Oil & Energy

An urban legend to comfort America: oil is oil, even if it is not oil

This is the fourth post in a series examining “urban legends” about energy that comfort Americans.  These five myths are:

I.      Our massive reserves of unconventional oil.
II.     We’ll run crash programs to solve peak oil, just as we mobilized for WWII.
III.    Demand creates supply, by raising prices.
IV.    Oil is Oil, even if it is not oil
V.    Demand creates supply, from new technology.

(4)  Oil is Oil, even if it is not oil

A common reply to warnings about peak oil is that we have vast reserves of oil.  True, but misleading and of limited significance over short- and medium-term horizons.

When the world relied mostly on oil from the wonderful super-giant fields, the distinction between different types of oil was trivial except to those in the oil business.  Sweet, sour, deep — these were technical terms.  Now that these conventional sources are peaking, we must turn to unconventional sources.  Calling unconventional sources “oil” leads to serious confusion.

More accurately seen, there is a spectrum of petroleum resources beyond conventionals.  Peak oil is a transitional period during which we move…

  • from reliance on relatively scarce, cheap, and easily tapped conventional oil
  • to more abundant, expensive, and difficult to exploit unconventional sources (and alternative energy).

Another way to see this:   extraction of conventionals are constrained by their limited abundance.  Unconventionals are constrained by our ability to produce them, due to their greater operational complexity and lower energy-return-on-investment (EROI).  The result:  the price of the oil products increases over time.  No matter how frequently said, the development of unconventionals probably will not lower the price of oil.  I believe that technological breakthoughs eventually will produce new energy sources — a faith-based statement — but that might be years or even generations in the future.

The difference in EROI is esp important and often ignored.  Conventionals require investment of little energy to yield a lot.  Unconventionals require substantial input of energy for extraction and processing.  This also makes it difficult to rapidly increase output, as their net energy gain scales differently than do conventionals.

One step further along the spectrum

Petroleum resources lie along a spectrum, as there is no bright line between  conventional and unconventional  resources.

For example, oil found deep under the ocean or in the polar regions is oil in a chemical sense, but economically quite different — due to the greater cost, technical hurdles, and time required for extraction compared to drilling conventional oil wells.  So they are somewhat arbitrarily considered unconventionals.

Further along the spectrum, Venezuela’s heavy oil is chemically oil — but with far greater processing requirements and a far lower EROI than regular oil.

Two steps further into fantasy

(1)  Bitumen (aka “oil sands”) 

Conflating bitumen is misleading (at best).   This is often done when calculating global oil resources, giving Canada the world’s 2nd largest reserves.  Its economics are radically different than for conventional oil, mined and processed rather than pumped and refined.  Both capital costs and operating costs are far higher than for conventional oil.  Note that comparison of “operating costs” and “breakeven points” are useless unless they include amortization of capital costs (which they seldom do).

Also, the massive infrastructure required to mine, transport, and process the ore makes scaling up operations difficult and slow — as companies are finding in Alberta.  Current plans call for Alberta to be producing 5 million barrels/day of synfuel by 2020.  That is probably insufficient to replace the decline of North America’s production by 2020, might exceed the available water and energy (natural gas or nukes) resources, and would leave much of Alberta looking like a moonscape.

For more information about mining bitumen see the following studies of the oil sands industry.  They provide balanced looks at the challenges and costs of expanding production in Alberta.

  1. Canada’s Oil Sands Resources and Its Future Impact on Global Oil Supply“, Bengt Söderbergh, Uppsala University, January 2005 (105 pages).
  2. Canada’s Oil Sands – Opportunities and Challenges to 2015“, Canada’s National Energy Board, June 2006 (85 pages).
  3. Canadian Oil Sands: A new force in the world oil market“, US Congress Joint Economic Committee, 26 June 2006 (14 pages, good maps)
  4. Canada’s Energy Future“, Canada’s National Energy Board, November 2007 (155 pages) – Scenarios out to 2030
  5. High costs squeeze oil sands“, Financial Post, 5 September 2008 — “Break-even price jumps 31%.”  Now aprox $85/barrel.”
  6. UBS says new oil sands projects need pricey crude“, Reuters, 19 September 2008 — New projects need $100+/barrel oil to turn a decent profit.

