Sunday, December 16, 2007
Still plenty of oil left in the global tank
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


As everybody who has filled up recently knows, petrol and diesel prices have risen and are staying up. The £1 a litre “barrier” was breached easily.

High oil prices contributed significantly to a 3.4% jump in manufacturers’ input costs last month, a 10.3% rise on a year earlier. Petrol was instrumental in pushing “factory-gate” inflation to a 16-year high of 4.5%. There will be more of this on Tuesday in the latest figures for retail and consumer price inflation.

Oil did not quite make it to $100 a barrel and, for a few days dropped below $90. But last week’s coordinated action by central banks pushed prices back above $90.

So the surge in prices in recent months has revived a familiar question. Is it because oil is starting to run out? Have we reached, or passed, the peak in world oil production?

A new film just out in Britain, A Crude Awakening: The Oil Crash, begins with a sombre Philip Glass soundtrack. Its opening line, “Oil is the excrement of the devil”, tells you where it is coming from. It outlines a vision of a world beyond oil and “how our civilisation’s addiction to oil puts it on a collision course with geology”.

Peak oil is a broad church. To be fair to A Crude Awakening, it is hard to argue too much with the definition on its website. “Peak oil doesn’t mean ‘running out of oil’, but rather ‘running out of cheap and plentiful oil’,” it says. The film is directed mainly at an American audience, profligate in its oil use.

But what about the peak-oil “ultras”, who claim world oil production has reached or passed the summit? It has such a widespread following on the internet that surely it must be true. Actually, it is wrong.

The “peak oil has already happened” argument was partly based on the fact that global oil production, on International Energy Agency figures, had never been higher than the 86.13m barrels a day of July 2006.

That, however, is no longer true. World oil output in October was 86.5m barrels a day, 1m more than in October last year and 3m more than in October 2005. It edged up to 86.55m last month.

Even if it was the case that global oil production had been flat over the past couple of years, however, it would prove very little.

Why? During this time the Organisation of Petroleum Exporting Countries (Opec) cut output and only recently started to increase exports again. Less than five years ago Opec was happy with an oil price in the $22-$28 a barrel range. Now it is content with $90. Opec increased output quotas by 500,000 barrels a day this autumn but refused to do so again earlier this month.

Production in many oil-producing countries is constrained, not by geology but by politics. Iraq is producing only two-thirds what it did on the eve of the first Gulf war in 1990. That was no golden age, production running below potential because of weak investment during the Saddam era. Iran is producing well below potential.

The most important reason for rejecting the “peak oil is here” argument, however, is that current production reflects investment decisions taken years ago, when prices were much lower. It was only just over three years ago that oil rose above $40 a barrel. A few years earlier it was $10-$11. Higher prices will bring more output on stream. A new study by Germany’s Energy Watch Group, which said the peak was in 2006, makes the astonishing admission that it took no account of prices.

There is a long history of crying wolf on peak oil, dating back to the 1920s. The patron saint of peak oil, the geophysicist M King Hubbert, predicted in 1956 that oil output from the lower 48 states in America would peak around 1970 and he was right. He also predicted global production would peak in about 1990 and he was wrong.

Colin Campbell, founder of the Association for the Study of Peak Oil and Gas, first called the oil peak in 1990 and then at regular intervals. His view today is that a peak remains imminent.

Peak-oil people get excited about the giant Ghawar field in Saudi Arabia because it is apparently producing water rather than oil. The Ghawar “water cut” has reached 30% and bestselling books have been written on its imminent eclipse.

But, as Michael Lynch, peak-oil sceptic and president of the consultancy Strategic Energy & Economic Research, points out in a paper, Crop Circles in the Desert, this is a low figure. The average water cut throughout the industry is much higher, at 75%. The Ghawar cut rises and falls but the field still churns out 5m barrels a day, even at the age of 50.

Lynch is dismissive of another argument, that no big oilfields are being discovered. That, he said, is the nature of the industry – big fields are easier to find and smaller satellite fields around them come later. Large areas with the oil potential of, for example, Saudi, have not yet been fully explored.

There is, then, plenty of oil in the tank. Opec says additions to recoverable reserves since the early 1980s have been three times cumulative output over the period.

So why are prices so high? I have been taken by surprise and so have the oil bulls. A couple of years ago Goldman Sachs came out with a bullish forecast that the price would average $60 over five years. Today that looks conservative.

