The Fate Of New Truths: Peak Oil Appears On “Nature”

With the publication of a prominent article on “Nature” in January 2012, the concept of “Peak Oil” has made another step forward in the debate on resource depletion. This article has made me rethink of the past ten years of work that I did as a member of ASPO, the association for the study of peak oil. Were we right with our prediction of impending peak oil? In a sense, yes, but the crystal ball is always foggy and it cannot be otherwise. The ASPO predictions were basically right but, as all predictions, they were approximate.

Working with a simplified model based on Hubbert’s early work of the 1950s, the founders of ASPO, Colin Campbell and Jean Laherrere, proposed in 1998 that the future of oil production would have followed a curve that was to peak at some moment between 2005 and 2010, to decline afterwards. Embedded within the Hubbert model was the concept that the gradually increasing costs of extraction would reduce the profits of the industry and force it to reduce investments.

As a “first order” model, the Hubbert one is not bad and the ASPO models caught very well the problems that the oil industry was going to face. From 2004 onward, prices have shot up a levels that have changed forever the oil market. But oil production, intended as “all liquids” (that is, including oil from tar sands, biofuels, etc) didn’t show a well defined peak, nor the decline that the Hubbert model predicted. Stubbornly, production has refused to decline and it may even be showing a modest increase in recent times. That doesn’t make the model wrong: as all models, it is an approximation of reality.

The “peak oil” concept has been often criticized on the basis of a classic idea in economic science: that prices mediate between demand and offer. Hence, oil prices should define what should be counted as “reserves”, intended as something that can, and will be, extracted. High prices should lead to more reserves and we would never run out of anything. It turns out that this criticism was not wrong, although not right, either, and its consequences were perhaps unexpected even for those who proposed it. When scarcity started to be felt in the oil market, the price correction mechanism kicked in. Prices rose and, according to the standard economic theory, that should have stimulated production. It did, in part, but with crude oil the mechanism has become a rat race. The more high prices made production profitable, the more production costs rose. That’s where we hit the ceiling.

This mechanism is very nicely caught by Murray and King in their article in Nature. The figure reported at the beginning of this post shows it very clearly. Over a certain price, production doesn’t respond any more. It becomes “inelastic”. The graph has to be read taking into account the temporal evolution of both prices and production: very high prices are a recent phenomenon and what we see is what I called the rat race. Even with increasing oil prices, the best that the industry can do is to keep constant the production of combustible liquids.

So, we are seeing that the price mechanism may slow down the expected production decline, but at the price of causing all sorts of problems. With high prices, the world’s economy must allocate more and more resources to oil extraction and these resources must come from somewhere. Since the economy doesn’t grow any more, keeping oil production constant means that some sectors must shrink and that is not without pain. Much of the present political turmoil in poor countries, for instance, is due to the high prices of food, in turn related to the high cost of oil. And, with prices so high, we see the perverse effect that producers can afford to consume more but, as a result, less oil is left for importers. In a sense, many importing countries have already passed their peak oil.

As Thomas Huxley said long ago, it is the customary fate of new truths to begin as heresies and to end as superstitions. Peak oil surely began as a superstition and it is still considered as such in some circles. But, with the events of the past few years, it is also attaining the status of truth, as shown by the article by Murray and King, who have clearly understood what lies at the basis of the idea. In some sense, however, peak oil is also taking some elements of a superstition, since it fails to take into account the price mechanism. In the end, reality might be better described by something like the “Seneca model” which takes into account second order effects and that predicts a production plateau followed by a sharp decline. Also this model may be a heresy, right now, but one day may become truth and later on a superstition. As always, the future is never what it used to be.

By Ugo Bardi

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