Excerpt from article #5, one of the few calcuations that include all costs and list most of the assumptions:

A new report found the break-even oil price required by new mining projects in the oil sands has jumped to $85 a barrel, an increase of $20 or 31% in barely more than a year.  In the report, National Bank Financial senior vice-president Peter Ogden said the break-even price– which assumes an 8% rate of return, capital costs of $120,000 per flowing barrel and operating costs of $27 a barrel — has crept up because of climbing labour and material costs and higher royalties in Alberta under a new fiscal regime beginning in January.  The break-even price in May, 2007, was $65 a barrel, assuming an 8% rate of return, capital costs of $100,000 per flowing barrel and operating costs of $20.50 a barrel.

Excerpt from the report described in article #6:

At the revised costs for Fort Hills, we believe a typical made-in-Alberta oil snads project generates a 10% IRR (after-tax) at approximately $100/bbl versus our previous view in the $80/bbl range. … This ugly combination of events mean we are likely at the breaking point for some oil sands development (including Fort Hills).

(2)  Kerogen (aka “oil shale”)

Conflating deposits of kerogen with conventional oil reserves is outright deception, as there is as yet no proven large-scale commercially feasible process for mining and refining shale oil (although some are under development).   It is not just a question of cost, but of developing the necessary technology. 

Most estimates show that decades will be required to perfect and scale-up extraction and refining of these reserves — assuming the many problems can be overcome.  I believe the largest running plant today is that of Fushun Mining Group in China, scheduled to produce 7,400 barrels/day in 2008 and 14,000 b/day at some point in the future (source).

For more information about mining kerogen see WiIkipedia on shale oil and shale oil extraction, and the Congressional Research Service report on Shale Oil dated 13 April 2006 (32 pages).

Conclusions

Now these distinctions are often ignored, as easy assurances of our vast energy resources are used to cloud our minds to the risks ahead.  As we come to rely more on unconventional energy resources, understanding these distinctions might mean the difference between prosperity and poverty.

Can we increasing production from such sources sufficiently rapidly to replace declines from super-giant fields like Mexico’s Cantarell and Kurwait’s Burgan fields?  Based on our experience to date, probably not without crash programs on a scale like that of major wars.  Avoiding a crash following peak oil might require starting these crash programs well before peaking — meaning research and planning on a scale far greater than today’s.

Just because we can does not mean that we will.  Optimists often confuse the two.  Much of the literature about Peak Oil seeks to create a sense of urgency so that we start work now, while rebuttals tend to urge (by result if not intent) complacency — starting tomorrow, next year, or whenever.

Please share your comments by posting below.  Please make them brief (250 words max), civil, and relevant to this post.  Or email me at fabmaximus at hotmail dot com (note the spam-protected spelling).

For more more information

Some posts about unconventional and alternative energy sources

  1. Links to articles and presentations of some A-team energy experts , 11 November 2007
  2. The most dangerous form of Peak Oil , 8 April 2008
  3. The three forms of Peak Oil (let’s hope for the benign form) , 23 April 2008
  4. The world changed last week, with no headlines to mark the news, 25 April 2008
  5. Fusion energy, too risky a bet for America (we prefer to rely on war) , 4 May 2008
  6. Peak Oil Doomsters debunked, end of civilization called off , 8 May 2008
  7. When the King of Saudi Arabia talks about oil, we should listen , 2 July 2008
  8. Red Alert: the Saudi Princes have annouced the arrival of Peak Oil , 11 July 2008
  9. Good news about oil, but for our grandkids – not us , 14 July 2008
  10. The secret cause of high oil prices , 6 August 2008

Here is an archive of all my articles about Peak Oil.

To see studies about energy — including oil, coal, nuclear, and alternative energy — see the FM Reference Page:  Peak Oil – Other Resources.

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14 replies »

  1. While it may be obvious that things such as oil shale, clean coal and so forth are ‘more expensive’ than light sweet crude… the real cost to the US is all about where the money goes.

    It says here that were we to indeed institute one or more ‘crash programs’ to use these resources more and better, and reduce foreign imports, the big difference is that the money stays here.

    If there is environmental impact as part of the cost… the solution is to pay Americans to fix that. In all such cases the money stays in our economy, increases employment, etc. The government could also impose stringent citizenship requirements for all associated workers, if that’s an issue.

