Prepare now, for oil prices will rise again.

Summary: This is part 2, following yesterday’s post, What’s causing the crash in oil prices? Today we look to the future.  Oil prices will rise again. Let’s not waste this opportunity to prepare.

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Contents

5. The bottom line: oil prices will rise again.
6. When should we prepare for peak oil?
7. For More Information.

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(5)  The bottom line: oil prices will rise again.

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The cure for high prices is high prices, which leads to greater efficiency (reducing demand) and more supply. Similarly, the cure for low prices is low prices, as they reduce investment and hence future prices. Every day we drain each existing field a little more, bringing it closer to its peak oil — when even advanced tech cannot maintain production. Estimate vary, but the global production decline rate is roughly 6%. That’s the new production that must be created each year to replace the annual production decline from existing fields. In addition, demand increases over time since a growing world needs more oil.

Prices must be high enough to induce people to drill and create this new supply. Current prices have only a modest effect on the decision to open a new field. Lower costs to drill are offset by higher cost of capital and lower forecast prices. Eventually reduced capital expenditures (capex) — described in yesterday’s post — will force prices up. We don’t know the cost to produce the marginal barrel of oil from exploration and production (i.e., not development drilling); indeed it changes over time. Sources I rely upon put it at very roughly $80 today. That’s an all in cost: capital (up-front cost), operating, overhead (to run the company), and the minimum required profit (no charities drill for oil).

None of this tells us about the short-term path of oil prices, which depend on decisions by thousands of organizations about production and storage — and unknowable geopolitical and economic factors.

None of this affects the geological reality that we tap ever-lower quality fields. Today’s fracked horizontal wells are more expensive than the vertical wells of a previous generation. Alberta’s oil sands and Venezuela heavy oil are more expensive than oil from the once-great West Texas fields. Pumping from the Saudi desert costs less than in the arctic. Deep offshore wells cost more than in shallow water.  We’re not running out of oil; it’s just getting more expensive.

Our grandchildren will see these gyrations as blips on the steady upward march of oil prices (until the eventual development of new energy sources render oil obsolete). What we do now can prepare for that future. We need to prepare for oil price bubbles (e.g., $140 in 2008), minimizing the harm they do by reducing our dependence on oil and maintaining an adequate strategic reserve.

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We need to exploit these oil price busts. First, we can cheaply fill the Strategic Oil Reserve from its current 696 million barrels to its maximum of 727 million — or even increase it. Second, low prices allow us to raise taxes on energy without economic penalty. Third, government action can minimize the boom-bust cycle of energy capex (which leads to more wild swings on the upside) by providing a stable flow of credit during busts.  The prescription of Walter Bagehot (1821-77) works for banks, and will work for the equally important energy industry:  provide “very large loans at very high rates” on good collateral.

Update: The Economist gives similar but broader recommendations in “Seize the Day“.

(6)  When should we prepare for peak oil?

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It’s inevitable, although we lack the data to reliably forecast the date. President Kennedy told us when to start preparing in his speech at U California at Berkeley on 23 March 1962:

“Knowledge is the great sun of the firmament,” said Senator Daniel Webster. “Life and power are scattered with all its beams.”

In its light, we must think and act not only for the moment but for our time. I am reminded of the story of the great French Marshal Lyautey, who once asked his gardener to plant a tree. The gardener objected that the tree was slow-growing and would not reach maturity for a hundred years. The Marshal replied, “In that case, there is no time to lose, plant it this afternoon.”

Today a world of knowledge — a world of cooperation – a just and lasting peace — may be years away. But we have no time to lose. Let us plant our trees this afternoon.

Energy r&d should be increased massively. I do not see anything with larger potential payoffs, in both economic and environmental terms.

(7)  For More Information.

See the most recent EIA report on world oil production. It’s quite stable; no evidence that production caused prices to crash. Another important report is the World Bank’s January 2015 report “Understanding the Plunge in Oil Prices:Sources and Implications“.

All posts about oil:

1. Peak Oil and Energy – posts on the FM site – Articles discussing all these issues in detail.
2. Peak oil and energy – Studies and reports, with links to authoritative outside sources.

Myths about energy:

1. An urban legend to comfort America: our massive reserves of unconventional oil, 29 August 2008.
2. An urban legend to comfort America: crash programs will solve Peak Oil, 5 September 2008.
3. An urban legend to comfort America: demand for oil creates new supply, 8 September 2008.
4. An urban legend to comfort America: oil is oil, even if it is not oil, 10 September 2008.
5. An urban legend to comfort America: alternative energy will save us, 16 September 2008.
6. Could a new “Manhattan Project” produce radically new energy sources?, 29 June 2010.
7. Coal-to-liquids as a case study of how excessive optimism is our enemy, 14 February 2011.
8. Eventually we’ll have unlimited cheap clean energy. But that will not help us or our kids., 15 February 2011.

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