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Bradley Parkes

Bradley Parkes

Parkes studied economics and geology in university, gaining a degree in both. This has fostered a career that has included roles in corporate finance, equity…

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Why The Peak Oil Argument Refuses To Die

Oil storage

The Peak Oil argument refuses to die. Today it has morphed into the Peak Conventional Oil argument. There are parts of the argument I agree with such as any finite resource will eventually run out, either due to regulation or over production, however, this is not what is happening right now.

Humans are pessimistic for anthropological reasons. Life has been hard. Pessimism is even believed to be genetic, however, explaining the current woes of the oil industry by using the Peak Oil argument fails Occam’s Razor. There is a simpler explanation found in economics 101, the adjustment of an oligopoly dominated market to a free market.

Econ 101

In a free market the quantity produced would be Qc and price Pc and in an oligopoly the price would be Po and quantity Qo. If the price is managed the perfect amount above the marginal cost curve it deters new entrants, but should demand expand too quickly and prices rise fast enough there is an incentive for new entrants to enter the market.

This is what happened between 2000-2011. The demand from emerging markets expanded faster than the oligopoly could increase production, leading to prices that rose far enough above the marginal cost of production enticing new entrants to the market. This was coupled with a technology advancement in gas production (no oligopoly and no managed price leading to greater incentives to adopt technology and not just free ride on cartel prices) which was transferred to the oil side of the energy sector and reduce costs on what had previously uneconomic sources of oil.

(Click to enlarge)

Oil Demand

To attempt to regain control of the market the oligopoly flooded the market to eliminate the high cost producers. However, by doing this the dominant oligopoly producer had to act as a monopoly producer and destroyed the cartel partners. While this was going on the new entrants and the free riders from the oligopoly produced market began to reduce costs and threaten monopoly producers ability to return to a managed market. What is happening is the emergence of a free market in oil.

Below is my response to an article entitled “The Oil Industry Faces a Grim Future?“

I disagree. I believe this analysis is incorrect.

What happens to a market when prices are held above the long run inflation adjusted cost for extended period of time? You get surpluses. What happens when you get surpluses? Prices decline. What happens when you get price declines? Inefficient companies (and in this case countries) go bankrupt. This is all economics 101.

Prices are not low, they are within on standard deviation of the long run inflation adjusted prices per barrel. The 2006-2011 prices were historically high on an inflation adjusted basis.

The long run mean inflation adjusted price of a barrel of oil from 1946 (Post war period) in 2015 dollars is $41/barrel, since 1980 it is $51. The price is barely below the mean of the last 36 years and above the mean for the past 70 years. This mean is also biased to the upside due to cartel behavior. A free market, like the one that is developing would have had a lower inflation adjusted price.

The low price narrative that is continually being repeated is to disguise poor capital allocation decisions, the inability to control costs and the reluctance to adopt technology.

Currently what is happening is that producers who were able to free ride on inefficient and cartel behavior are being forced to adjust a free market in oil. In a few years costs will be lower for those that survive and those that cannot reduce costs they will disappear.

The energy business has historically been slow to adopt new technology and methods. This forced adjustment to a free market will accelerate the adoption of technology. Directional drilling was first used in the 1930s but only adopted in 2000s and wells have been fracked since the 1940s, the AAPG released a paper in the 1950s discussing the first 10 years of this practice. It took 70 years to combine the two. No other industry would survive adopting technology and change this slow. The only reason why is 100 years of oligopoly (Texas Railroad Commission followed by OPEC).

Related: Venezuela Escapes Bankruptcy… But Oil Production Continues To Plunge

Because prices were held above the marginal cost of production due to the cartel effect producers were to free ride and be inefficient. This is essentially no different than what the automakers had to adjust to when the Japanese gained market share in the 1980s. But to claim costs are low is incorrect and forecast dire straits ad infinitum bears the semblance of the predictions of the end of the US automakers in 1980.

Further using the peak oil declining EROEI argument also ignores history. When Col. Drake drilled the first well into a “conventional” reservoir in the 1860s the EREOI was very low, maybe negative. However, over time the EREOI improved. To compare “unconventional” production or oil sands today versus conventional wells in Saudi Arabia that have had continual, but slow technology improvements over the past 70 years is to assume that the EREOI is static and not dynamic. EREOI for oil sands has improved since the 1950s, and unconventional EREOI has improved just in the past 5 years. Unless you can tell me what the return on energy will be for a SAGD project when they begin using microwaves to reduce bitumen viscosity and eliminate the need for natural gas, then the EREOI argument is a strawman. It is like comparing baseball players of today versus the 1890s, fun over a drink but a waste of time.

Some historical perspective is required in analysis. The issue is not that prices are low, poor capital decisions were made when prices were historically high. The world is not ending. The sector is fine. All that is happening is the normal transition from a cartel dominated oligopoly priced market to a free market. Its economics 101.

