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Still Another Update on Oil

Professor Ferdinand E. Banks
ferdinand.banks@telia.com
March 24th, 2015

According to Professor Vaclav Smil, (2002) "Most discussions of the earth's energy resources and their use by modern societies betray a widespread lack of scientific literacy, and abound in misinformation, biases, and proffers of dubious solutions driven by various special-interest agendas."

I agree, but at the same time I think that this magnificently perceptive observation is blemished by that scholar later referring to oil pessimists as "Cassandras", and then heavily endorsing such things as an evaluation of global oil reserves by the United States Geological Survey (USGS), which estimated that undiscovered conventional oil reserves were plentiful, and 20 percent or higher than that agency's previous assessment, which for me immediately leads to the question of how those ladies and gentlemen arrived at the estimate of 20%.

If you want or need to investigate that and similar issues, then you might be interested to know that my new book ENERGY AND ECONOMIC THEORY (2015) is now available, but everybody - to include myself - should examine and try to keep in mind a few numbers that I intend to present and examine in my next book. (It can be added that in Greek mythology, Cassandra, the daughter of Priam, actually possessed the gift of prophecy, but it was her fate never to be believed. For some reason, her name has come to mean someone who predicts misfortune.)

Proved global oil reserves amount to approximately 1.5 trillion barrels, remembering that a trillion is a thousand billion. As noted just below, the Middle East has a large share of these, which means that OPEC has more, and perhaps much more. I can also point out that recently Russia expressed a willingness to discuss oil pricing with OPEC, since that country and Saudi Arabia are the largest exporters of oil in the world. In 2014 World Proved Reserves in billions of barrels were as follows.

>200

Saudi Arabia (267.0) Venezuela (211.2)

100-200

Canada (173.6) Iran (151.2) Iraq (143.1) Kuwait (104.0)

50-100

United Arab Emirates (97.8) Russia (60.0)

25-50

Libya (47.1) Nigeria (37.2) Kazakhstan (30.0) United States (26.5) Qatar (25.4)

10-25

China (20.4) Brazil (14.0) Algeria (12.2) Mexico (10.4)

Saudi Arabia and Russia are the largest producers, with perhaps 10.5 million barrels a day (=10.5 mb/d), and where the future is concerned, I believe it likely that Russia will find much more oil and natural gas, especially offshore its northern border, where a large 'strike' was recently made in cooperation with the American firm Exxon Mobil. Incidentally, on average, one tonne (= 1 metric ton =1t) of oil is 7.33 barrels. (I mention this because one often sees tonnes instead of barrels.)

World oil production/consumption as this is being written is about 90 mb/d, and OPEC accounts for roughly a third of global output. The U.S. consumes approximately 18 mb/d of 'liquids' (of which 9.5 mb/d is domestic crude oil , and about 2.5 mb/d ethanol, natural gas liquids, etc), while 6-7 mb/d of these items are imported. (China is now the largest crude importer, with the U.S. in second place).

The U.S. crude oil output is growing now because of the 'shale boom', but predictions can be found that this U.S. growth will cease about 2019, with total crude output about 12 mb/d. U.S. imports at that time are estimated to have declined to about 3-4 mb/d - which may or may not be true - but it has been suggested that they will begin increasing, which I also happen to believe. (And in case you have forgotten, the hydraulic fracturing ("fracking") that has brought about what is called 'the shale oil revolution' features pumping water, chemicals and sand through a horizontal oil or gas well under high pressure to break open channels (fractures) in the reservoir rock. The sand grains hold those channels open, allowing the oil natural gas to flow to and exit via the well bore hole.)

There is also a cheerful reference in Smil's work to the value of unconventional oil that is "locked" in tar sands (or 'oil sands') and oil shale, and it was duly noted that these resources were already being exploited in the U.S. and Canada. 'Heavy oil' was also alluded to, and this is oil that belongs in a very different category from 'conventional oils'. Here it pays to notice that oil reserves consist of oil that can be extracted at a cost that is approximately the same as the oil that is presently being exploited. This is not the case with much of the heavy oil in Venezuela, because a few years ago an oil executive vowed that his firm would find some way to increase output from heavy oil deposits in that country. Kuwait also wants to make an expensive attempt to exploit heavy oil in that country.

