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Monday, September 16, 2013

Peak Oil and the Bet

After reading about the now-infamous 1980 bet between the Neo-Malthusian biologist Paul Ehrlich and the Cornucopian* economist Julian Simon used several times over the last week to justify renewed optimism about the world's energy outlook, I feel compelled to write a quick primer on what exactly Peak Oil is (and by default nearly every other scarce resource on the planet).

To begin with: the Bet. Basically Ehrlich believed that, after geologist M. King Hubbert's theory of US peak oil production in 1974 was effectively proven correct**, resource scarcity would be reflected in the prices of several key resources (metals, oil, etc.), since increased demand and lower production requires higher prices, right? Simon, on the other hand, believed that technological progress would increase efficiencies and allow us to effectively "get more for less," and that increased efficiency would be reflected in lower prices over time. In 1980 the two bet $1000 on a basket of commodities, Ehrlich betting that the prices would be higher ten years later in 1990, and Simon betting they would be lower. Unfortunately for Ehrlich he was a victim of timing, since the Bet exactly corresponded with the last great push into conventional oil fields and a simultaneous splurge in new exploration technologies in the extractive industries, thus prices did in fact go down throughout the 1980s. If the two had bet on this same basket any time in the last 23 years Ehrlich would have won nearly every time.

While the Bet cost Ehrlich a few bucks, it cost humanity a great deal more, because as time has past most people remember only that Ehrlich lost the bet, not that his theory has been more than proven correct since then. For instance, since 2003 oil has crept up from around $30 per barrel to a high of $150 a barrel, and has been hovering somewhere around $100 a barrel for years now. A gallon of gasoline was $1.50 in 2000, and it hasn't really dipped below $3.00 since 2010. Gold is double the price it was in 2000; same with silver and copper. If technological progress is supposed to be making things more efficient then why are prices rising?

The answer to this requires understanding only a few basic economic principles and a little deductive reasoning (since, unfortunately private corporations control nearly all the world's oil reserves and, naturally, have zero interest or reason to give the public a reasonable accounting of reserves).

So, let's chat about the basics here. The most common misconception about Peak Oil is that the "peak" in the name refers to peak oil reserves, when in fact it refers to peak oil production. For all intents and purposes, we will never run out of oil, but the entire global economic enterprise (as organized today) is dependent on relatively cheap oil, and we will most certainly run out of that...most likely in the next 3 decades. Here's why.

Oil and gas companies are corporations that are primarily motivated by profit, thus they will extract and refine the oil that is most profitable first (I.E., easiest to get at), only resorting to less conventional sources (I.E., hard to get at) once the conventional ones are used up or appear to be stalling. So, right off the bat we reach the first bit of deductive reasoning: if the world is flush in oil reserves then why are oil and gas companies spending so much money on ridiculously expensive extraction techniques like hydraulic fracturing, off-shore drilling, and deep sea Arctic drilling? Either oil and gas companies are running an extremely complicated and expensive gambit, or Occam's Razor*** demands the most obvious and simple explanation: the conventional fields are running dry and prices are so high that it is now economically feasible to drill expensive and unconventional fields.

If Occam remains true (and I believe he does in this case), and conventional sources of oil are indeed running out, then we simply need to look at the basic economics of profit motive in order to see rather quickly that Peak Oil production is likely to rear its ugly head some time in the near future. Here's the deal, oil and gas companies are largely dealing with two hard economic realities: as they increasingly find their oil in unconventional sources their bottom line will continually rise, which wouldn't be a problem if the global economy didn't require cheap oil to function. These two realities more or less push oil and gas companies into a box, with a price floor beneath them that is steadily rising and a price ceiling of around $110 per barrel, above which all bets are off w/r/t the optimal functioning of the global economy.

So, you see the pickle: if prices can't rise and costs are continuing to rise, then the profitability of oil and gas extraction will be squeezed from both sides and it will simply be a matter of time before prices either crash the global economy or it will be unprofitable to keep oil production at its current levels...either way the global economy will not be able to function properly since the primary economic input (energy) will be scarcer and more expensive^.

However, this is where the term "peak" becomes a further misnomer, because in reality Peak Oil will look a lot more like choppy seas than falling off a cliff, at least at first. Effectively we'll see exactly what we're seeing now: prices rise, leading to increased production and lower demand, thus prices decrease a little, making production unprofitable and stimulating demand, and the cycle starts over again with production stalling out largely at the levels we've seen since 2004^^ and the global economy grinding along without ever really recovering.