By Bradley Parkes via Economisms.com

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  • Guy Minton on October 25 2016 said:
    Economics of shale oil in a nutshell. All areas in shale oil are not the same. Some will produce better than others. If it is not a prime area, there is some things they are doing that yields a little better now days, but you can't get blood from a turnip. If it won't yield enough at $40 to pay for the cost of drilling and operating costs, it won't be drilled. That covers about 80% (roughly) of most shale areas. Half of that 20% is marginal at $40, but good at $50. The rest won't be drilled if oil stays at $50.
    Most offshore needs a lot more. 30% of oil production is offshore. Chart all you want, but it won't change reality,
  • Tom on October 26 2016 said:
    There is one element in the writer's argument which he needs to address. Tapping oil reservoirs in the ground today is more costly than it was 50 years ago. Yes, technology has made it possible and there will be efficiencies in using new techniques to accomplish getting to these more difficult to find and exploit oil reserves, but nevertheless, the cost of doing so has increased per barrel of oil. The price of oil needs to reflect this increased cost. The author has merely extrapolated from an historical price of 50 years ago using general inflation to arrive at what the price should be today. However he must also add the higher cost of oil exploration and extraction to arrive at the price of oil expectancy today. The price of oil is low because, large investments in E&P produced supply above oil demand. Once demand and supply returns to equilibrium, the price of oil will be $70 per barrel.
  • i on October 26 2016 said:
    The argument hasn't died because the "peak oil" problem hasn't gone anywhere and the EROEI problem still exists.

    As we transition from conventional to unconventional oil, EROEI decreases. It takes more expensive energy to produce energy. As that happens, the price increases. This is the long term *structural* problem.

    The current "glut" is a political and economic phenomenon and refers only to extracted oil. This eventually gets used up. When everyone finally notices that we've lost a lot of our production capacity via bankruptcies and shut-in wells, expect shortages and a price spike.

    Oil will continue to be valuable as long as it's affordable and yields enough surplus energy to matter. There is probably no scenario whatsoever where these two conditions persist past 2100.

    Today's children will live in interesting times.
  • Geneo on October 26 2016 said:
    Well thought out article. I do like the way you explained the lower oil prices, especially since you don't see it as a sign of a unstoppable deflationary collapse as I do.
    I'm still think that Gail Tverberg may unfortunately be more correct. Basically because peak oil price was accomplished at 50% mark. Encaustic the last 50% will be too expensive to get out of the ground .
  • MQSP on October 27 2016 said:
    The argument presented in this article is weak neo-liberal nonsense. The cognitive dissonance is strong.

    Peak Oil is not the authors primary target. He is attempting to demonstrate the primacy of the free market, maybe to himself, who knows. In neo-lib fantasy-land the free-market conquers all. He would be wise to read Halls 'The Energy Wealth of Nations' for a crash course in biophysical economics.

    The idea that the 'Oligarchy' (whatever that is) is coming to an end is frankly ludicrous and contrary to trends that have been extant for nigh on 20 years.

    There are many players both private and state owned. It is the private firms that are in retreat as state actors increasingly deny access to 'reserves'. I understand the counter argument "if only markets were accessible!". In reality-land the only way to achieve this goal is via military endeavour and we all know how this plays out.

    The article reeks of someone trying to shore up a belief in a particular brand of 'progress' which is failing. Ironically, in no small part due to the economic impact of Peak Oil.
  • Nick on October 27 2016 said:
    Shallow analysis, however the author is able to see the difference of oil price with oil cost. On these point, you see the past where oil industry has been based on conventional oil reservoirs, and compare it with the present where conventional oil reservoirs are converted on brown oil fields from where is produced more water than oil. The same can we say for unconventional oil and gas reservoirs, the fact that the oil operators on these reservoirs, drill deeper and longer and inject considerable volumes of fracking fluids and huge amount of sand which cost more and as the result produce less, to 6-10% and living 90-94% in the reservoirs, all these leads to low EROEI.
    Considering and biofuels, where many taxpayers are subsidizing the industry, considering the 4 mm bbl/d oil produced from unconventional oil reservoirs, and considering around 5 mm bbl/d produced from bitumen and extraheavy oil reservoirs, and considering the rest of supply from conventional brown oil fields, we all must be aware that oil industry may very soon will be on other shocks. To avoid these, the oil and gas industry, other than drilling on infill areas, must develop new technologies which increase the recovery factor.
    Actually, the oil operators know few EOR technologies from which few are considered as commercial, but most of these EOR are on the experimental and development stage, and are expensive, and the application may be limited on feasible reservoirs. The world is awashed on oil resources, but the oil operators are behind on time to recover these resources, even the industry has been involved on researches for more than 50 years.
    Oil operators and different government must invest time and money on oil recovery technologies which increase the oil recovery by using EOR and convert the resources on reserves, and decrease the cost of production. This can be done by mobilization of peoples with new ideas on EOR and not limiting the researches only on some consortiums. The oil industry must activate peoples with new brainstorm ideas on EOR, and after they will have these ideas, the consortiums will be able to advance and develop the ideas on different field pilots.
  • Robert Rapier on October 27 2016 said:
    'When Col. Drake drilled the first well into a “conventional” reservoir in the 1860s the EREOI was very low, maybe negative.'

    EROEI can't be negative. It can only approach zero. Net energy can be negative.
  • alturium on October 29 2016 said:
    If you exclude the U.S. and Canada, the world CRUDE or CONVENTIONAL production peaked in 2005. It also appears that the world peak may have been reached in 2015. We have been on a plateau for crude oil since 2005.

    Reaching the peak has resulted in a different effect than expected higher prices. It has led to deflation and collapse in the ability to produce growth. IMHO, the two inputs to our growth-based system are cheap energy and cheap debt. We have reached the end of cheap energy, and so the system compensates with cheap debt.
  • Mike Lynch on November 18 2016 said:
    The reality is that peak oil was based on a pessimistic bias and a lot of really bad math. My book goes into this in detail, and explains that 'peak oil' is not a useful concept. The Peak Oil Scare and the Coming Oil Flood, published by Praeger.

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