Oil is expensive because of geopolitical uncertainty, strong demand from the global economic boom of the past few years and speculative investment. Opec, which has most of the reserves, is happy to extract money from consumers to fund spending programmes. Most oil is in places we would not want it to be.

Demand has responded to higher prices, but not enough. The International Energy Agency’s worry is not that oil has reached a peak – it expects a 50% rise by 2030 – but that demand will rise faster than supply. We will see how much impact next year’s economic slowdown has.

Sheikh Yamani, the former Saudi oil minister, famously said the stone age did not end because the world ran out of stones. How will the oil age end? In a speech to mark the bicentenary of the Geological Society, “Peak Oil – a metaphor for anxiety”, BP’s Michael Daly predicted that we would be debating when the oil might run out in 100 years’ time. Long before then, thanks to high prices, alternative energy sources, climate concerns and technological advances, we will have probably passed the peak – but for oil demand rather than supply.

PS The concerted action by central banks to ease money market pressures is covered elsewhere [newspaper edition] but two views are emerging both on this and on interest rate cuts, including this month's from the Bank of England.

One is that central banks are abandoning economic purity and taking their eye off the inflation ball, and that they should allow economies to suffer the consequences of past excesses, even if that means a painful recession. The other is that what we are seeing is classic central banking in the Walter Bagehot mode, the first duty of a bank being to keep the system working.

The purists have got it wrong, failing to see that central banks are responding to an economic shock which, if unchecked, would do more than penalise a few irresponsible bankers, borrowers and investors.

They also fail to understand the process through which monetary policy affects inflation – through demand. If inflation were very high you might need a recession to get it out of the system. That is plainly not the case now.

From The Sunday Times, December 16 2007


Matt Simmons has been travelling the world for years gathering on-the-ground data. The Oil Drum is a blog full of geologists, physicists, statisticians, economists, and a bevy of oil industry veterans and current members.

You are an undistinguished economics commentator trying to sell newspapers, tackling something outside his field, quoting a guy who's trying to sell books.

It's pretty clear which side has more credibility here.

Posted by: RN at December 16, 2007 01:28 AM

"Opec says additions to recoverable reserves since the early 1980s have been three times cumulative output over the period."

But unfortunately if you look at the figures for world oil consumption and world oil discovery, consumption is now three times discovery.

Posted by: Minh at December 16, 2007 09:05 AM

"... monetary policy affects inflation – through demand"

Demand for oil and food is a global phenomena. MPC actions may reduce or increase UK demand, but isn't price set by world-wide demand ?

On a different topic. I liked your piece "Foreign workers ‘keep jobless on welfare’". I have a great deal of respect for Frank Field.

Posted by: Nick Thorne at December 16, 2007 10:17 AM

"They also fail to understand the process through which monetary policy affects inflation – through demand."

C'mon David, cyclical factors can only have a temporary influence on inflation. Even the purest of Keynesians would accept the long-run neutrality of money.

Nick Thorne makes a good point, but like Merv has pointed out 'inflation is made at home'. Looser policy/strong demand/rising import prices can only have a long-run impact on inflation if the central bank monetizes the supply shock.

Concerns about inflation derive from the fact that adding liquidity to the system can only work to a point. The problem we have now is one of solvency and uncertainty. Liquidity can help solve the latter, but not the former. Unless that is, central banks decide to inflate away the banking system's bad debts.

Posted by: Sell Everything at December 16, 2007 10:22 AM

Strange comment from RN - and an entire absence of argument. Matt Simmons has been travelling the world .... "to sell books". Precisely. I have a paper from Simmons calling the peak in the 1990s. One thing we know about in this debate is that geologists (Simmons of course is not a geologist) are hopeless at callng the peak - and Minh, you are wrong about consumption and reserves - look at the data.

I take Nick's point about global price pressures but part of my argument is that global demand is slowing too. As for Sell Everything, you're not only providing an argument for a significant slowdown in demand and money supply growth but the Bank of England's modus operandi of the past 10 years appears to have passed you by. Growth in relation to trend has been, and still is, the main determinant of inflationary pressures over the forecast horizon.