    The point being, that money is spent is less important in this case than where it is spent. The same would hold true for solar, wind, tidal, and conversion of cars to natural gas. If we impose stringent domesticity requirements across the board, that means our economy grows and citizens prosper regardless of the cost per delivered BTU or whatever. Energy at this point is a national security matter, and I don’t see any free market types or globalists proposing we offshore our defense, and have our protection depend on the lowest bidder regardless of national origin. Even if all these programs are handled by the private sector on a for-profit basis, government can bound these efforts in an appropriate manner to ensure that the money stays here. And they should.
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    Fabius Maximus replies: I do not understand what you are saying. Why is it important where the oil money goes? Should nations importing our software and movies think the same way? Where does this end?

    Nations most open to the global trading system tend to be the richest among their peers. Like the US, Hong Kong, Singapore. Nations at the other end of the spectrum practice autarky, like North Korea — or “import substitution” strategies that mired so many third world nations in poverty in the decades after WWII.

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  2. You need to look at where the oil is being used before you can suggest a fix. Most of it goes into transportation.


    The biggest gains are to be had in reducing consumption simply by being more efficient.

    That is what the Tax system is for, and that is what it should be used for instead of taxing income, and capital gains etc. We in the developed world are by and large taxing the wrong things.

    Use the Tax system to send the market a signal. Recapitalise public transport (tramways, light rail etc).
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    Fabius Maximus replies: The allure of oil or carbon taxes: easy money AND doing good!

    I suspect it is too late to increase taxes on oil. In the first age of oil, the glut, consuming nations could leverage the excess supply by taxing its sale/consumption — profiting as much as the actual producers.

    In the second era, scarcity, the game changes. We cannot complain that oil prices are too high, then raise the price even higher through taxes. If we believe the price should be higher, the oil producing nations can fix that for us.

    Oil is the only natural resource for many nations, and they must get the best price possible for the finite resources.

    {Correction: See Celebrandil’s following comment. I misunderstood his point!}

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  3. FM, I think you missed my point entirely of what I was trying to say. I am not so much in favour of taxing the oil, rather – Taxation should be used more creatively to attain our goals.

    Suggestion: Tax manufacture/sale/resale of non hybrid vehicles – say, 5% per annum for 20 or 40 years. Admittedly there is a problem in obtaining consensus over that length of time (laughably so) – but I am in favour of at least _starting_. Even over one election cycle, a difference could be made if a government committed itself.

    Create new jobs in hybrids and associated technology etc. There is a huge market potential. The world is warming, oil is getting scarce, people like you and me are feeling the pinch.

    I’m in favour of shifting the tax base away from swingeing, wealth destroying taxes like income tax, capital gains tax, payroll tax etc. Taxation is perhaps one of the few sovereign powers governments have left. Use it asymmetrically for our benefit.
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    Fabius Maximus replies: Yes, I totally misunderstood. Thanks for the correction! I have added a note to that effect on the previous comment.

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  4. As part of a fiscal stimulus, a gov’t half-boondogle construction program of building more solar power arrays & wind turbines, when unemployment is high (above the 5 yr rolling qtr average?), would be more reasonable to increase spending then pure tax rebate stimulus.

    On the taxing of oil, or better, gas — yes! (very politically unpopular tho). The tax could be set to rise in a smooth fashion, so that if there is a supply price spike up, the tax could be decreased to maintain a more smooth rising curve, and when the supply price drops, the tax could be increased so as to keep the after tax price rising more smoothly than the pure spot market/ futures trading price would.
    Consistent, smoothly increasing price would send the more correct signal that $40/bbl ($1.50/gal?) is gone and ain’t coming back.

    BTW, what is the long term price of gas when oil has a long term price of $100/bbl?

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  5. Tom Grey
    “BTW, what is the long term price of gas when oil has a long term price of $100/bbl?”

    That depends in part on the taxes in your region and the cost to transport from the refinery to the gas station. In my region the cost is (Price per barrel)/42 (gallons per barrel) + $1.15 (for taxes, refining, transportation, and gas station profit). In the $100 example above I should be paying $3.53 and am paying $3.56.

    The formula doesn’t always work because the actual price per gallon of gas is a blended rate depending on a lot of complicated transportation, storage, and price contract issues. Last summer when oil was $147/bbl I was paid a maximum of $4.08 per gallon of gas when I should have been paying $4.65.

