Crude awakening?

10/24/2014 complex systems , depletion , economic growth , energy , Finance , limits , oil , risks , systemic instabilities 0 Comments

There seems to be a lot of confusion regarding the recent behavior of the world oil market. After five years of relatively stable oil prices, a barrel of WTI crude has dropped from around 110 to 81 dollar (see chart below). I have been following a discussion in the opinion-pages of Svenska Dagbladet clearly displaying this confusion. The discussion started with an article from Kjell Aleklett, a physics professor in global energy systems at Uppsala University, arguing that falling oil prices may signal the start of a global economic downturn. After which Magnus Grill, a political representative of the Peoples Liberal Party (Fp) and energy businessman, replied by arguing that Aleklett did not understand economic theory and that we instead more likely will see an economic upswing in the close future. So how come these two prominent people get to totally different conclusions? While this is a very complicated subject, fraught with international politics, there are some key points I would like to make from the natural resource dynamics and economics perspective.

First of, Grill makes a fundamental mistake when he writes that the concept of peak oil is about running out of oil resources. Peak oil simply refers to the peak in production of oil, as opposed to demand which is generally assumed to increase. The concept is mainly useful for understanding that there are geological conditions/limits to oil extraction which makes oil increasingly expensive and harder to extract, leading to higher capital expenditures (i.e. diminishing economic returns). Peak conventional oil is according to many system scientists not some fuzzy academic concern but a reality, for the US in 1970 and for the world since about 2005-2008 (e.g. Hall, 2010; Turner 2014). Even the conservative IEA has warned about peak oil. The issue is not really about how much oil there is in the world, since there are surely untapped reservoirs, but rather how much effort we can afford spending trying to get to those oil resources. The harder we have to work for getting more oil (e.g. tar sands, fracking, and deepwater drilling) the less net energy we produce for society. In the 1970s every one barrel of conventional oil in form of energy input yielded about 30 barrels of energy in output (i.e. 30:1). Today that relationship is somewhere around 18:1 (Hall, Lambert and Balogh, 2014). Since oil is still the largest source for global energy use (~33%) this has significant implications for the overall economy. 

Whether or not you buy in to the fact that non-renewable resources are finite and has a depletion function, or maximum yield curve, there are simple economic factors connected to oil which impacts growth. We also have to think about that oil is subject to supply and demand. So while Saudiarabia may have released some reserves, as they are the price setters, there are other more long-term trends influencing the market. Conventional oil production has been stagnating while the production of unconventional oil, especially shale oil in the US, has compensated for the decline and allowed for a small production increase. However, at the same time, many of the major economies are in recession and reducing their energy demand. For example, Italy has lost 25% of its oil consumption over the last five years (Bardi, 2014). And many other economies are in trouble, now even perhaps Germany. So if there is a increase in supply while demand is falling the market may eventually determine that oil prices should go down. Here, the role of financial operators perceptions play an important role. How low prices will go depends on several factors, but short-term the markets confidence in oil can influence large swings, such as the drastic drop witnessed in 2008-2009. And Saudi oil policy also matters. In the long term, however, oil prices are likely to rise. Secondly, Grill argues that lower oil prices is a good thing that could lead to economic upswing. That depends, if you are an importer or exporter. Sweden is dependent on oil imports, mainly for transportation. So for us it is perhaps beneficial but may also deter our society to shift from oil to other liquid fuels. But, lower oil prices hurts economies dependent on oil exports and non-conventional oil drillers dependent on a high oil price (around 75-90/barrel) to break even (Forbes). If oil prices stay low for any longer period industry will probably produce less oil. Thus, lower oil prices in a resource constrained world does not necessarily imply increases in global growth. 

This is in essence what peak oil means. Peaking does not mean running out of oil but rather that producing more oil becomes much harder/expensive than before. It is therefore possible that oil will cost less in the future, but that we won't have the money to pay for it. So the real question is, up to when are we able to afford further production? And the crucial point is that when a society's economy is based upon non-renewable energy resources there are limits to growth. It is just how nature works, the laws of thermodynamics, and there is no point in trying to argue with nature. There is however a point in arguing with Magnus Grill since he doesn't seem to understand the complex relationships between ecological and social factors influencing resource extraction and energy availability.