2005 August 23 Tuesday
Collapsing Saudi Oil Production Could Not Cause $200 Per Barrel Oil

John Tierney of the New York Times has accepted a bet with oil investment banker Matthew Simmons on whether the price of oil could triple in the next 5 years due to collapsing Saudi oil production.

I proposed to him a bet using what Julian considered the best measure of a resource's value: how it compares with the average worker's wage. I offered to bet that the price of oil would not rise faster than the average wage, meaning that future workers would be able to afford oil more easily than they could today.

Mr. Simmons said he favored a simpler wager, based on his expectation that the price of oil, now about $65 per barrel, would more than triple during the next five years. He said he'd bet that the price in 2010, when adjusted for inflation so it's stated in 2005 dollars, would be at least $200 per barrel.

Remembering a tip from Julian, I suggested that we use the average price for the whole year of 2010 instead of the price on any particular date - that way, neither of us would be vulnerable to a sudden short-term swing as the market reacted to some unexpected news. Mr. Simmons agreed, and we sealed the deal by e-mail.

Simmons argues that the real Saudi oil reserves are as much lower than their official claims and has developed this argument into a book: Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy. Even if Simmons is correct and even if production in the rest of world's old fields can't be expanded much to compensate for falling Saudi oil prduction I think Simmons made an obvious error: The demand curve for oil will not support such a high price per barrel.

Given very high oil prices three things will happen in response:

  • Economic activity will decrease and hence oil demand will fall. The world will fall into a severe recession as happened in 1973-1974 and 1979. Decreased economic activity will help bring down demand and prices.
  • Economies will restructure to use less energy per unit of economic activity.
  • Non-oil energy production will rise.

In the short run supply of other energy sources is pretty inelastic. But in the medium to long run oil prices can not rise above the cost of substitutes.

The inflation adjustment in their bet creates another distortion. If oil prices skyrocket then part of the inflation adjustment in the bet will be for the increase in oil prices. A nominal tripling in the price of oil will yield less than a real tripling in the value of the dollars received.

Oil has two big uses: Space heating and transportation. In each case nuclear or coal electricity can substitute for oil. Transportation is more problematic due to the cost and weight of batteries. But check out a site which has a calculator for electric versus oil space heating costs. At the $2.17 per gallon of heating oil in August 2005 in New England and $0.075 per kilowatt-hour (kwh) of electricity in 2003 (sorry, couldn't find a US national 2005 figure but the trend is downward - note the calculator appears to take dollars, not pennies) and assuming a heating pump in the US northeast oil at today's prices already costs 128% of electricity for heating and costs 97% of electricity for hot water heating. Therefore oil is already uncompetitive for space heating assuming that oil prices remain at least as high as currently.

Some electricity still gets generated from oil in a few areas (if memory serves: New York City) where environmental opposition to coal has kept oil burners in operation. But coal accounts for a little over half of all electricity production in the United States followed by nuclear as the second largest electric power source. The United States has a large supply of coal and could also build hundreds of nuclear reactors. Plus, wind power is declining in price. Therefore in a period of sustained rising oil prices electric power would displace oil for space heating.

Even if we add a few cents per kwh for new coal plants to sequester carbon dioxide and require scrubbers to reduce emissions coal electric plant costs put price ceilings on the use of oil for heating. Similarly even if we assume the nuclear power industry is being too optimistic on new nuclear power plant costs new nuclear electric power plants put price ceilings on the use of oil for heating.

Replacing oil with electric in transportation is more problematic. However oil demand for transportation will get more elastic with time. The market can adjust to higher gasoline prices in a number ways. While hybrids are not now cost effective in the United States hybrids would become cost effective at around $5 per gallon of gasoline and in 5 years Toyota predicts technological advances will make hybrids cost effective even at today's prices by 2010. Plus, people can shift to smaller cars, move to places closer to work, and take jobs closer to home. More expensive but lighter materials become cost justifiable in vehicle manufacture as prices rise as well.

In the medium term I expect battery technology advances to make electricity even more substitutable for oil in vehicles. Plus, coal conversion to liquid fuels would provide another way to put a price ceiling on oil for transportation. The Germans did it in World War II. Certainly we could do it today.