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  6. I have little problem with the article by FM but I do with several responses. The problem I have is entropy. This is the universal concept that greater organizational complexity of a system requires greater expenditures of energy. Study the human brain it is a primary example. But while entropy cannot be eliminated it can be mitigated by efficiency. I think FM has it generally right in concept, and perhaps his only fault is that it is difficult for any lay person to imagine the scope of complexity (and therefore conceptualize the difficulty in managing the variables) of recovering a resource of unknown quality through a natural system of indefinite characteristics in a future of variable economics. This is why oil and gas companies are not drilling across vast expanses of already leased territory. And why more leasing will lead to lower recovery levels per leased square area.
    We cannot continue to pretend our ancestors we’re stupid enough to leave easy pickings in the ground.
    Taxes, regulation, gov’t contracts are a component of efficiency. So are the qualities of the resource. Various people can say “We might have 19B barrels of oil under the Eastern continental shelf” My question will be “How many of those barrels will be used to pave our roads and how many will allow us to drive on those roads?” Who the hell knows? No one until you explore it, drill it, transport it, refine it, market test it, etc., etc. We might end up subsidizing that oil with an equal amount of electricity by the time its all done . And the only way the American consumer will have a hint is the price of gas and fuel oil will go up again.

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  7. A further comment on taxation:
    My wife and I own the following vehicles: An f-250 superduty (Oh no we’re bad!) Its a 2001 with 22000 miles on it. We intend to use it when needed for 20+ years.
    A new Nissan frontier. Again driven as needed. Probably good for 15+ years at the rate we drive it.
    A Honda Element 2003 driven all the time. Probably good for ten+ years or until we replace it with a plug-in hybrid vehicle.
    Tax incentives directed at categories rather than efficiencies do nothing but skew the market. And encourage consumption of other resources. We need efficiency not favoritism. What good does it do to encourage some one to dump his resource rich SUV to a person lower down the economic scale who can’t maintain it as efficiently and who’s income supports it less. ( unless its sold cheap) only to encourage them to buy a more efficient car they may drive more since it costs less per mile? Nothing. The solution is an efficient system. Energy behavior is what we must modify. Not consumer fashion. By the way uncle Sam paid for about 40% of that F-250 due to our already stupid tax structure.

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  8. One more comment on Celabeau’s post on taxation:
    The so called Picken’s plan where we switch to electricity for home heating would probably imply heat pumps, or off peak electric. My father-in-law recently put in off-peak electric. This required an addition to his house for a large storage tank, which resulted in higher property taxes, not to mention a more expensive furnace compared to propane. I don’t know how county assessors look at underground reservoirs for heat pumps.

    If the railroads switch to electricity it is usually mentioned that they would have to pay higher property taxes on electric infrastructure, while they pay no tax on the diesel fuel or locomotives in most states.

    The interstate highway system pays no property taxes, while railroads pay taxes on their roads.

    Besides taxes their could also be higher insurance costs.

    Auto example:

    A Honda Fit for instance is around $7000 cheaper than a Toyota Prius I believe. The insurance, sales tax, and license costs here widens the gap even more. I will use the metric system, because I think it is easier to follow:
    The roughly 5 liters/100km for the Prius and 6.7 for the Fit makes the choice of a Prius quite difficult economically. At about $1/liter, that is $1.70/100km savings or at 40000km/yr (our level of driving) it is $680/yr. Unless the cars last 15 years with comparable maintenance, the gas has to get a lot higher for this to work. So massive tax subsidies or taxation are required. We bought the Fit just over a year ago, and have watched the fuel economy closely, so the Fit number is from experience.

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  9. I’m not sure I’m communicating this taxation thing well. With regards to the prius, yes you have to own that car for a long time to get your investment worth out of it. But if you look at it, it was really the first mass market hybrid. Things improve over time.

    Yes taxes distort markets, but isn’t this the case already? Where I live there is a 10 percent GST on virtually everything. On top of this is all the other wealth destroying taxes you would be familiar with – income tax, capital gains etc.

