From our friends at CATO:
http://www.cato.org/pubs/handbook/hb111/hb111-43.pdf
Peak Oil
A growing number of market analysts, industry investors, and policy
advocates are convinced that conventional crude oil is becoming more
scarce, and thus more expensive, as the world consumes ever-larger quantities
of something for which there is only a fixed supply. A cottage industry
has thus arisen around the proposition that global oil production will soon
peak and then begin a slow but rapidly accelerating decline. This approach
of ‘‘peak oil,’’ according to some, explains the growing scarcity—and
thus the rising price—of low-cost crude oil.
Although there is mathematical certainty about the fact that at some
point conventional crude oil production will peak, there is little reason to
think that day is necessarily on the economic horizon given production
data over the past several decades. If oil were growing scarcer, for instance,
we should see some evidence of that in rising crude oil prices. But a
rigorous analysis of crude oil prices from the first quarter of 1970 through
the first quarter of 2008 by economist James Hamilton finds no statistically
significant scarcity signal at all. On the contrary, his analysis finds that
‘‘the real price of oil seems to follow a random walk without drift.’’
Hence, we cannot say for certain what most people seem to believe—
that oil prices have been increasing over time.
Furthermore, Hamilton’s analysis suggests that the best predictor of
future price (that is, future scarcity) is present price, but the variance is
large: 15.28 percent per quarter. That’s because small changes in the
supply or demand for crude oil have major price impacts in the short run,
and any number of minor global events affect the supply or demand for
crude oil. Table 43.1, for instance, demonstrates how a forecast for future
oil prices made in the first quarter of 2008 grows over time given the
observed instability of oil prices.
A conclusion that one can draw from the table is that even if prices
rose dramatically in the near future, one could not say with confidence
whether that price rise reflected underlying physical scarcities caused by
long-term oil field depletions or any number of other short-term supply
or demand phenomena commonly seen in the oil industry.
Although peak oilers are correct that new oil discoveries over the last
several decades have been smaller and less frequent than in the past, how
much crude oil is yet to be discovered is by definition unknown and
unknowable. Hence, predictions about ‘‘peak oil’’ in the near term may
be correct—or not. We simply don’t know enough to say.
There are, however, four reasons for optimism. Together, they suggest
that expansion of supply is just as likely—if not likelier—than contraction
in the near to mid-term future.
First, high oil prices induce more exploration and more risk taking by
oil companies. Economist Klaus Mohn observes: ‘‘When the oil price
increases, oil companies take on more exploration risk.
Consequently, discovery rates will fall whereas the average discovery size will increase.’’
His examination of exploration and development data off the Norwegian
coast suggests that for every 10 percent increase in oil prices, reserves
increase by 8.9 percent in the long run.
Second, high prices may likewise induce more production from OPEC
countries as well. Claims about depleting reserves may be correct, but
there may be many more fields to come.
The Persian Gulf is one of the least explored areas of the world as far
as oil and natural gas are concerned. Only about 2,000 exploratory wells
have been drilled in the entire Persian Gulf since its emergence as an oilproducing
region. The United States, by comparison, has seen more than
1 million such wells. Even today, more than 70 percent of oil exploration
activity is concentrated in North America (which holds less than 3 percent
of the world’s oil reserves), whereas only 3 percent of that activity is
occurring in the Middle East (which holds about 70 percent of the world’s
oil reserves). Moreover, given that most of the exploration in the Persian
Gulf occurred decades ago before nationalization of the oil industry, the
dramatic advances in exploration technology and know-how have not for
the most part been applied to the most promising geological formations
in the world. More than a few industry observers argue that, yes, we will
almost certainly discover a new Saudi Arabia sometime in the future—
but it will likely be in Saudi Arabia.
Will high prices induce substantial new investments in oil exploration
in the OPEC countries and Russia, which likewise sits atop very promising
but scarcely explored geological formations? Only time will tell, but it is
hard to imagine that profit-maximizing oil states would forgo economically
promising investments indefinitely, particularly when the oil and gas industry
is the primary source of state revenue and prices are on the rise. If new
oil is not forthcoming, it will likely be due to political—not geological—
constraints.
The upshot is that the observation that major new oil discoveries have
declined over the past several decades in both OPEC and non-OPEC
countries is problematic because oil prices have likewise been falling over
most of that period. Trends in discoveries may historically have more to
do with price and politics than with geological scarcity.
Third, major new oil field discoveries are not necessary for major
increases in supply. Increasing average field recovery rates from 35 percent
to 40 percent, for instance, would increase supply by 300 billion to 600
billion barrels, which is akin to adding a new Saudi Arabia or two to the market.
Given that field recovery rates have steadily improved over time—
they averaged only 22 percent as recently as 1980—there is reason to
hope that high prices will induce new investment in—and corresponding
improvement in—low-cost extraction practices and technology.
Unconventional sources of crude oil are another source of potential
new supply. The International Energy Agency believes that 6 trillion
barrels of crude oil reside in heavy oil and bitumen stocks (primarily tar
sands like those in Alberta, heavy oil deposits like those in Venezuela,
and oil shale in mineral deposits such as those found in the Rocky Mountain
West), of which 2 trillion may be ultimately recoverable. Given that
conventional oil reserves worldwide total 1.3 trillion barrels, this suggests
that, should conventional crude oil prices rise high enough because of
depletion—or alternatively, should extraction costs of unconventional
crude oil decline substantially because of technological advance—massive
new sources of unconventional oil supply could enter the market.
Beyond unconventional crude oil are even larger possibilities for synthetic
oil production from gas-to-liquid technologies, coal-to-liquid technologies,
agricultural oils, and methane hydrates found on the seabed and
in permafrost Arctic regions. Hydrocarbons for oil production can be
harnessed from many sources, and conventional crude oil fields are but
one source of many.
Fourth, investments in new field production have followed the oil price
spiral and new supply will soon be entering the market. A recent tally in
the Oil & Gas Journal of publicly known oil development projects under
way found that 28 million barrels a day of new supply is coming from
47 countries over the next two decades, a sum that represents approximately
one-third of existing daily global production. Although production declines
from existing fields will certainly offset that new supply to some degree,
the encouraging fact remains that new supplies at the margin are still
potentially quite robust.