Share |      By Randall Parker at 2005 August 23 11:02 AM  Economics Energy


Comments
Ned said at August 23, 2005 11:44 AM:

In addition to the sources you cite, there are also enormous reserves of oil in sand and shale deposits. From Wikepedia:

Reserves
Estimates vary as to how many barrels of oil are contained in oil shale reserves. The US Office of Naval Petroleum and Oil Shale Reserves estimates there are some 1.6 trillion barrels of oil contained in oil shales around the world, with 60-70% of reserves (1.0-1.2 trillion barrels) in the United States. Most US oil shale is concentrated in the Green River Formation in Wyoming, Utah and Colorado. These oil shale resources underlie a total area of 16,000 square miles

Estonia has some five billion tonnes of oil shale reserves.

The Australian Geological Survey Organization estimates that the country has 32-37 billion tonnes of oil shale, equivalent to 220-260 billion barrels of oil.

Canada has 1.7 billion tonnes of oil sand distributed throughout the country.

Germany has reserves equivalent to three billion tonnes of oil shale.


Economics
Below forty dollars a barrel, oil-shale oil is not competitive with conventional crude oil. If the oil price were to stay permanently at over forty dollars a barrel (with no chance of declining, which could be the case if oil shale were to be exploited on a large enough scale), then companies would exploit oil shale. Generally, the oil shale has to be mined, transported, retorted, and then disposed of, so at least 40% of the energy value is consumed in production. Water is also needed to add hydrogen to the oil-shale oil before it can be shipped to a conventional oil refinery. The largest deposit of oil shale in the United States is in western Colorado (the Green River Shale deposits), a dry region with no surplus water. The oil shale can be ground into a slurry and transported via pipeline to a more suitable pre-refining location.

During the oil crisis of the 1970s, people thought that oil supplies were peaking, expected oil prices to be around seventy dollars a barrel for some time to come, and invested huge amounts of money in refining oil shale — money that they lost. Because of the astronomical sums that were lost last time around there is considerable reluctance to invest in oil shale this time around. Investors are waiting to see if oil prices really will remain this high (in mid-2005: US$60+). Prices are rising because of increased demand in rapidly developing countries, particularly China. Will high prices result in the discovery of more oil, as happened in the seventies, or will alternatives to drilling for oil have to be developed? Investors, burnt badly in the 1980s for their enthusiasm of the seventies, are in no hurry to develop oil shale. Those who lost money then are inclined to believe that more oil will be found by and by.

China is challenged severely by high oil prices. The Chinese government has sponsored a project to extract oil from shale.

Note that most of the oil sands/shale deposits are found in nice, friendly locations like the US, Canada, Australia and Germany.

Also, look what Brazil has done with ethanol:

http://www.washingtonpost.com/wp-dyn/content/article/2005/06/17/AR2005061701440.html

The economic and environmental costs here are not trivial, but they're not insurmountable either. The only reason nobody's doing anything with these alternatives now is the fear that the high price of oil will come crashing down (as it has in the past), leaving investors in alternative fuel projects with large, unrecoverable capital outlays.

John S Bolton said at August 23, 2005 2:05 PM:

Since the Bank of Japan now has had to come up with a few extra hundred billion dollars, to support the dollar, the oil shock recession goes through as soon as they stop providing the necessary larger increments of dollar support. Then interest rates and inflation shoot up, which catalyzes further oil price increases. Then economic growth goes negative in most countries. The dollar support has prevented the adjustments from taking place; so we have a backlog of readjustments to hit all at once. Private credit in Japan does not need to be covered in their banking system with 50 % government securities as reserves; there is a terminus to this dollar support. The dollar buys less than a third as much oil as it did a few years ago, yet oil is Japan's major import.

Peter said at August 23, 2005 9:46 PM:

Reducting oil usage in transportation isn't likely to be as easy as suggested. Moving closer to one's workplace would save gasoline, but if gasoline prices are high enough houses in distant suburbs and other remote locations may lose value, making it impossible or at least very difficult to move. Also note that the decentralized nature of residences and workplaces make significant expansion of mass transit problematic. As for hybrids, while they'll probably get better with time, most of the models now on the market in the United States offer relatively minor gasoline savings over regular vehicles - the Toyota Prius is an exception, but the dealers are price-gouging big time.

