Two weeks behind the Zeitgeist

by John Quiggin on August 6, 2007

I’ve been following the Peak Oil debate with a mildly sceptical eye for some time, and it struck me a while ago that despite high prices, global oil output hadn’t grown much, but hadn’t declined either. I came up with the innovative description of our current position as “Plateau Oil“. If I had bothered with Google, I would have noticed that the International Energy Agency had offered the same description two weeks earlier. And if I’d thought about for more than a couple of seconds, I would have realised that the supply of topographical metaphors is so limited as to make this a forced move (Australians use “Tableland” to describe the same landform and there’s also “Mesa”, but Mesa Oil is taken, and “Tableland Oil” sounds silly)

Anyway, why are we (apparently) observing Plateau Oil and what does it mean?

The standard economic theory of exhaustible resources says that, on average, the price of an exhaustible resource should rise at a rate equal to the owner’s marginal time discount rate. With constant prices, producers would prefer immediate sales (bringing the current price down and the future price up) and if prices were rising fast and expected to continue doing so, producers would reduce sales bringing about an immediate increase in prices and lowering the expected rate of increase in the future. This theory isn’t always applicable, but something like oil, where most of the major discoveries have apparently already been made, seems like a good case.

Applying this model it seems reasonable to project price increases of 5-10 per cent a year into the future. In the long run, this should more than offset growth in demand arising from population and income growth, so consumption of oil should gradually decline over time, just as Peak Oil theory says it should. But right now, thanks particularly to China, demand growth is strong enough to counterbalance the large price increases we’ve seen in the past five years or so.

There is no reason to be particularly alarmed about a gradually rising price for oil. As I’ve said before, our main problem with carbon-based fuels is too much not too little. And a gradual decline in oil consumption over the next few decades is not going to cause any real problems.

Of course, on a long enough timespan, the history of aggregate oil consumption is going to look like a sharp spike, rising from zero to current levels over 150 years, and then declining to zero again in the future. But the scale that matters to us is the rate at which we turn over our capital stock of motor vehicles and other oil-using capital, and this is measured in decades, not centuries.

{ 17 comments }

1

Andrew 08.06.07 at 11:49 am

I worked on this topic some 17-18 years ago for A Very Big Oil Company.

Fundamentally, at the start of the 1990s, some 30 supergiant oil fields produced about a third of the world’s production. The next third came from fields 31-300, and fields 301-12000 odd accounted for the rest.

So you have, at the right tail of the distribution of very large sources of supply, very few fields. At the time I did the study, nearly all of these were already well into production (and in some cases, decline).

Since the time of that study, virtually no super giants have been found and brought on stream, with the possible exception of Kashagan in Kazakhstan and a cluster of fields offshore Azerbaijan. One by one, the known super giants like Canterell, Burgan and (possibly) Ghawar are showing unmistakeable signs of age.

At the time of the study, we came up with the term “world oilfield” – the shape of the world’s historic and projected supply curve looked exactly as John describes, a rise, a plateau, then a long steady decline.

2

Dan bednarz 08.06.07 at 12:21 pm

John,

Could you cite the “Peak Oil Theory” sources from which you are drawing this rather sanguine interpretation? Frankly, I think you’ve been dabbling, and that is why you, for example: overlook demand destruction taking place in poor nations and exporting nations cutting exports to meet domestic demand; use “peak” instead of “plateau” perhaps to not fully admit decline follows (and not at the same rate–it’s a bell curve more or less); the lack of scalable substitutes, the fact the once decline begins the gap between supply and demand increases.

Please visit websites TheOilDrum and EnergyBulletin for a fuller take on peak oil, which is not a theory but a simple geological fact, unless you believe oil is perpetually being replenished by the earth.

Finally, you are correct that there is a connection between peak oil and global warming: both require massive lowering of fossil fuel burning.

3

Chris Williams 08.06.07 at 1:24 pm

Given that in Derbyshire and Yorkshire, a ‘peak’ (a la ‘Peak District’) is actually a plateau, we can go right on talking about ‘peak oil’ with no loss of meaning.

4

P O'Neill 08.06.07 at 3:02 pm

I think that there are other shorter term things going on besides the longer term considerations you mention and the impact of China. For example, OPEC deciding that western refining companies were capturing “too much” profit with the scarcity of refined petroleum and so deciding to squeeze them on the supply side. There was a truly remarkable amount of “maintenance” going on at US refineries earlier in the year. There are also technicalities on the speculative side, such as the oil futures yield curve. OPEC was keeping the supply outlook tight to make it harder for speculators to roll over their futures contract at a profit. But they are less concerned about speculative profits now and so the supply tightness can be relaxed a bit. If, from their perspective, OPEC decides that the refining and speculative markets are working a bit better, supply could rise.

5

derek 08.06.07 at 3:20 pm

We’ve been pulling oil out of the ground for two hundred years, and we’ll be pulling it out for another two hundred. Of course the peak looks like a plateau from the ant’s-eye view of current affairs. Anyone who thought peak oil would look like a sudden crash of supply has been getting their ideas from Mad Max movies.