Shale oil (and shale gas) have turned out to be a big deal in the U.S., particularly the Bakken, Eagle Ford, and Marcellus shale deposits. The last time I looked the number of oil rigs in the U.S. for all categories of oil were close to 1,550, which was the highest level since record keeping began 26 years ago, but a few months ago there was talk of that number decreasing because of the decline in oil prices. (The expression 'oil rig' may refer to a drilling rig or oil platform, where the former is an apparatus for on-land drilling and extraction, while the latter is for offshore work )

These and other oil rigs in the U.S. are being financed by some of the 165 billion

dollars that were scheduled to go into new oil production and exploration in 2014. It is difficult to ignore however a statement by the CEO of Exxon Mobil, often the most profitable of all the firms in the U.S. (and not just firms that are producing oil and natural gas), that it has not been possible to exploit shale outside the U.S. with the same facility as within (with the possible exception right now of the southernmost district of Argentina), and there are even some shale deposits in the U.S. which have been extremely disappointing. He should know, because that brilliant firm paid 41 billion dollars for shale properties that, in his words, left his firm "in a world of hurt".

"World of hurt," can mean a number of things, but Bob Moriarty - CEO of the brilliant site 321 Energy - suggests one of them. "Shale wells, on the other hand, deplete very rapidly. Once you've spent the money (you invest in them), you have to produce like crazy to pay for production, no matter what the oil price is". He could have added that a lot of the money being invested apparently comes from junk bonds, which carry a special kind of risk, and even some of this high-risk purchased by large financial institutions has gone sour.

Moreover, and somewhat more abstract, a portion of that risk derives from the aforementioned high (but difficult to estimate ex ante) depletion, and the sad fact that in the first year of production, some shale wells might produce more than thirty percent of all the oil that they will ever produce!

Last year (2014), the largest oil producers in the world, in millions of barrels a day (= mb/d), were Saudi Arabia (10-11), Russia (10+), U.S. ( 9-10+), China (4), Canada (3.7), Iran (3.7), United Arab Emirates (3.4), Iraq (3), Kuwait (3), Mexico (2.9), Venezuela (2.7). Clearly, Venezuela's production is not commensurate with its large reserves. Two decades ago Norway and the U.K. might have been on this roster, but output in these countries peaked about the turn of the century, and there is no sign of recovery. It can also be noted that oil production in the U.S. peaked in late 1970, but due to the exploitation of shale oil, there is talk of a new peak. Even so, there is no reason to be over-optimistic, because as noted above, despite the talk of the U.S. becoming a major oil and natural gas exporter, that country still imports these items. The biggest U.S. suppliers are Canada, Mexico, Venezuela and Nigeria. Nigeria though has said that they will not export oil any longer to the U.S.

Many persons who read my new book might already have a modest acquaintance with academic energy economics, and this acquaintance may have convinced them that when considering oil and oil-type markets, and the price of these commodities, the work of Harold Hotelling (1931) should be carefully scrutinized. Hotelling was a brilliant economist, and it is easy to believe - as Professor Hotelling told us to believe - that if it appears that the oil price is going to rise, and we are in possession of oil that could be extracted and sold tomorrow or today, then if there was an expected price rise that was very large, we should wait and sell tomorrow. Thank you, Professor, but merely accepting this does not tell us what we need to comprehend in order to think and talk in a logical and impressive manner about oil and gas, and also other resources (like copper). We need more, and the purpose of my next book will be to provide a part of that 'more' in simple and orthodox terms.

One final remark about the above observation. If the opinion of the present author is that Hotelling's work on resource extraction is 'lightweight', then how did Robert Solow - U.S. Army veteran, outstanding teacher at MIT and Nobel Laureate - become involved with it. The key observation here is that Solow's brilliant article (1974) was not concerned with more than a presentation, simplification and extension of Hotelling's theory of resource extraction at a time when the pedagogical literature was exclusively in an elementary 'Hotellian' mode. The belief that Hotelling's model or any embellishment thereof could interpret or predict supply and price movements in real world energy markets - especially oil markets - made its appearance a few years later, although on at least one occasion the gentlemen attending an OPEC meeting openly cursed the Hotelling model for its failure to support a usable analysis of oil pricing.