Peter said at August 23, 2005 9:46 PM:

Reducting oil usage in transportation isn't likely to be as easy as suggested. Moving closer to one's workplace would save gasoline, but if gasoline prices are high enough houses in distant suburbs and other remote locations may lose value, making it impossible or at least very difficult to move. Also note that the decentralized nature of residences and workplaces make significant expansion of mass transit problematic. As for hybrids, while they'll probably get better with time, most of the models now on the market in the United States offer relatively minor gasoline savings over regular vehicles - the Toyota Prius is an exception, but the dealers are price-gouging big time.

Randall Parker said at August 23, 2005 9:57 PM:

Peter,

People can move to be near jobs or can switch to jobs nearer to their homes. Employers can move to be near potential employees. Employees can work from home. Employers can agree to longer work days and 4 day work weeks to eliminate 20% of commuting travel. People can car pool. People can take buses or ride bicycles. People can buy much higher MPG cars. The market has plenty of ways to adjust if the incentives become large enough.

Are there costs to all this? Of course. If there weren't costs then people would already be doing all this. But we do not absolutely need to use oil even if it costs $200 per barrel. Make oil more expensive and people will respond in a great many ways.

Engineer-Poet said at August 24, 2005 5:53 AM:

On the other hand, the destroyed resale value of all those SUV's is going to be painful all by itself.

TangoMan said at August 24, 2005 11:26 PM:

Most investment bankers aren't stupid guys, so why did Simmons make the bet when he was surely aware of the Simon bet?

Cheap ($5,000) publicity for his book.

Don't underestimate the impact of a falling dollar to future price levels. The public finances of the US don't exactly inspire confidence these days, and with no sign of fiscal discipline in Washington Simmons might be expecting a fall in the dollar.

Also consider the gasoline shortages currently taking place in China. Gas prices are still set via command, rather than through market signals. The shortages are a result of decreased production because China is refining at a loss these days.

If the Chinese politicians decide that low oil prices are needed to keep the economy transforming they may willingly subsidize the price of gas even as the price of oil increases. I think that this is quite likely to happen for a market response would have the industries with the lowest marginal utility dropping out, or reducing consumption, first for they wouldn't be able to sustain operations. In a market economy, that's actually an efficient response. However, I'd venture the opinion that the US and Europe have larger proportions of their economies that can buffer the increased cost of oil - much of China's economic transformation is of the classic bootstrapping effort and if the low rungs of the ladder are removed, that makes the jump up the value chain that much more difficult.

Also, the social disruption of protesting farmers, and factory workers, may be more worrisome to China than the prospect of protests are to US decision politicians.

So, China may reach a strategic decision to "invest" its US dollar surplus into subsidizing oil rather than buying US treasuries. Now, this definitely can't be sustained indefinitely, but it might go on long enough to offset economic behavior in the West that is responding to market signals.

If Simmons' bet was denominated against a basket of currencies, then much of the above wouldn't matter. However, the bet is in US dollars and he may be factoring in that the day of fiscal reckoning will arrive before his bet comes due.

Also, oil has a demand elasticity of about 0.13-0.25 so it is more essential to consumers and industries than more elastic goods. Further still, there are the sunk costs of the whole "oil economy" and to start phasing in substitute goods will require a lot of investment capital and some of the alternatives will require that numerous consumers dip into their capital budgets and divorce themselves from the oil economy. With the prospect of making new fixed expenditures, many consumers may elect to suffer the higher variable costs on their existing capital investments but operate them, not at where the demand curve would lead one to believe, but at the minimum amount that they can justify without incurring new capital expenditures needed to get to the predicted demand curve.

Even still, I think he did it for the free publicity for his book, because the $200/brl price point is pretty extreme.

David Davenport said at August 26, 2005 3:50 PM:

[ The Australian Geological Survey Organization estimates that the country has 32-37 billion tonnes of oil shale, equivalent to 220-260 billion barrels of oil.

Canada has 1.7 billion tonnes of oil sand distributed throughout the country.]

Hard to extract that stuff without damaging the ecology. It's basically a type of strip mining.

Coal -- most of that would be extracted by strip mining, also.

If it's not Green, it's not good enough for the 21st century.