Posted by: David Smith at December 16, 2007 12:44 PM

David - discovery, not reserves. Oil production has exceeded discovery every year for the past 20. We are now producing 3 barrels of oil for every 1 barrel we find.

Also, if you want to tackle peak oil you really need to make the distinction between conventional oil and non-conventional. Conventional is "cheap and easy" whereas non-conventional has very poor ERoEI. Campbell (when calling the peak) always talks about conventional oil.

Posted by: Minh at December 16, 2007 01:35 PM

I'm not sure the data on discoveries tells us anything very useful. Firstly, estimates of the likely extent are imprecise at the time they are made. Secondly, we only have good information on discoveries by quoted oil companies, which are a fairly small proportion of the total. I'm aware of course of the distinction between conventional and non-conventional oil. In neither case are we at or near a peak.

Posted by: David Smith at December 16, 2007 03:51 PM

So the discoveries data is unreliable? You could say exactly the same about the reserves figures.

Posted by: Minh at December 16, 2007 06:31 PM

And on conventional production:

Conventional crude - Latest available figures from the Energy Information Administration (EIA) show that crude oil production including lease condensates increased by 891,000 b/d from August to September. Total production in September was estimated at 73.49 million b/d, which is 800,000 b/d lower than the all time high crude oil production of 74.30 million b/d reached in May 2005.


Posted by: Minh at December 16, 2007 06:34 PM

I'd hoped you weren't one of these silly people who believed the peak had already been reached but it appears you are. As I say in the piece, even if production had apparently reached a plateau over the past couple of years it would have told us nothing, for the reasons I set out. The fact is that oil production is on a rising trend. The serious debate is whether incremental oil supply will be sufficient to meet rising demand. Those who say the peak is here or has passed will be proved wrong this time, as on every previous occasion, and just give the peak oil argument a bad name.

Posted by: David Smith at December 16, 2007 08:38 PM

I never said we were past peak, and anyway the exact timing of the peak isn't all that relevant, given that we probably need to start preparing some 20+ years in advance if we are to adequately mitigate the effects of peak (as the Hirsch report says).

All I am saying is that:

1. Conventional oil is what is most important, as Campbell says - that is the cheap and easy stuff, not stuff like tar sands which takes almost as much energy to extract as you get from the product.
2. The current high water mark for conventional oil production remains over 2 years ago.
3. We now discover 1 barrel of oil for every 3 we produce - an unsustainable situation.

All you seem to have said is that the peak in world oil production has been called wrong in the past (which indicates nothing about whether we are past peak, at peak or way before peak) and that OPEC says they are adding plenty of reserves.

But it's clear that OPEC has an incentive to exaggerate its reserves, and there is a great deal of evidence to suggest that they have a lot less left than they say.

As you say, whether production can rise quickly enough to meet demand is what is important now. In fact what really matters is whether exports can rise to meet import demand. This is covered in detail on under the topics "peak lite" (meaning supply shortfall before peak due to production slowing down as peak is approached) and the "export land model".

Posted by: Minh at December 16, 2007 09:45 PM

surely the issue is that post-"conventional" oil (ie the cheap and easy stuff, the price needs to go up to justify pulling out the more tricky stuff? That is what has happened, so all laws of basic economics are safe....which is I think what David has implied, ie that oild production will continue to rise because it is economically viable to find the same economics applies to encourage people to find alternatives too...which makes veg oil cars etc possible (although since veg oil has an impact on food & it's prices / scarcity that takes us into a whole other debate!)

Posted by: Colin Flockton at December 17, 2007 09:52 AM

David, I understand the mechanichs, and agree with your analysis. However I am quite surprised (and a little disappointed), not to find a real comment on the outlook of prices.

So, in the mid-term, are current price levels too high, due to the effects of too much speculation etc, too low, as further reserves are likely to be costlier to discover, or just about right and expected to more or less stay where they are for a few years as we have reached a rather steady equilibrium?


Posted by: Fiv at December 17, 2007 01:21 PM

The whole debate about peak oil is a little irrelevant.

What we want is energy, which for a long time has been provided cheaply by oil. Unless the demand for oil falls away, or a massive discovery of 'cheap' oil is found, then we will have to pay much more for our energy in future. This might be from $100 per barrel oil, but eventually oil will become more expensive than other alternatives, e.g. solar, fuel cell technologies etc, and we will adapt our economies to use those energy sources.

