Crash Course Chapter 20: Peak Cheap Oil
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OK – we’re up to the chapter on Peak Cheap Oil and this one is a doozy.
This is one of the most important chapters, this is a big subject, and I wish to acknowledge that much of this chapter stands on the shoulders of the hundreds of dedicated people who have gathered the data, made the points, and tirelessly worked to advance our understanding of the role of energy in our lives.
I tip my hat to these sources and many others.
Energy is the lifeblood of any economy. But when an economy is based on an exponential debt-based money system and that is based on exponentially increasing energy supplies, the supply of that energy therefore deserves our very highest attention.
But we need to be careful here because it’s a mistake to lump all types of energy together because they have very different uses in our economy and they are not interchangeable.
What we’re going to examine in this chapter on Peak Cheap Oil is transportation fuels. The liquids we put in our trucks and cars and airplanes. Why?
Because 95% of everything that moves from point A to point B across the globe does so based on petroleum derived liquid fuels. This makes petroleum quite special and unique.
Said another way, currently natural gas and coal cannot be substituted for oil. It’s not reasonable to lump them all together. In fact, it would be risky to do so, as it would lead us to make some very bad decisions about our future.
In order to understand what “Peak Cheap Oil’ means, we need to share a common understanding about how oil fields work and how oil is extracted.
A common misperception is that an oil rig is plunked down over an oil field, a pipe is inserted and then oil gushes from a big, underground lake or cavern that eventually gets sucked dry.
It turns out that it is pretty much just solid rock down there and oil is only found in porous rocks, like sandstone, that permit the oil to flow through the rocks crevices and pores.
No vast caverns or lakes of oil exist down there. Oil has to be carefully extracted from what turns out to be a very solid rock matrix.
It’s better to think of a conventional oil field like a margarita where the oil is the tequila mix and the rock is the crushed ice.
When an oil field is tapped we find that the amount of oil that comes out if it follows a very prescribed pattern over time that ends up resembling a bell curve.
At first, shortly after the drink is discovered, there’s just one straw in our margarita but then with excitement more and more straws are stuck in and more and more drink rather easily flows out of the glass.
But then that dreaded slurping sound begins and now, no matter how many new straws are inserted and no matter how hard they are sucked upon, the amount of margarita coming out of the glass declines until it is all gone and we are only left with ice.
That’s pretty much exactly how an oil field works.
Every oil field exploited to date has exhibited this same basic extraction profile. And what is true for one is equally true when we measure across many oil fields and then sum the result.
Because individual fields peak, so to do collections of fields. Peak Oil, then, is NOT an abstract theory so much as it is a physical description of an extremely well characterized physical phenomenon.
How much oil remains to be discovered is a theory, but the process by while oil fields depleted is rather well-understood. Peak Oil is simply a fact.
Also, Peak Oil, is NOT synonymous with “running out of oil”. At the moment of the peak roughly half the oil that was there in the first place still remains.
But something interesting happens at the half-way mark. Where oil gushed out under pressure at first, the back half usually has to get laboriously pumped out of the ground at higher cost, obviously.
Where every barrel of oil was cheaper to extract on the way up, the reverse is true on the way down. Each barrel becomes more costly in terms of time, money and energy to extract. Eventually, it costs more to extract a barrel of oil than it is worth and that’s when an oil field is abandoned.
Here’s our experience with oil in United States. From the first well drilled in 1859 until 1970 more and more oil was progressively pumped from the ground.
But after that point less and less came out of the ground. It is said, then, that the US hit a peak of oil production in 1970 at just under 10 million barrels a day and today produces less than that. Those are the facts.
Counting ONLY crude oil consumption here, the remaining balance of the United States’ 15 million barrel a day crude oil habit is met by imports. That is, the US imports close to half of its daily needs.
Although the amount of oil the US imports is falling due to the combined effects of producing more and consuming less, the temporary boost from shale oil should be seen as exactly that; a relative flash in the pan. We'll cover that in more detail in the next chapter
Now in order to produce oil, you have to first find it, right? It’s pretty hard to pump something you haven’t found. US oil discoveries peaked in 1930, which yields a gap between a peak in discovery and a peak in production of 40 years. Remember that number.
Here’s an interesting aside. Suppose we wanted to become “independent from imported oil” and decided to replace those 7 million imported barrels with some other form of energy.
Ignoring for the moment that you cannot substitute electricity for liquid fuels, Those 7 million barrels represent the same power equivalent as more than 500 additional nuclear power plants.
Considering the concerns we have with the 104 we have operating right now, I think it’s safe to say nuclear power is not a realistic candidate for reducing oil imports.
Well then how much would we have to increase our solar wind and biomass energy production to equal 7 million barrels a day?
There we’d have to increase our currently installed base by a factor of 1,400. Not 1400%. 1,400 times as much.