David Davenport said at August 26, 2005 3:52 PM:

How to get more oil? Give the A-rabs the Native American treatment, that's how.

Yehuda Draiman said at January 25, 2008 3:02 PM:

Is this statement true

Alaska’s Gull Island Oil Fields Could Power U.S. for 200 Years
By Mark Anderson
“Crude oil is the real ‘currency’ of the world,” said Lindsey Williams at a gathering of the Midwest Concerned Citizens group in Kansas City on July 22. But Americans will never hear about huge oil and gas reserves in the United States, which, if ever tapped, would bring today’s fuel prices at least as low as $1.50 per gallon and make America more energy independent.
As a Baptist missionary in the 1970s, Williams said he rubbed elbows with members of the world’s power elite—who boasted of detailed 30-year and 50-year plans to control the flow of oil and information.
A huge quantity of crude oil and natural gas exists under Gull Island, located in the waters of Prudhoe Bay in Alaska, says Williams. He cited key British Petroleum memoranda and related the statements of upper echelon oil officials who told him that Gull Island would be kept under wraps, limiting domestic supplies so Americans would someday see prices hit up to $10 a gallon at the pump.
“Every issue in the world today relates to crude oil,” said Williams. The U.S. occupation of Iraq and the saber rattling about attacking Iran fit into the crude oil matrix.
Iran is being targeted because it’s one of several countries that want to use their own currencies for oil sales, rather than using the U.S. dollar. Williams told AFP that any country that doesn’t want to “play ball” with the U.S. government and the financial and oil interests is, in essence, put on a hit list.
The United States, he said, learned that Iran intended to form its own bourse and not use the dollar for oil sales. Therefore, the notion that Iran is a menacing “almost-nuclear” country was trumped up, presented as fact via the corporate media and Iran is now in the crosshairs.
Other nations wanting more independence from U.S. meddling include Norway, Venezuela, Nigeria, Bolivia, Sweden and Russia.
The 30-year plan, which was first proposed three decades ago and is nearing fruition, included smug assurances from oil officials that the United States will triple its crude-oil usage and alternative fuels will not be allowed to gain enough ground to make a difference. They also noted that all foreign oil production will be scaled back to the United States and that Americans soon will pay $4 to $5 a gallon at the pump and could pay as much as $7 to $10 down the road.
In the early 1960s crude oil was selected as a tool of world control, Williams said, adding, “What we pay at the gas pump is a form of taxation.” The American consumer’s dependence on crude oil thus far has enabled people from foreign oil-producing nations to buy T-bills (U.S. treasury notes) in order to support the U.S. national debt and continued deficit spending. The need to support that debt puts the U.S. government in a bind, forcing Americans to remain dependent on foreign oil.
Williams, as a chaplain in 1970 when the trans-Alaskan oil pipeline was finished, ministered among the pipeline workers. However, as time passed he made a favorable impression with the top brass and was asked to improve worker-company relations. Next thing he knew, he said he was sitting at meetings of the World Bank, the International Monetary Fund and various meetings of oil executives over a three-year period.
He told AFP that the IMF-World Bank acts as a middleman between oil producing nations and refineries. In so doing, they set oil prices, he said.
The big event in that three-year period was in 1977 when an Atlantic Richfield oil executive told him, “We have just drilled into the largest pool of oil in North America—[and] in the world!”
That pool was Gull Island. It was said that there was enough natural gas to supply America for 200 years. But to this day, “not one drop” of that oil has been released to American refineries, Williams said.
Williams said the executive had warned him that the Gull Island find was highly classified. Do not repeat any of this, he was told. Obviously, that warning did not stop him.
Comment by Lindsey Williams - January 11, 2008 at 1:48 am

Can anybody verify this claim

Yehuda Draiman said at January 25, 2008 3:03 PM:

Hidden beneath the Rockies lies a big oil field! 2 trillion barrels
Let us say it is true. How come everyone is not running to exploit it, like they exploit any other economic and financial benefit?
The other aspect is how much energy, and at what cost – financial and ecological, is it going to take to heat the oil shale up and extract the oil.
I suggest conserving resources; we should use renewable energy, such as Solar and Wind energy etc. to heat up the shale.
Another issue is they are waiting for oil to reach $200 per barrel so the government can reduce the deficit and outstanding loans.
I hope that is the truth and that there are no hidden agendas.