In short, the reality of Peak Oil will be a long, slow grinding economic death that could go on for decades, with investment in important things like infrastructure, healthcare, education, and general welfare slowly declining until we run out of cheap energy options and the capital to change the course of events. Peak Oil wouldn't be so scary if it weren't coupled with so many other horrible things, like climate change, other increasingly scarce resources, population overshoot, etc. Any one of these things would be daunting enough, but all of them together are overwhelming in their combined complexity. However, the complexity is exactly what makes this moment in time so important because right now will still have the resources to make a wholesale change in global economic activity that would help stall many of these trends so that our grandchildren are not living in a sludge hole of broken promises and the rusting ruins of techno-narcissim.

In future blog posts I'll discuss my Chokepoints Theory of complex systems, but for now I would like to leave this bright and cheery post with a bit of legitimate optimism: we may be facing horrifying systemic issues, but humanity's greatest strength has been our ability to pluck insights out of seemingly thin air. We are now more connected than ever, and if there was ever a time for a single idea, or complex of ideas, to form into a global movement that time is now. So, as long as people are looking to the future and being honest about the implications, there is always hope that something will emerge that can change the course of events.

*A brief explanation of these two terms, Neo-Malthusian and Cornucopian: In the early-19th century political economist and philosopher Thomas Malthus posited that population overshoot would increase resource scarcity (primarily food and water), leading to mass starvation. While he had the unfortunate timing of writing just as the Industrial Revolution created 200 years of plenty for the Western world, Neo-Malthusian is the term given to those who propose that his theory is still alive and well in the world. Cornucopian refers to a group of economists and technologists who believe that increases in technological efficiency will allow us to effectively never run out of economic inputs, thus negating resource scarcity.
**In 1956 Hubbert came to the conclusion, based on proven reserves and known exhaustion rates of oil fields, that US oil production would peak between 1965-1974. He was largely derided at the time for his theory, but most people agree that 1974 was in fact the year that US oil production peaked, which is what allowed OPEC to strong-arm America during the oil embargo.

***Occam's Razor states simply that the easiest solution is likely the correct one.

^One of the chief rebuttals to Peak Oil is that as expensive techniques like Hydrofracking become more commonplace and technology increases costs will go down and hence prices will go down as well. While this is certainly true, the question is how much will costs go down? The general trend since around 1990 has been for costs to increase regardless of technological improvements. There is also the obvious corollary to this in that unconventional oil plays come with necessary and terrifying potentialities for environmental degradation, such as the BP oil spill, the ongoing tar sands spills in Alberta and the pipeline spill in Arkansas. While these "one-off" events have long-lasting and very real economic consequences, they are largely left off the balance sheet when it comes to calculating the "cost" of unconventional oil plays. This brings me to the second major rebuttal to Peak Oil, which is the recent rush of investment in natural gas in the US because of the increased usage of hydrofracking. Never mind the obvious environmental hazards involved in this new unconventional source, there are two major reasons why this is unlikely to lead to the supposed "Saudi America." The first is that the cost of drilling these wells is ridiculously expensive and the exhaustion rate is extremely sharp, so within a few years most wells have slowed to a trickle, thus leaving the over-all cost of extraction very high. In some cases, it actually takes more energy to extract and refine the gas than we receive from it at the end. The only reason this appears to be a cheap way of doing things is because so much money is rushing into the sector, thus driving down prices, but what this really looks like is a Ponzi scheme, where the modus operandi is to keep drilling faster and faster to keep up with demand and stay ahead of the sharp exhaustion rates of the wells. The second problem with natural gas is that our infrastructure is not actually outfitted to run on natural gas, not to the degree that we would need in order take advantage of this so-called natural gas renaissance. This begs the obvious question, then: if we will need to pour all sorts of money to retrofit our infrastructure to run on natural gas, then why the hell wouldn't we just pour that into renewables? I'll leave you to follow the money trail on that one.

^^One of Hubbert's acolytes Kenneth Deffeyes used a refined version of Hubbert's methodology in the 1990's to predict that world peak oil production would occur somewhere around 2004. Surprise, surprise, oil production has largely stalled since 2005 and prices have risen steadily since then, with the economic consequences manifest. One can't help but wonder, if oil is cheap and abundant, why isn't oil production increasing to meet rising demand? Occam's Razor, my friends, Occam's Razor.