Oil Prices and the Mayflower Problem

Mr. Cobb. Thanks for the insightful article. You may find a great deal more at theoildrum.com.

Kurt, Are you claiming that North American NG production is flat, even though USA NG production is rising? I happen to believe based on my research that the only reason USA NG production is rising is b/c of the higher price, which has brought on more supply at much higher costs. I'm also aware that the new shale production is masking declines in conventional NG, that Canadian production is still on a treadmill, and that the production profile of new shale NG wells is such that they peak fast and flame out.

Would you not agree that at higher prices, say above 10/MMbtu, that there is now the prospect that North American NG will rise--led by the USA?

G

Gregor,

I say North American natural gas "appears to have peaked" because I am hedging a bit. Canadian natural gas production, according to the National Energy Board, is dropping year-over-year and is expected to end down about 300 billion cubic feet for 2008 versus 2007 by my calculations. U. S. production appears headed for a rise above levels last seen in 2001 when marketable production hit 20.6 tcf. The run rate for 2008 would be the equivalent of 21.3 tcf. We might move above the current plateau for a bit as the U. S. exploits shale resources.

But I would refer you to the work of David Hughes of the Geological Survey of Canada on the likely future of Canadian natural gas production. It looks very grim indeed. Also, you might want to look at a summary of Jean LaHerrere's work on The Oil Drum or his original article. I think that unconventional production will not allow us to avoid the coming cliff in North America production which LaHerrere judges to be around 2010. That's when long-lived conventional production is expected to start dropping like a stone, proving once again that you can't produce what you don't discover. Could this cliff be delayed a few years? Of course, but not for long and not by unconventional gas production which while ramping up quite nicely won't be large enough to counter the coming cliff if LaHerrere is correct.

So, to answer your question. Yes, in the short run I think American production can rise and probably allow North American production to exceed the plateau. But, in my view, the relief will only be temporary.

Thanks Kurt. I saw David Hughes present at ASPO in Boston, in 2006. Grim indeed. My research also shows that both Canada and Mexico are already taking advantage of our NG, via exports. Though Canada is still a net exporter of NG to the US, the balance is shifting quite alot. I remain impressed with the market's ability to take advantage of the very cheap BTUs that can be purchases via NG, even as North American NG remains largely landlocked, without an export vehicle (Save Alaska LNG). My call is that Canada and Mexico, like the US, will import virtually no LNG over the next year as long as cheap NG can be had for less than or around 8-10/MMbtu. Global LNG volumes are going for much more than that, as I am sure your are aware. Even in northern hemisphere Summer. However, the US analytical community remains only interested in the increased production, and has now built a wide consensus that an NG glut is here.

My views on general NG outlook here: http://siliconinvestor.advfn.com/readmsg.aspx?msgid=24871370

Best, and thanks for the reply and your writings.

Gregor

Nice article. I wonder about the meaning of the "actual production" versus the "Hubbert trend" in the Reynolds piece that is illustrated here. They are both production over time curves. The Hubbert trend would assume the extraction technology at the date of estimation, and the "actual production" would in theory estimate with advanced extraction technology unknown to Hubbert or earlier researchers. However, the "actual production" over time in the plot is less than that estimated by Hubbert until it is near the peak. That would only be so if the producers gradually slowed production on purpose, which is unlikely based upon past experience, in general (there are some exceptions, in Saudi and OPEC, for example).

What is shown is the same overall reserve, just shifted forward in time. If there is indeed advanced production that extracts more oil or gas than would have otherwise been attainable, then the area under the curve grows, and the peak is shifted forward in time if the rate of extraction is held constant. If the rate of extraction increases, but not the efficiency of extraction, then the production curves are backwards, and the Hubbert trend becomes the actual trend.

Price is a trivial dependent variable of the resource (geology) and extraction (technology). It is just a manifestation of demand.

Gary,

I think you are correct that price is a trivial variable if by that you mean that it's not a reliable indication of future supply, only current demand as you suggest. With regard to the trend of production, the Hubbert trend here is an idealized representation of the same total production over time including all the effects of technology. The actual production may or may not follow the suggested curve for any one resource, the curve of which will depend on myriad factors including geopolitics, economic recessions, etc.

But I think in the case of oil, we are actually seeing this slowing or plateauing of production though the shape of the oil production curve looks quite a bit different from the actual curve illustrated. Whether that slowing is due to deliberate withholding of supplies is subject to debate. I suppose it also depends on how you define deliberate. Would the failure of national oil companies to invest in exploration as money is diverted to social and military needs be considered a deliberate slowdown in production? Or would the slowdown be an inadvertent consequence of a policy that is not consciously trying to do that?