Technological hurdles to extract oil from shale
"Despite all the attempts to develop a shale oil industry in the United States over the past 100 years, the fact remains that no proven method exists for efficiently moving the oil from the rock. There are a number of candidate processes possible, but none has demonstrated a practical capability to produce oil."
Experts with field experience who are bullish on the prospects for America's oil shale. But they recognize that, here and now, we are still not there yet technologically.
There are a number of problems yet to be solved before US oil shale can be recovered on any type of meaningful scale, let alone a mass scale. And getting the extraction technology right is only one monkey wrench in the works with US oil shale. There are others.
For example, there are questions of air quality regarding domestic oil shale operations. How badly would these operations pollute the air? Would the levels be acceptable? Shell isn't sure.
There are questions of water availability. During the extraction process, how much water would be required?
Experts are not sure. An early "guess" is two to three barrels of water per barrel of shale. This could be a conservative estimate. Either way, will the massive amounts of water necessary for heavy-duty shale extraction even be available in the first place, given that the Colorado River Basin is already running low?
You also need to account for the environmental and ecological damage and restoration to pre-drilling condition.
American technology and knowhow will find the answer – all you have to do is wave the dollar bill in front of corporate America and they will find the answer “by hook and by crook”. Then the executives, the shareholders and the politicians will laugh all the way to the bank.
Yehuda Draiman

Jay Draiman, Energy Analyst said at May 20, 2008 9:08 PM:

Water is the source of life - treasure it! R4.
Water is the source of all life on earth. It touches every area of our lives. Without it, we could not thrive — we could not even survive.

Sustainability – “We strive to meet the needs of the present generation without compromising the ability of future generations to meet their own needs”.
We should discourage wastefulness and misuse, and promote efficiency and conservation.
"Conservation is really the cheapest source of supply,"
For the benefit of mankind, maintain the quality of life and preserve the peace and tranquility of world population. Water resources must be preserved - to sustain humanity. We must eliminate wasteful utilization of water, conserve our water sources and implement rigid conservation methods. We should utilize solar and or other source of renewable energy to operate desalinization projects from the oceans. Utilize renewable energy sources to purify and transport the water to its final destination. As world population increases the scarcity of water will become a cause for conflict, unless we take steps now to develop other sources of water for drinking, rainwater harvesting – storm-water and gray-water utilization. Designing of landscaping that uses minimal amount of water.
"With power shortages and a water scarcity a constant threat across the West, it's time to look at water and energy in a new way,"
To preserve the future generations sustainability, we should look into urban farming – vertical farming. The term "urban farming" may conjure up a community garden where locals grow a few heads of lettuce. But some academics envision something quite different for the increasingly hungry world of the 21st century: a vertical farm that will do for agriculture what the skyscraper did for office space. Greenhouse giant: By stacking floors full of produce, a vertical farm could rake in $18 million a year.
Jay Draiman, Energy and water conservation consultant
May. 2, 2008
PS.

Hydro dynamics: forget oil. Sharing freshwater equitably poses political conundrums as explosive and far-reaching as global climate change.
Quoted from other sources
Anyone who has ever stood on a beach and looked out into the vast expanse of an ocean knows that there is a lot of water on this planet. In fact, 70 percent of the Earth's surface is covered by water. It may seem like water is all around us, but safe, clean, reliable drinking water is not a cease¬less resource. The problems facing drinking water range from failing infrastructure, to climate change, to insufficient supplies.

Personal Conservation
Preserving our water resources is not a job for water industry professionals alone. We all have a vested interest in ensuring that water remains safe, af¬fordable and available. Therefore, each individual American has a responsibility to monitor and control their water use, There are many simple ways for people to reduce excess water use, lower water bills and protect the environment, espe¬cially in die spring and summer months, Beyond the standard constraints of watering the lawn only when neces¬sary and washing car wisely by using soap and a bucket of water, some steps include: draining water lines to outside faucets, disconnecting hoses, shutting off outdoor water sources during cold weather and running a small trickle of water on whiter nights to prevent pipe from freezing.
Conclusion
Water supply management is an issue that affects us all. It may not be apparent to every citizen today, but with climate change and population shifts transforming the United States, it soon will be. Effective solutions need to be put into place today before we are faced with a water crisis. A focus on careful planning, treatments, innova¬tions and conservation measures will help to create stability for long-term water management. Commitment to keeping water at the top of the list for communities and citizens will better prepare us for whatever the future of water holds.