Theoretically, this could happen before we even reach peak oil, and we might decide to leave it all in the ground!

P.S. If this happens soon enough and we shift to renewable energy, then all our worries about climate change may be solved as well.

Posted by: Paul C at December 17, 2007 01:22 PM

On prices - my view has long been that we are well above the sustainable level of oil prices - but save for a brief fall to $50 earlier this year, so far the markets have disagreed. As for the prospect of a shift away from oil, that is precisely the point made at the end of the article.

Posted by: David Smith at December 17, 2007 01:28 PM


Sorry to stick with this, again on prices: So you think there is still a possibility that OPEC will allow prices to drop back to anywhere near $40-50 price levels?

In my recent experience, every time it goes below $90, they cancel decisions to increase production. I think they naturally like getting double money offering nothing more, and expect they will continue to do anything to keep prices up there, or higher.

Further, it seems that any perceived risk of the planet finding an alternative has deteriorated as time has gone by, and as prices have increased, so I expect the decision makers in those countries feel pretty 'safe' towards that. Finally, if anything, environmental debates (and associated political benefits) provide an 'external' incentive for finding alternatives, making the whole system more price inelastic, which exporters would naturally exploit.

So, though an analysis of the macro situation would lead to expectations of lower price levels, the fact that OPEC is a cartel skews that balance completely. Effectively the price is what they chose it is, and currently, OPEC seem to have very little incentive to choose a lower one. What could make them decide otherwise?

Am I missing something basic here?

Thanks again

Posted by: Fiv at December 17, 2007 01:56 PM

If Opec believes the market can bear a high price, it will indeed be happy to take it. But there are some voices within Opec who believe that present high prices are bad news in the long run for the cartel. If demand weakens, such voices will come to the fore. Not long ago - last year - that meant defending $50. It remains to be seen what level that might mean in the future.

Posted by: David Smith at December 17, 2007 02:11 PM

"Growth in relation to trend has been, and still is, the main determinant of inflationary pressures over the forecast horizon."

If you truly believe this, perhaps you should think about going back to university and learning some modern macroeconomics. I realize you must have studied in the 1960s, but I assumed the lessons of the 1970s didn't pass you by...

You're right though, I am confused. Confused about how you can write an article a few months ago explaining why we should ignore growth in money because 'in recent years, M4 has had a weak relationship with inflation and money GDP' as 'it has been significantly boosted by lending to “other financial companies”' Yet now, as this process shifts into reverse, it suddenly seems to be important. Really confusing...

Posted by: Sell Everything at December 19, 2007 12:14 PM

I know you're not an economist, but it is worth persevering with these things, and also trying to read what I say rather than reinterpreting it in a rather bizarre manner. Anybody who has followed the MPC will know that it uses an output gap approach and, as I say, that the main determinant of inflation over the forecast horizon (typically the next two years, though the Bank has relatively recently begun to offer forecasts for three years) is output in relation to spare capacity and growth in relation to trend. My comments on the money supply, as should have been clear, were intended to reassure even those who regard it as important. As you have recalled, the relationship between broad money and money GDP has been weak.

If you do want to learn a bit more about these things, I can recommend some reading material.

Posted by: David Smith at December 19, 2007 12:27 PM

I'm afraid I can only read what you write, not what you say. Perhaps that has something to do with my confusion?!

Posted by: Sell Everything at December 19, 2007 02:53 PM

My point is only one of credibility. You may well turn out to be right on the result.

But hundreds (thousands?) of far smarter, better read and researched people than yourself think not.

You have merely a pedestal from which to speak. That's a different issue from the fact that, on this topic, you have little or no credibility, and your "sources" have scant more.

It is a shame that people like yourself often don't take the public trust more seriously and do better research before using their pulpits. For many of us, with any luck you will lose it.

Posted by: RN at December 24, 2007 02:45 PM

And a merry Christmas to you too. If that's your point, it's even more facile than I thought. I've been following peak oil for a long time - I imagine a lot longer than you have, because you don't seem to know anything of the central arguments. A newspaper article, by its nature, has to condense. As for those hundreds (thousands) of smart people, they're balanced by many, many more - who are just as smart - who believe that this peak oil scare, like all the others before it, will turn out to be wrong.

Posted by: David Smith at December 24, 2007 03:17 PM
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