When we look at worldwide oil discoveries we find that those increased in every decade up to the 1960’s and then have decreased in every decade since then with future projections looking even more grim.
The exact peak of discovery? That was in 1964, 44 years ago, and that is another cold, hard, indisputable fact.
Remember, in order to produce oil you have to find it first.
And here is the third, and final fact about production I want to present. This is a chart of global crude oil production only – it leaves out biofuels and natural gas liquids.
Why? Well, they only amount to roughly 10 million barrels a day collectively, and they’re not used nearly with the ubiquity oil is in global transportation.
Conventional crude is the easy, high-energy yield stuff and it is what the world’s past 100 years of growth has been built upon.
We can see here that since mid-2004, for some reason, oil production has been flat. Whatever the reason for this is, it isn’t price because oil has climbed from $50 a barrel to around $100 a barrel in 2012 and 2013.
And it isn’t because oil companies have been skimping on investments in oil exploration and production – those budgets have more than doubled from $300 billion in 2005 to $700 billion in 2013.
If ever there was a strong incentive to get oil out of the ground and off to market, $100 a barrel is it; and spending $700 billion is ample sign of dedication to that cause.
And yet, despite all that, global production remains nearly unchanged. In just a few short years, it’s now costing us double to extract roughly the same amount of oil out of the ground.
What’s clearly at work here is that we’re finding more oil, but it’s expensive. Even vastly increased oil budgets have only managed to battle the declines in conventional oil to a standstill.
Interestingly, the global peak in discoveries was exactly 40 years prior to the leveling off of this production graph possibly echoing the US gap between the discovery and production peaks.
I’m soft-pedaling this to an enormous degree. Let me be blunt. If we are already at peak, as these data suggest is possible, then we are in trouble.
However, the most urgent issue before us does not lie with identifying the precise moment of peak oil.
That is, truthfully, an academic distraction because the economic dislocations will begin as soon as there’s a gap between supply and demand that is solved by higher prices.
Here’s a very simple and clever way to think about the supply and demand problem that was developed by Dallas geologist Jeffrey Brown which he calls the export land model.
Suppose that we have a hypothetical country that produces 2 million barrels of crude a day but which is declining at 5% a year.
We’d note that, at first, they’d be able to export 2 million barrels; but after ten years that would decline to one and a quarter million barrels a day. This seems manageable. But now, suppose that this country uses oil itself, as all countries do.
Taking that into account, we see that our hypothetical country consumes 1 million barrels a day, with this internal demand increasing by 2.5% a year. This is also reasonable.
So, what happens to future exports under this model? They go to zero in just ten years. This is the miracle of compounding but in reverse where exports are eaten into from both ends.
It turns out that this is a very realistic scenario because we can already observe that production is declining even as demand is increasing in a number of countries.
When world production will hit its exact peak is a matter of some dispute with estimates ranging from right now to some 30 years away. But as I said before, the precise moment of the peak is really just an academic concern.
What we need to be most concerned with is the day that world demand outstrips available supply. It is at that moment that the oil markets will change forever and probably quite suddenly.
First we’ll see massive price hikes, that’s a given. But do you remember the food ‘shortages’ that seemingly erupted overnight back in February of 2008?
Those were triggered by the perception of demand exceeding supply, which led to an immediate export ban on food shipments by many countries.
This same dynamic of national hoarding will certainly be a feature of the global oil market once the perception of shortage takes hold. When that happens, our concerns about price will be trumped by our fears of shortages
In order to understand why oil is so important to our economy and our daily lives, we have to understand something about what it does for us.
We value any source of energy because we can harness it to do work for us. For example, every time you turn on a 100-watt light bulb, it is the same as if you had a fit human being in the basement pedaling as hard as they could to keep that bulb lit.
That is how much energy a single 100-watt light bulb uses. In the background while you run water, take hot showers, and vacuum the floor, it is as if your house is employing the services of at least 50 such extremely fit bike riders.
This “energy slave count” if you will, exceeds that of some kings in times past. It can therefore truly be said that we are all living like kings. Although we may not appreciate that because it all seems so ordinary that we take it for granted.
And how much ‘work’ is embodied in a gallon of gasoline, our most favorite substance of them all? Well, if you put a single gallon in a car, drove it until it ran out, and then turned around and pushed the car home you’d find out.
It turns out that a gallon of gas has the equivalent energy of 500 hours of hard human labor, or 12-and-a-half 40 hour work weeks.
So how much is a gallon of gas worth? $4 $10? Is you wanted to pay this poor man $15 and hour to push your car home then we might value a gallon of gas at $7,500.
Here’s another example. It has been calculated that the amount of food that average North America citizen consumes in year requires the equivalent of 400 gallons of petroleum to produce and ship.
At $4/gallon that works out to $1600 of your yearly food bill is spent on fuel, which doesn’t sound too extreme.