WATER!
The indispensable source of life-without water there would be no industry, no agriculture and, most importantly of all, no life. In dry parts of the world this essential commodity is even more precious. Almost all human actions involve water from taking a shower to reading a newspaper to driving a car or simply eating a sandwich - almost everything we do or touch is somehow related to this precious treasure. We ask that you stop and think how you use water and what you can do to conserve this essential natural resource.
*Water, beliefs and customs,
*Water as a vehicle of the economy,
*Water, source of art and life, irrigation and cultivation.
The people have decided to act to try and develop a real awareness program on the theme of water preservation and distribution in an attempt to help maintain the original purity of rivers and streams.
In many parts of the world water sources and wells are not equally distributed. Water as a source of life can also be at the source of conflict.
Whether we live in India, Iceland or the Atlas… we have always tried to trap and tame water. Dams, pumps, canals, water treatment centers; there are so many different ways to exploit this resource that we often forget how fragile this unique and essential treasure actually is.
Unfortunately, many of the things we do every day can harm our water. That’s why all people and government should be working with municipalities, farmers, business leaders and developers just like you to take action to protect our water and clean it up.
Small changes can make a big difference. This guide outlines practical things we can all do to preserve and protect our water. We all need to be part of the solution.
Concentrated Solar Power, which requires no solar panels at all. It works by concentrating sunlight onto a small pipe using cheap parabolic reflectors. The pipe contains a liquid that’s heated to very high temperatures by the sun and drives a steam boiler that rotates a turbine to generate electricity (much like nuclear power plants, but without the nuclear waste). It’s cheap, low-tech, and far more affordable than solar power. Plus, it can be built in practically any desert, so it doesn’t take up valuable land. As another bonus, when CSP operations are built near the ocean, they can desalinate ocean water as a side effect, providing fresh water for irrigation to grow food. This is the only renewable energy technology I know of that can produce cheap energy, fresh water and crop irrigation all at the same time. Plus, it has no emissions, no toxic chemicals, no nuclear waste and very little environmental impact..
“You can’t escape the responsibility of tomorrow by evading it today” - Abraham Lincoln said it.
“That man is richest whose pleasures are the cheapest” – Henry David Thoreau.
“To waste, to destroy, our natural resources, to skin and exhaust the land instead of using it so as to increase its usefulness, will result in undermining in the days of our children the very prosperity which we ought by right to hand down to them amplified and developed” – Theodore Roosevelt.
“When the ‘study of the household’ (ecology) and the ‘management of the household’ (economics) can be merged, and when ethics can be extended to include ‘environmental’ as well as human values, then we can be optimistic about the future of mankind. Accordingly, bringing together these three E’s is the ultimate holism and the great challenge for our future” – Eugene Odum.

Jay Draiman, Energy Analyst said at June 29, 2008 10:45 PM:

Renewable Energy Manufactures/suppliers should use their own product to manufacture.

The manufacturers’ of Solar Panels and other forms of renewable energy with related support products manufactures/suppliers - should have at least the decency to practice what they preach what they market to the public.
That would be the best marketing approach I can think off.
If they believe in the product they manufacture/sell, they should utilize it to its fullest potential.
It will give the manufacturer the actual experience of utilizing the product on a daily basis, view and experience any shortcoming or improvements that are needed, implement the improvements and capitalize on that revision to improve the product and its performance.
This will instill confidence in the public to purchase the product.

Jay Draiman, Energy Analyst

PS
As with any new technology, PV will become more efficient, cheaper and cleaner to produce. In order for this to happen we (Governments / NGOs / Individuals) need to invest more time and money into making PV viable, e.g. through increased incentives, regulations, technical standards, R&D, manufacturing processes and generating consumer demand.
Just like the automobile industry, the manufacture used its own product.
Over the years the automobile industry and technology has evolved from the early 1900 to what it is today the year 2008.
I predict that in 10 years the automobile we know today will change drastically for the better, with new fuel technology and other modification that will improve its scales of economy and features.


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