“Hegel remarks somewhere that all facts and personages of great importance in world history occur, as it were, twice. He forgot to add: the first time as tragedy, the second as farce.”
Karl Marx, The 18th Brumaire of Louis Bonaparte, New World Paperbacks, 1991, p. 15.
Now I know how a hula hoop feels. After more than a decade of neglect, articles about petroleum are suddenly popping up throughout the general and even scientific press, all with the same theme--Oil supplies are more limited than generally believed, and scarcity and rising prices will appear within three years or twenty years (depending on the writer), with Dr. Campbell (1997) being both the most pessimistic and vociferous. The fact that many of the pessimists are geologists and have published in scientific journals lends credibility to their assertions.
A brief history lesson: In 1989, both Campbell and I published predictions about oil prices in the 1990s (Campbell 1989, Lynch 1989). He argued that world oil production had peaked in 1989 and that prices would reach the $50-60/bbl range in the early 1990s. (All figures converted to 1997 dollars) My report argued that most forecasters were being too pessimistic about non-OPEC oil supply, and that prices were most likely to decline to the $13-18/bbl range by 2000. At the time, I was called a heretic (Petroleum Economist 9/89), a badge I have worn proudly. Of course, a weather forecaster who always predicts rain will occasionally be right without understanding meteorology, but at this stage there is more than enough evidence to keep us from being soaked again by bad forecasters.
To be honest, though, bad energy forecasting is redundant. In the early 1980s, there was an enormous consensus that oil prices must inevitably rise and would be in the range of $100/bbl. by 2000. Government organizations, oil companies and environmentalists, consultants and academics, nearly all were completely wrong about what was happening and would happen, primarily because of their reliance on simplistic and incorrect theories and models. (Lynch 1994) The general lesson is that the expert consensus can be very wrong, the specific lessons are that people were incorrectly assuming prices must rise and that non-OPEC supply would peak soon.
Recognizing that oil supply forecasting is dominated by pessimistic bias is key to assessing current forecasts. While early post-1973 forecasts were much too optimistic about the impact of higher oil prices on U.S. oil production, since the late 1970s, nearly all forecasts for all non-OPEC regions have been too low. As one of many possible examples, Figure 1 compares the leading forecasts from the 1989/91 era, including my own and Campbell’s. (The FSU is excluded because of the political collapse of its oil industry.)
Why is it so Hard?
In truth, forecasting oil supply is exceedingly difficult, especially at the national level. Geology, to the extent that it is known, only partly explains production trends. Although some forecasters incorporate technological advance in their models, fiscal regimes, local infrastructure, and many other seemingly unrelated factors can also modify the underlying trends in exploration, discoveries and reserves. The construction of roads into Arauca province in Colombia made exploration there feasible and the Canos Limon discovery represented a major increase in Colombian oil resources. Over the long-term, this is repeated globally in such a way as to constantly move oil fields into the “available” resource category, or lower their costs, which is the same thing.
Assembling a database which covers all of the geological, political, fiscal, economic and infrastructure factors for the fifty or so significant oil producers is a Herculean task, so far unaccomplished. And the data which does exist is often very bad. Dr. Campbell treats as a great revelation the well-known fact that some Middle Eastern countries inflate their reported oil reserves, but those estimates have nothing to do either their total resources or current production. And outside the Middle East, not only is the data better, but production is clearly rising despite the pessimists’ repeated assertions that such is impossible.
And good data can be misleading. In the Third World, drilling has dropped steadily, with the number of drilling rigs operating falling 50% from 1982 to 1996, yet production has increased continuously, rising 78% over the period. Too many factors, some intangible, influence the discovery and production process for any but the biggest and best funded oil supply modeling effort to succeed. Certainly the Hubbert model, where only resources and past production are used to predict future production, is woefully underspecified.
What do we know?
Certainly there is enough evidence of abundance to explode the myth of a geological constraint on oil production. By any geological measure, exploitations levels in the rest of the world are much lower than in the United States in 1970, the year that lower-48 production peaked and began its decline. For example, the average well in the United States produces 11 b/d, while the average well in S. America produces 80 b/d. In the Far East, the amount is 300, the South Pacific 500, Africa 780, and so forth. (All estimates exclude OPEC countries, where well productivity is much higher).
Similarly, the total number of wells drilled historically in the United States as of 1970, the year that production peaked in the lower-48 states, was 33.4 per 100 square kilometers of sedimentary basin. Yet, in the rest of the world, the number is less than one. And at current drilling rates, it will be nearly 400 years before they reach the 1970 U.S. level; even if drilling grows by 5% per year, it will still take 120 years. And in the interim, oil production technology will have advanced even further.