However, when we consider that those 400 gallons represent the energy equivalent of 100 humans working year round at 40 hours a week, then it takes on an entirely different meaning.
This puts your diet well out of the reach of most kings of times past. Just to put this in context, as it is currently configured, food production and distribution uses fully 2/3rds of our domestic oil production. This is one reason why a cessation of imports would be, shall we say, disruptive.
Besides the way that oil works tirelessly in the background to make our lives easy beyond historical measure, oil is a miracle in other ways. In this picture , a typical American family was asked to cart out onto their front lawn everything in their house that was derived from oil. That’s quite a sight.
How easily could we replace the role of oil in our style of consumer-led, growth-based economy? Not very.
We currently use oil mainly for transportation, sitting at right around 70% of all oil consumption. The next biggest block is for industrial purposes followed by residential which means heating oil.
This last, tiny little sliver? That’s oil used to generate electricity. With the exception of Biofuels, which I’ll get to later, all renewable energy resources either provide heat or electricity meaning that even if we entirely replaced ALL of the electricity and heat currently provided by oil with renewables, we’d only be addressing these tiny slices here.
And in the industrial processes, oil is the primary input feedstock to innumerable necessities of life such as fertilizer, plastics, paint, synthetic fibers, innumerable chemical processes, and flying around. When we consider other potential fuel sources we find that they are mostly incapable of fulfilling these needs.
Biofuels and coal could potentially fill some of these functions but certainly not without a massive reinvestment program and not anytime soon.
Let’s review a few key facts. You have to find oil before you can produce it and key fact #1 is that world oil discoveries peaked in 1964.
US discoveries peaked in 1930 and 40 years later production peaked. We are now 44 years after the global discovery peak.
Key fact #2 is that world production of conventional crude has been flat for the past 8 years even as prices have increased by more than 100%.
Taken together, key facts #1 and #2 suggest the possibility that Peak Oil is already upon us.
If true, then we are going to wish with all our hearts that we had begun preparing for this moment a decade or more ago.
Key fact #3 is that the US oil imports are the energy equivalent of more than 500 nuclear power plants which is five times as many nuclear plants as currently exist in America and nearly twice the total number of nuclear plants in the entire world.
The next key concept of the Crash Course is that Peak Cheap Oil is a well defined process that is nothing more than a physical description of how oil fields age.
We have literally thousands of studied examples under our belts and given the preponderance of evidence, the debate on Peak Oil is over. It is a mathematical inevitability at current consumption levels. Only when the peak will arrive is up for discussion.
Mostly hidden from us in plain sight is Key Concept #10: The amount of work that oil performs in service to the average person is equivalent to having hundreds of slaves.
It is this work that makes our lives what they are; staggeringly comfortable by historical standards. The average middles class life in western society would be the envy of kings in times past.
The next key concept of the crash course is that oil is a magical substance of finite supply but of unlimited importance. This cannot be overstated.
Transitioning from one fuel source to another is a devilishly expensive proposition posing enormous challenges with respect to cost, scale and time.
Our species transitioned over many decades from wood to coal because coal was a better fuel source.
And we transitioned over several decades from coal to oil for the same reason. In both cases this happened because the new fuel source was plentiful, cheap, and higher-yielding in terms of energy output per unit of weight compared to the older fuel.
Nobody has been able to advance any candidates as our next source of transportation energy that is better than oil on all three counts.
A common pushback to this point is a firm belief many people hold that new technological breakthroughs will ride to our rescue here.
I’ll explain in a future chapter why this is very likely to prove a false hope.
All I’ll do here is remind you that technology is not a source of energy – it may well help us to better exploit our existing energy sources by extracting them more easily, or consuming them more efficiently – but technology can’t create energy for us.
The Second Law of Thermodynamics prevents that. So, it is a big mistake to confuse technology with energy sources.
And finally, what we really need to keep a careful eye out for is the supply of oil being exceeded by demand and this raises the next Key Concept: Oil exports are being hit two ways; by rising demand and declining production.
This raises the prospect that the moment when the world’s nations finally realize that there is not enough oil to supply everybody may come much sooner than most suspect.
Exponential functions are hard for most humans to grasp and oil exports are being doubly-squeezed, subjecting them to a surprisingly high rate of decline.
This completes an immensely brief tour through peak cheap oil. If you have not already done so, you owe it to yourself to become knowledgeable on this subject due to its unequalled importance.
We have links aplenty on the essential books, papers, articles, websites and other resources on PeakProsperity.com.
In the next section we will address the current quote-unquote revolution occurring in shale oil and gas. I’ll explain why its impact is likely to be short-lived, and why it really won’t offer much help in addressing our energy predicament.
Please join me for the next chapter addressing the false promise of Shale Oil.
Thank you for your attention.