil market developments … and nothing about what he said depends upon whether the peak in world oil production did happen in 2005 or 2007, or will happen in 2011, or won’t happen until 2100 … and framing remarks as about peak oil distracts attention from the real issues.

Hamilton framed his article as if it were about peak oil, he titled his article “More thoughts on peak oil,” but when he gets down to explaining what he thinks is important, none of his article depends on peak anything.

Supply and demand: Boring and relevant

The underlying issue remains that the short run price elasticity of both supply and demand for crude oil are low, which means shifts in the supply or demand relationships become manifest mostly in changing price. Over the last several decades, most oil price shocks have been precipitated by supply interruptions. The duration of historic supply shocks has mostly depended upon the Saudi government’s willingness to use its spare productive capacity to fill the gap until the interrupted producer recovers.

When readily available spare capacity can fix an oil shock, there is little reason for significant investments by other producers to expand their own supply capability. When significant increases in supply appeared called for, they take years. The great non-OPEC supply boom of the early 1980s was mostly a delayed supply response to higher oil prices of the 1970s. Given the inherent years-long delays in any substantial supply response, it isn’t surprising that the price increases of 2005-2008 didn’t bring an immediate outpouring of new supplies.

The oil price run-up of 2005-2008 was mostly driven by a demand-side shock: increasing demand resulting from rising incomes in developing nations, especially China. Saudi production dipped a little rather than increased as post-2005 oil prices continued higher, and that response may have set the stage for the sharp price spike of 2008. All of these developments are well analyzed in Hamilton’s 2009 paper, “Causes and Consequences of the Oil Shock of 2007-08.” (Ungated version here.)

Conceivably, Saudi reluctance to increase production revealed the exhaustion of its spare capacity. Over the last few years there has been a lot of speculation about Saudi Arabian reserves, and not a lot of real information available publicly. But an alternative interpretation was that the demand-side shock – rapidly increasing world demand for oil – led the Saudi’s to reevaluate the reserve price they put on their spare capacity. In any case, the spare capacity seems to be back: in 2011 Saudi production reached a 30-year high after it increased production in response to Libyan supply interruptions.

Don’t be distracted

Yergin, not Hamilton, may be to blame for this latest round of peak oil debate. But the thrust of Yergin’s WSJ article was to undermine any focus on peak oil and to suggest the interesting action is elsewhere. Obviously I agree with Yergin on this point. It is perhaps a bit ironic, given the peak oiler-based anti-Yergin outrage that has erupted, that Yergin accepts the basic idea of a peak. He just believes the peak is at least 20 or so years away and will be long and flat and lacking in much social drama. Yergin’s error, to the peak oil crowd, is not being alarmed.

I also agree with Hamilton: the slow supply response to higher prices over the last few years have contributed to significant economic problems in the world economy. It seems quite reasonable to worry about how these issues will continue to play out over the next five or ten years.

Sure, it is possible to frame the explanation of crude oil prices over the last few years or the next ten as a “peak oil” story, but whether we are or are not at peak world oil production is essentially irrelevant. The question of peaking distracts from examination of the real action.

My advice to oil industry analysts: Use some other approach to understanding and explaining oil industry developments.

Don’t peak.

Yergin on oil, II

Michael Giberson

I second Lynne’s recommendation of Yergin’s column in the Saturday Wall Street Journal.

On the topic of Hubbert’s peak and peak oil generally, I particularly recommend these two paragraphs:

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.

The idea of “proved reserves” of oil isn’t just a physical concept, accounting for a fixed amount in the “storehouse.” It’s also an economic concept: how much can be recovered at prevailing prices. And it’s a technological concept, because advances in technology take resources that were not physically accessible and turn them into recoverable reserves.

Yergin’s proposed alternative to thinking in terms of “peak oil” is to think in terms of a plateau in production, you might call it a long-drawn out peak, which will be limited more by price and demand than by exhaustion of supplies.

The WSJ article is accompanied by a 20-minute video interview, mostly about Yergin’s new book, The Quest, to hit the stores tomorrow.

The international possibilities of petroleum from shale will reshape markets

Michael Giberson

There is a lot of natural gas locked up in shale in the world. Once shale gas was mostly a footnote to the energy industry, known about but inconsequential because mostly inaccessible. But the technology, and hence the economics, of shale gas development has improved. And those improvements are reshaping the world’s energy markets.