Only by arguing that there is some magical difference between the geology of the U.S. and all other oil-producing regions can one expect that they must peak any time in the next several decades, if then. Essentially, the only evidence of a production peak in the next two decades is a mathematical model which has repeatedly forecast false peaks.
Oil production trends are determined by the level of drilling and investment, the primary indicators of change in production capacity. And the past few years clearly demonstrate that at $18/bbl, investment will be more than enough to ensure rapid growth in non-Middle East oil production. Whether that oil is labeled conventional or unconventional is a philosophical question; the origin of their gasoline matters not to motorists.
The Next Decade
The current glut is no fluke, but a continuation of the historical experience of the oil industry. If anything, now more than ever it is obvious that large amounts of oil will be developed in the next decade, depending primarily on producing government policy and the price of oil.
Large quantities of cheap oil are now available in Iraq, Russia and the Caspian, enough to easily add 5 mb/d by 2010. In every case, the obstacles to development are not geologic but political and/or regulatory, that is to say, transient. In the non-OPEC Third World, there have been no signs that the linear growth of the past four decades is about to cease, so that 5 mb/d is likely to be added from that source alone. Heavy oil from Canada and Venezuela should grow by additional 2 mb/d, and conventional oil from the OECD (excluding Mexico) could add 2 mb/d as well. If the price remains at $12/bbl., then about 4 mb/d is lost (delayed really) from the Caspian, heavy oil and the more expensive OECD production.
Thus, if demand rises by an optimistic 20 mb/d from 2000 to 2010, OPEC excluding Iraq could find that it has only 6 mb/d in new demand. Even with low oil prices, OPEC probably will have only 10-12 mb/d in new demand. While 12 mb/d sounds like an enormous amount of oil, 50% more than current Saudi production, it only represents a 4% per year growth rate. Expressed that way it sounds stingy, particularly considering that OPEC production has grown more rapidly than that since the 1986 price collapse, and the members are heartily dissatisfied with the revenue growth during that period. This does not suggest there will be either significant growth in OPEC power or sustained market tightness in the next decade.
Accuracy or Safety?
Of course, not everyone wants an accurate forecast. A bureaucrat avoids trouble with superiors by being within the consensus, a politician might predict rising revenues to justify spending programs, and bankers prefer to be conservative to protect their assets. Many have argued that it is better to adopt a conservative oil supply forecast to be safe.
But the foolishness of this was demonstrated in the late 1970s, when policymakers (and oil companies) argued that prices were low because markets were too short-sighted to see impending scarcity, necessitating governments’ intervention. Using these arguments, the U.S. subsidized shale oil and the Trudeau government in Canada subsidized exploration in the Arctic, while conserving natural gas that it could have sold to the U.S. for $8/Mcf. (Gas which is now being sold for less than $2/Mcf). Reviving such policies would be expensive farce.
Where do we go from here?
Lynch (1996) demonstrated at length that since the late 1970s, most oil supply forecasts have been too pessimistic and showed the methodological errors behind those errors. Nearly all predicted near-term peaks for all non-Middle Eastern oil producers, and they continually revised their work by increasing the peak and moving it a few years into the future. Dr. Campbell’s work follows this pattern precisely and there has yet been no reason to believe his current forecast is any more accurate than his earlier ones. Companies that invest expecting oil prices to soar in the next few years will not be rewarded any better than the ones which did two decades ago.
Other predictions of peaking oil production in the distant future (twenty years or more) are also likely to prove invalid, but they certainly are not relevant for any practical purpose. Although markets are often accused of not foreseeing the long-term future, the truth is that no commodity has ever suddenly experienced long-term scarcity and sharply-rising prices. The more realistic threat is that weak oil prices will destabilize one or more oil producing governments and cause severe short-term price spikes. And by focusing on the chimera of scarcity, governments could well be unprepared to respond to this very real danger.
Sources:
Campbell, C. J., The Coming Oil Crisis, Multiscience Publishers, 1997.
Campbell, C. J., The golden century of oil 1950-2050: the depletion of a resource, Kluwer Academic Publishers, 1991.
Campbell, C. J., “Oil price leap in the early nineties,” Noroil, December 1989.
Lynch, Michael C., "The Analysis and Forecasting of Petroleum Supply: Sources of Error and Bias," in Energy Watchers VII, ed. by Dorothea H. El Mallakh, International Research Center for Energy and Economic Development, 1996.
Lynch, Michael C., "Bias and Theoretical Error in Long-Term Oil Market Forecasting," in Advances in the Economics of Energy and Natural Resources, John R. Moroney, ed., JAI Press, 1994.
Lynch, Michael, Oil Prices to 2000, Economist Intelligence Unit, May 1989.