Furthermore, it is difficult to understand the popularity of Hotelling's work, or why it received a respect that might be excessive. A respect that prevented an earlier introduction of more sophisticated models, by which I do NOT mean my own work. It is here that alert students should take special note of some valuable advice from physics: the important thing is not to come up with new ideas - there are always plenty of those available - but to get rid of defective notions as rapidly as possible.

Another example might be useful. Serious fighting may still be taking place again in Iraq and perhaps neighboring Syria, production trends have been pronounced as weak or downward in Venezuela and Mexico, the oil sector in Nigeria is ostensibly in trouble from well-organized theft, and bad things are happening in Libya, where a war was once started by the NATO 'president' to ostensibly protect civilians, but was actually aimed at providing increased access for somebody to the oil in that country, and the large confirmed reserves it possesses.

These 'irregularities' ostensibly attached a risk premium to the ('appropriate' or 'relevant' or 'equilibrium' or 'competitive or 'whatever') world oil price, causing - early in 2014 - that price to begin rising at an unexpected rate. A theory continued to prevail however that without this risk premium, and even taking into consideration 'bad vibes' from the direction of the Ukraine, the (average) world price of oil would or should descend to something much lower. Perhaps down to the 'eighties' or lower. That has now happened, mostly because of the increased oil production in North America, and the decision of rich Gulf countries not to reduce output. We are still sometimes told though that oil importing countries should do everything possible to weaken OPEC, and where weakening OPEC is concerned, Iraq - which is sometimes called 'The New Prize' - and shale oil are usually mentioned. I consider this to be a good topic for your or my next lecture, especially if we are lucky enough to have a posse of self-appointed and unfriendly energy experts sitting in the first row.

With all due respect, I consider shale resources a marvelous bounty for the U.S., but even so I don't have an excess of confidence in analyses or predictions about the shale future, nor negative fantasies about The Organization of Oil Exporting Countries (OPEC). It is often claimed now that OPEC can no longer control the oil price, and will soon be on 'life support', but my position is that eventually OPEC should possess more than enough 'juice' to put a 'floor' under the oil price of around $100/b, which in the not too distant past sufficed to provide OPEC with an annual income of approximately a trillion dollars (= $1,000,000,000,000 = 1012 dollars).

The above paragraph should be carefully perused, because it is behind the arguments in my next book that the proposed large scale exporting of oil and natural gas by the U.S. hardly deserves to be labeled 'goofy'.

This might also be the place to quote the often quoted T. Boone Pickens: "OPEC sets the price for oil. Of the 92 Mb produced every day in the world, OPEC is producing a third of it. It is big enough, and it is organized and credible. It is a cartel. 30% of oil can set the price by adjusting their 'spot' sales." Good for you Mister Pickens! This judgment merits the widest possible circulation, and you deserve our thanks, even if it happens that as these lines are being read, the oil price is weak and getting weaker. There is a reason for that unexpected situation, and my hope is and has always been that my work should enable readers to determine that reason for themselves, and to discuss it with confidence and maybe a sophisticated flair in front of their colleagues and others.

REFERENCES

Banks, Ferdinand E. (2015). Energy and Economic Theory. Singapore, London and New York: World Scientific.

______. (2000). Energy Economics: A Modern Introduction. Boston and Dordrecht: Kluwer Academic.

Hotelling, Harold (1931). 'The economics of exhaustible resources'. Journal of Political Economy (April).

Moriarty, Bob (2015).'Low Oil Prices are an Act of Economic Warfare'. The Energy Report (Feb 13, and reproduced in 321 Energy.)

Smil, Vaclav (2002). The Earth's Biosphere: Evolution, Dynamics and Change, Cambridge (Mass): The MIT Press,

Snyder, Michael (2014). 'Anyone That Believes That Collapsing Oil Prices Are Good For The Economy is Crazy'. Talk Markets (December 9).

Solow, Robert M. (1974). 'The economics of resources or the resources of economics'. American Economic Review.



Professor Ferdinand E. Banks
ferdinand.banks@telia.com
March 24th, 2015




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