Meanwhile, although supplies have been going neither up nor down, the number of people who want oil hasn’t stopped going up.

6

Matt Kuzma 08.06.07 at 4:06 pm

I’m not up on my mathematics-to-economics translation (I do remember that “marginal” means “derivative”) so the only sensible thing to do is to fumble about at random:

Isn’t there something about the price-inelasticity of demand for oil that changes your conclusions? When enough of the economy (namely transportation) is based entirely on oil, doesn’t that mean demand can only drop so much in the face of rising price? I’m not a big peak-oil zealot, but isn’t there some real concern that a sufficiently precipitous drop in supply could cause a widespread increase in the price of everything that needs to be moved from one place to another at any point in its supply chain and, that category including essentially everything, cause a general downturn or “crash” in the economy? Is there some way to determine how steep the supply drop-off would have to be for it to really have an impact on the economy as a whole?

7

Bruce Wilder 08.06.07 at 4:37 pm

To help Matt Kuzma with his fumbling:

the theory of “peak oil” is that the amount of energy consumed in producing consumable petroleum products — e.g. fuels — will gradually increase, both because greater effort has to be expended in extraction, and because the quality of extracted petroleum declines. That’s the supply side.

On the demand side, the demand curve is shifting, due to the rapid economic growth of industrializing countries, but the long-run elasticity of demand remains significantly greater than “1”. The upshot of this combination is that there is an effective ceiling on long-run price, but as long as the world is in the current plateau period, there will be too little reserve production capacity in the supply chain. (Why would anyone invest in greater capacity, when everyone knows physical throughput will decline?). The price of oil and derived consumable products is subject to price spikes, in response to any disruption in the supply chain, because there is too little slack in that supply chain. Such spikes are expected to spur investment in alternative energy sources, bringing to bear the high long-run elasticity of demand.

As actual production declines from the current plateau, slack in the (then over-built) supply chain will increase substantially everywhere except the fields (and that will be adequately compensated for by storage), and price “spikes” will disappear.

That’s when the real political fight over global warming issues will begin — as countries and regions where economic development has lagged are tempted to exploit petroleum as an energy source, keeping high-pollution consumption high.

8

engels 08.06.07 at 4:48 pm

How about altiplano oil?

9

paul 08.06.07 at 4:52 pm

from far enough away, a plateau will look like a peak. and isn’t the fact that the rate of production/extraction is not increasing at the same time demand is what the Peak Oil crowd is really concerned with?

10

Adam 08.06.07 at 6:20 pm

This feels to me more like a few years behind the zeitgeist. Hasn’t it always been well-known that the “peak” would be some form of plateau, or even a set of “rolling hills” or insert-your-own-topographical-metaphor-here?

11

gmoke 08.06.07 at 6:22 pm

According to John Robb, few if any people in positions of power in Washington are cognizant of peak oil let alone plateau oil. According to Jerome a Paris, few if any people in positions of power in Europe are cognizant of peak oil let alone plateau oil.

The major industrial nations are about to start riding down the bell curve without even noticing. James Howard Kunstler should be happy to have his ideas confirmed.

12

mpowell 08.06.07 at 7:15 pm

The difference is b/w the way peak oil is presented: as a description of a natural enough phenomenon or a prediction of disaster. Sure, our plateau looks like a peak from a large enough time scale. But if the curve is smooth from a large enough time scale, it won’t cause economic disaster. Different people put different spin on the concept of peak oil. And if we are in a plateau that is sustained for 10 or more years, the economy will probably be okay. So from this perspective, I would say that the current evidence is discrediting the doomsdayers’ outlook.

13

Bruce Wilder 08.06.07 at 8:15 pm

The doomsayers are certainly wrong to predict that oil will reach and sustain some very high price.

The plateau, because of insufficient slack, may well be marked by price spikes. But, in the long run, there’s more oil producible at reasonable economic cost than we can afford to burn. Anytime, a wise economic course requires collective human self-restraint, there be danger.

14

ljh 08.07.07 at 12:52 pm

“if the curve is smooth from a large enough time scale, it won’t cause economic disaster”

The downward production sloping curve is unlikely to be smooth on any timescale relevant to you and I. When production is at a maximum, and there are natural disasters or wars that reduce the availability of oil, there will be spikes in oil price that will be disastrous for those whose way of life is dependent on continued cheap oil supplies i.e. almost everyone in the developed world.

15

mpowell 08.07.07 at 3:26 pm

>When production is at a maximum, and there are natural disasters or wars that reduce the availability of oil,

How is this different from the current situation? Or the situation for most of this century?

16

mpowell 08.07.07 at 3:27 pm

Bruce Wilder, isn’t the real concern that we’ll simply shift from burning oil to coal?

17

Earthbound Misfit 08.08.07 at 6:13 am

How is this different from the current situation?
You’re starting to ask the right questions. The answer, of course, is that we are seeing the beginning of Peak Oil. The Resource Wars have already begun. It is no coincidence that Iraq is sitting on the largest undeveloped conventional oil fields in the known world.

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