    Your disposable income shapes who you are more than most people realise. If you can afford to educate yourself throughout your life, if you can service your debt commitments, what schools you can afford to send your children to … even if you can AFFORD to have children! Its one of the reasons people put having children off until they are well into their 30s. Because they spend 6 months of the year working for the government and the rest is scratching to make ends meet.

    The comment “Energy behavior is what we must modify.” was insightful, but strip everything off of that except the word “energy” … it is really behaviour that we need to modify. There needs to be a financial incentive to change the way we live.

    The world will change dramatically in the next 40 to 50 years. It will change regardless of what we think. Unless we change to adapt to unfolding circumstances, then things will be a lot harder than they need to be.

    The best way to do that in my opinion is to use the taxation system – creatively. Shift the tax base from wealth destroying taxes to the things that you need to disengage from over time. 5% per annum, for however long it takes. Reduce other taxes accordingly.

    If a state did this, I think it would be an example of a State exploiting a sovereign prerogative asymmetrically, against emerging threats.

    If this were done, I’m not convinced there would be solid dangers to its potential use in social engineering experiments. On the contrary I think if it were done correctly it would unleash a lot of creativity that is currently stifled.

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  10. FM, you wrote: Fabius Maximus replies: “I do not understand what you are saying. Why is it important where the oil money goes? Should nations importing our software and movies think the same way? Where does this end?

    Nations most open to the global trading system tend to be the richest among their peers. Like the US, Hong Kong, Singapore. Nations at the other end of the spectrum practice autarky, like North Korea — or “import substitution” strategies that mired so many third world nations in poverty in the decades after WWII.”

    I think it matters where the money goes because anything we extract domestically with domestic labor and equipment stays in our economy, as opposed to going to nations that are oligarchic, support some of our enemies some of the time, and so on. It adds to our GDP instead of theirs and gets recycled as consumer purchases. That seems an unmitigated good.

    If other nations retaliate by saying that software or movies are part of their national security interest, so be it. As of now we, the Japanese, and the EC define food as a national security interest and interfere in those markets. Why should we and they not? What is the alternative?

    This doesn’t imply a totally closed economy or autarky. Although it is important to note that other reasons may contribute or be dispositive, even, in the case of the US, Hong Kong, and Singapore. The position of these entities in the post-WWII geopolitical realm was somewhat unique, and they had the considerable advantage of not having been destroyed and/or primitive like Europe, Japan, and China. In addition, you have argued strongly that this era is ending, anyway. So perhaps, at least in part, what succeeded then needs to change?
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    Fabius Maximus replies: One of the fascinating aspects of economics is that people refuse to believe the basic “laws” — no matter how often or thoroughly proven by actual experience. The world has two centuries of experience with free trade. Not only is the theory clear, nations have experimented with almost every combination of trade barriers and import substitution theory.

    The result is clear that free trades makes a nation richer. Like most things in life, it is not an all or nothing. Focused trade barriers often work in certain limited circumstances. But the general principal is clear that as well demonstrated as anything in the universe of public policy.

    ” anything we extract domestically with domestic labor and equipment stays in our economy, as opposed to going to {other} nations … It adds to our GDP instead of theirs and gets recycled as consumer purchases. That seems an unmitigated good.”

    This is a version of mercantilism. Although repeatedly tried, it consistently has proven an inferior strategy. Many find it intuitively appealing, despite the devastating analytical rebuttals economists have produced (one of the major efforts of economists since 1800).

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  11. Update: cost of mining and converting oil sands into synfuel.

    High costs squeeze oil sands“, Financial Post, 5 September 2008 — “Break-even price jumps 31%.”
    One of the few calculations that include all costs and list most of the assumptions. What they call a “break-even price” is actually a minimum at which investment is worthwhile (it includes a minimum profit).

    Excerpt:

    “A new report found the break-even oil price required by new mining projects in the oil sands has jumped to $85 a barrel, an increase of $20 or 31% in barely more than a year. In the report, National Bank Financial senior vice-president Peter Ogden said the break-even price– which assumes an 8% rate of return, capital costs of $120,000 per flowing barrel and operating costs of $27 a barrel — has crept up because of climbing labour and material costs and higher royalties in Alberta under a new fiscal regime beginning in January.

    “The break-even price in May, 2007, was $65 a barrel, assuming an 8% rate of return, capital costs of $100,000 per flowing barrel and operating costs of $20.50 a barrel.”

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