# Peak Oil, from Stefan Jovanovich

February 26, 2007 |

Here is a link to Vaclav Smil's recent piece on Peak Oil.

## Ken Smith writes:

In fact, when the price at the pump hit \$3.00 a gallon last summer, it was America's number one gripe.

Filled tank yesterday, price of gas was just short of \$3 a gallon for premium. Bought 12 oz of coffee at Starbucks for \$1.80 plus tax, just short of \$2. There is no shortage of coffee beans. Shortage or supply has nothing to do with price of coffee. Demand for coffee in relation to price is economically irrational since a cup of coffee is mostly water.

What is the cost of water per cup? A cup of coffee and a gallon of gas, what the hell are people bitching about when they buy gas? They should be bitching that coffee cost so much. Gasoline is a bargain. Coffee is expensive.

## Kevin Bryant writes:

The professor (Vaclav Smil) may be an expert in many things oil related but I'm not sure he understands the definition of peak oil, at least as Hubbert expressed it. Hubbert himself is sometimes blamed for the confusion until he clarified his methodology in 1982.

Hubbert's theory
proceeds from a graphic representation of yearly production divided by cumulative production (an expression of production rate) on a y-axis and cumulative production on the x-axis. On this graph, "peak oil" is that point at which half of total reserves have been produced. Estimates of total reserves are of course up for debate; however, Hubbert's graph can be used quite neatly to extrapolate this value.

After the early production years, data points on the graph form an uncannily straight line. The theory or the main point of the graph is not to predict annual production or even when annual production will decline, rather, it highlights that the ability to find oil is principally determined by the fraction of oil yet to be discovered. One of the best analogies I've come across is the one about fishing in a pond: the more fish you catch, the harder it becomes to catch the next fish. Unfortunately oil has no offspring making the comparison less dramatic than it could be.

Corollaries from Hubbert's main theory then suggest that once peak is reached, production begins to fall precipitously and/or the marginal cost of production increases geometrically. Actual production experience for single wells seems to corroborate the significance of the halfway point. There may be a lot of oil left in the ground but getting it out in ever increasing amounts becomes an increasingly vexing and costly challenge - the Canterell reserves and the tar sands of Canada are prominent examples of these dynamics in action.

For a more detailed discussion of "Hubbert's Peak," Ken Deffeyes (dismissively referred to in the professor's article), also a geologist, has written two books on the subject: Hubbert's Peak: the impending world oil shortage and beyond oil, and The View From Hubbert's Peak.

Hubbert will, of course, ultimately be right; there is only a finite amount of petroleum and other usable hydrocarbons in the earth's crust. What Vaclav Smil ("the professor") and others in the oil & gas business have been trying to point out is that most of the planet has not had anything close to the intensive exploration that the United States' lower 48 had gone through when Hubbert first shared his magic curve with the world. They also find Hubbert's "discovery" of a perfect bell curve evidence of how little he understood the "erl" business.

Global Reserve estimates are like CBO projections of future deficits - very big numbers that have only political meaning. "Proven reserves" - the amount of oil and gas that a company knows is there under the ground because they have verified that it - never go out more than 2 decades of current production. The reason is very simple: "proving" that the stuff is there (as opposed to simply pumping it out of the ground) is the major variable cost. This is why the pond analogy is all wet (rim shot, please!). The size of the pond is a function of the amount of capital and ingenuity people are willing to put into the discovery of new reserves, and the present value of any discoveries they make.

Hubbert's Peak as a theory is analogous to a professor from the business school measuring Wal-Mart's inventory against its revenue history sales and "discovering" (sic) that the Walton brothers were running out of peanut brittle. The Walton brothers were (and measured against historic sales) always will be running out of peanut brittle. Hubbert's "methodology" is an accounting truism about any business that has an inventory; it's called the inventory to sales ratio.

I once asked Buster Turner about Hubbert. Buster had an advanced degree in petroleum geology from the University of Oklahoma, and his best fishing buddy was the State geologist who was a full professor at I.U. He was not a man who scorned academic learning. Quite the contrary. But he thought Hubbert was a perfect example of academic arrogance, what he called "the damned professoriate." Hubbert, he said, didn't even understand how much the tax code had favored finding and pumping oil and gas out of the ground in the domestic United States instead of exploiting overseas reserves. As Buster put it, "Congress had been sending everyone in the oil & gas business a telegram for 50 years that said 'Drain America First."' And so they did.

You put your finger on the key issue it seems to me, moving from the theoretical to the practical. Enlarging the pond requires capital. Investing capital requires appropriate risk/return. There's a reason there haven't been any super giant oil fields discovered in the last thirty years. All the low hanging fruit has been picked. Further discoveries will require significantly more investment relative to output.

Again, Canterell and the tar sands are evidence, in my opinion, that further discoveries will be found only after significant time (I understand several years will be required to bring the "new" Canterell discovery to production if further tests bear out its potential) and expense. Otherwise, neither project would be as seriously pursued given their less than ideal economics.

Whether or not oil depletion is decades away or centuries away, the costs of exploration and production are likely to increase dramatically, which points to higher oil prices over the next decade.