Peak Oil is You

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Page added on January 25, 2012

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No oil for old countries

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I THINK my colleague is right to take some encouragement from the latest Energy Information Agency outlook. As one would expect to occur amid a period of sustained, high oil prices, American oil consumption has fallen from 2005 while its production has risen. That, in turn, has led to a decline in the quantity of oil imports (though not necessarily or consistently in the value of imports, given the volatility in oil prices). A better balance between oil production and consumption is likely to be an important part of the process of adjusting America’s total current account balance. And given the havoc dear oil has wrought on the American economy in recent years, a better production balance is economically useful. Less consumption will mean less of a blow to demand when prices soar, and greater production will mean an American windfall that could conceivably help offset any decline in household spending.

It’s difficult to get too excited about the figures, however, for a couple of reasons. The EIA does not project sustained drops in consumption of the sort seen since 2005; indeed, consumption in 2035 is expected to be more or less where it was in the early 2000s, when prices were quite a bit lower. And while I suppose it’s nice that CO2 emissions are expected to grow at a slower pace between 2010 and 2035 than they did between 1990 and 2005, a forecast of essentially no improvement in American emissions over the period is nonetheless quite depressing. The EIA can’t do much more than extrapolate from recent trends, of course; they’re sadly unable to project the development of remarkable new technologies in 2017. What this shows, however, is that present trends in growth or demographics won’t bail us out of our oil dependency or climate problems; it will take technology and policy to accomplish that.

I think it’s worth adding a bit more to the discussion based on a new NBER working paper by James Hamilton, who does great work on the relationship between oil prices, production, and economic growth. Mr Hamilton notes that, all else equal, better technology and higher real oil prices lead to higher levels of oil production, as we’d expect. Over the whole of the past century, however, production in individual fields has tended to follow a simple trajectory, despite rising prices and better technology: oil output rises, peaks, and then drops. And both within America and globally, long-run improvements in oil output are primarily due to the development of new fields, rather than more intense extraction from oil fields. In the American context, for example, production generally rose for much of the 20th century even as production from individual states often peaked and fell, because America was able to develop progressively more of its continental expanse—from the East Coast, to the Midwest, to the Plains, the West Coast, Alaska and the Gulf.

You can see the net trajectory in the chart above. Eventually, you run out of new land to develop. The last little uptick at the far right represents new production from the Gulf (itself a product of marvelous technological advances that allow wells to be driven miles beneath the sea floor) and from the northern Plains, especially North Dakota. That’s a nice addition to supply, but it leaves America well short of its previous peak. Those fields, too, will eventually be exhausted. Globally, new discoveries are being made all the time. Over the past half decade, however, new production has not offset declining output at older fields. Meanwhile, global demand has soared.

Mr Hamilton writes:

However, my reading of the historical evidence is as follows. (1) For much of the history of the industry, oil has been priced essentially as if it were an inexhaustible resource. (2) Although technological progress and enhanced recovery techniques can temporarily boost production flows from mature fields, it is not reasonable to view these factors as the primary determinants of annual production rates from a given field. (3) The historical source of increasing global oil production is exploitation of new geographical areas, a process whose promise at the global level is obviously limited. The combined implication of these three observations is that, at some point there will need to be a shift in how the price of oil is determined, with considerations of resource exhaustion playing a bigger role than they have historically.

Mr Hamilton goes on to recapitulate arguments he’s made elsewhere, on the impact of oil shocks on growth. Recent American experience is not particularly encouraging. Rising American energy output is a useful macroeconomic development. But it might well be a good idea to reduce American oil consumption and raise net oil exports through via an increase in America’s petrol tax. That’s never a popular notion, but oil-induced recessions aren’t much fun either.

The Economist

One Comment on "No oil for old countries"

  1. BillT on Wed, 25th Jan 2012 3:21 pm 

    “…Raise net oil EXPORTS…”? We use about 17 million barrels per day. We produce 6-7 million barrels per day at best. Tell me how we can increase exports by decreasing domestic use through taxes/price? We would have to decrease our use by 66+% to just break even.

    And this from an ‘economist’? BS! Proves why we are in the trouble we are in if this is how they think.

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