For the purposes of my analysis, I'm not sure it makes much difference. The petroleum system is an above-ground and below-ground system inextricably combined. I think Reynolds model does a pretty good job of modeling such systems because the distinctions between intentional and unintentional production decisions don't seem to be that salient to the ultimate result: A surprise increase in prices near the peak.

Your statement "In a parallel universe far, far away where neoclassical economists run everything and conditions allow for perfect markets and perfect information, finite energy resources gradually climb in price as they are depleted" is not accurate unless you also allow for perfect foresight. The problem is that technology can (and does) reduce the cost of extracting natural resources. This reduction in cost can (and does) reduce the market price. I should also point out that reliance on Hubert's Peak for worldwide production is based on reliance on existing technology and an existing number of oil fields (or at least having the rate of existing oil field discoveries decline). This is a fundamental fallacy. For example, when the cost of production does rise, even in the short-run, it produces incentives to invest in new technologies for extraction of oil (shale oil, oil sands, etc.). The Canadian oil sands today are accounting for an increasing share of oil production because the higher price makes extraction there viable. If technology can push down the price, the trend in Canadian oil sands pricing may actually start to decline. Similarly, shale oil, of which the United States is estimated to be sitting on 1.5 TRILLION barrels may eventually prove economically viable (this compares to total US "proven" oil reserves of 20 to 30 BILLION). In the short-run to make it viable, the price will have to stay over $100 a barrel for a few years. However, if it does stay at this amount, to the extent that oil shale does become viable, Hubert's Peak will become irrelevant for a long time (although eventually it will return when those supplies reach their limits). Indeed, the price of oil could drop dramatically once again as new technology to extract oil shale drives down prices (as technology inevitably does).

Another problem is that price is not driven solely by supply but by the interaction of supply and demand. If the price begins to rise quickly, individuals can (and do) make adjustments that cause demand to fall. This fall in demand can serve as a break on prices and cause them to decline.

So it is not so automatic that prices will ever rise exponentially at any point whatsoever. What actually happens is more of a roller coaster effect. Prices rise, new technology springs into action, prices fall and decline or flatten until that technology reaches its limit and then the pattern continues. Thus we are likely in for many more times that we will be hearing that we are "running out of" natural resources before we actually get anywhere near the limit of them.

Indeed, at present worldwide rates of consumption, the oil shale that lies within the United States will buy the entire world at least another 50 years of consumption even if there is no oil shale anywhere else on the planet (which there is, so the time horizon may actually be measured in hundreds of years). Luckily, however, since this oil will be very expensive using present technology, it will become clear that we ought to transition to other forms of energy. We will never run out of oil, not because we exhaust it all, but rather because the cost of extraction will get so high that we cannot afford not to find an alternative. The same is true for every other natural resource and the market will provide us with the answer as to when we will be forced to make that transition (if we wait until then, the price will start to rise, causing individuals in lower incomes to not be able to afford it anymore).

Zagros Madjd-Sadjadi
Associate Professor of Economics
Winston-Salem State University

Thank you Prof. Madjd-Sadjadi for an excellent summary of the neoclassical view. Where we actually disagree is that you measure everything in terms of money, and I measure everything in terms of energy. I do not doubt that market mechanisms often work much as you suggest. But they are unlikely to work as you outline for replacing oil. I plan to take up the reasons for this in my next column which will be about the problem of receding horizons. Oil shale is a case in point. It always seems that we are on the cusp of exploiting it in a big way, if only the price were (plug in a figure). But after that price comes and goes, the oil shale stays in the ground. I look forward to your response to my next piece should you decide to write one.

Metals are recycled.

On balance, it is quite unlikely that aggregate demand for oil will collapse, as it did after the two previous price spikes, just as it is unlikely that massive net new oil supplies will come on stream in the near future. This does not mean that prices will remain as high as they are today for the indefinite future: such stability is improbable. But it means we should expect a sustained period of relatively high prices even if ?peak oil? theorists are proved wrong. If proved right, this would be true in spades.

Given the weaker forecast at landfall, things are not looking as dire. Bad, but not catastrophic. Still showing a near direct hit on the LOOP, but damage has come down, to weeks rather than months. CAUTION: Just because the storm is weakening, and therefore less forecast damage to the GoM infrastructure, doesn't mean this storm can't kill you. Stay safe, stay gone!