The Energy Information Administration has released a preliminary analysis of several regions throughout the world which concludes the now-producible shale gas resources are vast:

Although the shale gas resource estimates will likely change over time as additional information becomes available, the report shows that the international shale gas resource base is vast. The initial estimate of technically recoverable shale gas resources in the 32 countries examined is 5,760 trillioncubic feet… Adding the U.S. estimate of the shale gas technically recoverable resources of 862 trillion cubic feet results in a total shale resource base estimate of 6,622 trillion cubic feet for the United States and the other 32 countries assessed. To put this shale gas resource estimate in some perspective, world proven reserves of natural gas as of January 1, 2010 are about 6,609 trillion cubic feet, and world technically recoverable gas resources are roughly 16,000 trillion cubic feet, largely excluding shale gas. Thus, adding the identified shale gas resources to other gas resources increases total world technically recoverable gas resources by over 40 percent to 22,600 trillion cubic feet.

By the way, the U.S. Department of Energy wants you to know that its early R&D investment in shale gas technology is producing results today.

But it isn’t just natural gas.

Technology is improving access to oil from shale formations as well. A story in the Wall Street Journal yesterday suggests that Israel may have the potential to become a major oil producer based upon its shale oil potential. See “Could Israel Become an Energy Giant?” In the U.S., oil from shale is one of the reasons North Dakota is booming, and their are several other oil shale efforts now new-and-improved as technology has improved.

It isn’t that everything you once thought you knew about the oil and gas industry is wrong, but you do have to pay attention and allow yourself to, reluctantly, learn something new once in a while.

More economists thinking about Peak Oil

Michael Giberson

I’m sure I haven’t yet come to grips with the views expressed by commenters on my last post about economics and peak oil, but here is another paper on economics, Hubbert’s Peak, and peak oil.  In short the authors  model resource extraction scenarios in the manner that economists sometimes do, and conclude that the timing of the peak production will be determined by “above the ground” factors such as cost of production, oil prices and political constraints on access to resources rather than “below the ground” geological factors.

Note that the economist views I’ve cited from time to time – from CERA/Yergin to James Smith and now Pierre-Noël Giraud at CERNA and colleagues from EDF-R&D in France – are not denying that petroleum is an exhaustible resource nor that production will peak.  But, and speaking just for myself now, I am denying that the date of the peak is particularly significant and that sometime shortly after the peak we will face any kind of significant social strife, economic collapse, or other major drama. I’m stuck in a “business as usual” pose, because I expect business as usual.

More specifically, I expect over time petroleum will become expensive relative to other energy sources, and we will substitute away from petroleum and toward alternatives as that happens.  Of course it is already true in niches – there is a reason we don’t have kerosene lamps in our homes anymore and remote flashing roadside signs are solar powered – and the niches will grow as alternatives begin to make more sense.  Eventually, petroleum will become the niche fuel in an energy economy mostly running on other sources.  I don’t expect the social trauma associated with this transition to be any more wrenching than the shift from wood to coal or coal to oil.

If you think I am wrong, I’m willing to be educated.  But note that it will take quite of bit of educating to get me to drop economist habits of thought, so the simpler way to convert me to another way of thinking about peak oil is to point to an analysis with a reasonable economic foundation. I encourage commenters to direct me to their favorite such analysis.

NOTE: Here is the authors’ abstract for the paper, “Hubbert’s Oil Peak Revisited by a Simulation Model“:

As conventional oil reserves are declining, the debate on the oil production peak has become a burning issue. An increasing number of papers refer to Hubbert’s peak oil theory to forecast the date of the production peak, both at regional and world levels. However, in our views, this theory lacks microeconomic foundations. Notably, it does not assume that exploration and production decisions in the oil industry depend on market prices. In an attempt to overcome these shortcomings, we have built an adaptative model, accounting for the behavior of one agent, standing for the competitive exploration-production industry, subjected to incomplete but improving information on the remaining reserves.

Our work yields challenging results on the reasons for an Hubbert type peak oil, lying mainly “above the ground”, both at regional and world levels, and on the shape of the production and marginal cost trajectories.