Peak Oil and the opportunity costs of compensated reduction

[Bioman]

Hi, I'm new to Peak Oil and I have a question about oil price projections and scenarios.

Allow me to sketch the context in which I would use these projections (it's for a report).

Large investments are being made in the bioenergy sector in the developing world. For example Indonesia has set-aside 5 million hectares of land, and the EU is looking into 86 million hectares in Africa and Brazil for the production of biomass feedstocks. The feedstocks would be used for the production of pyrolysis oil and/or solid biofuels (which will then be shipped to Europe). China and India are also investing massively in Africa, South East Asia and Latin America.

With this in mind, a coalition of 13 developing countries has asked the UNFCCC to include a mechanism to protect forests. The idea is called 'compensated reduction' or 'avoided deforestation'. The scheme is easy to understand: developing countries would be paid by the West to conserve their forests (which store vast amounts of CO2). The compensation would consist of 'carbon credits' which can be traded on the carbon market (such as the European carbon exchange).

The World Bank recently wrote a large report about the viability of the scheme and agreed that it would make technical and economic sense to implement it, even though a lot of uncertainties remain.

However, recently, both Brazil and Indonesia have sharpened their stance and said that the scheme - as it is being defended by international organisations - does not take into account the 'real opportunity costs' of avoided deforestation.

Obviously, these two countries want to squeeze more money out of the system. Just putting a price tag on a hectare of forest, based on how much CO2 it stores, is not nearly enough, given 'peak oil' and the potential for bioenergy production - that's what they're saying.

Now this is where I need your help. As some of you may know, the price of carbon mildly correlates to the price of fossil fuels, but not nearly as strongly as biofuels do. In other words, when oil prices are high, a hectare of forest would bring in much more money if converted into biomass plantations than if it were to be valued merely as a carbon sink (carbon prices are at a historic low and have never crossed the €35/MT line).

Moreover, Brazil and Indonesia say agriculture is a 'dynamic' and technology-driven sector that allows for efficiency increases and innovation, over time. If a forest is kept as a carbon sink, it just stands there, and nobody can increase its efficiency as a carbon sequestration machine. In that sense, a forest is 'static' and not up for the creation of more value. Brazil always gives the example of its own ethanol producers to prove its point: through biotech, agronomical and technological innovation they cut cost by up to 75% and increased the efficiency of their production process by up to 100% in 25 years time. Avoided deforestation projects have similar time-horizons, but can not enjoy the same efficiency evolution.

This critique by Brazil and Indonesia is only beginning to permeate the debate about avoided deforestation/compensated reduction. Peak oil is becoming a critical factor here, because obviously, the 'real' opportunity costs of avoided deforestation are biofuels that can be produced at US$ 35 per barrel of oil equivalent or at €60/MT of coal equivalent.

So does anyone know where I can find realistic medium to longterm price projections for oil, preferrably written by Peak Oil advocates? We want to calculate the opportunity costs using these numbers. We have run several simulations using other, more official price projections, and they show interesting results. But I'm sure the scenarios would look quite different were they based on PeakOil data. I understand there are several Peak Oil authors, but whose medium to longterm price projections are most pessimistic?

Thanks for your help.

[pup55]

realistic medium to longterm price

Welcome Bioman.

If you would care to be more specific about what you mean by "medium" and "long term" we might be able to take a stab at it.

a hectare of forest would bring in much more money if converted into biomass plantations than if it were to be valued merely as a carbon sink

This is an interesting problem. It is made even more interesting by trying to figure out who owns the land and will therefore be compensated. I don't remember what the actual stats are, but some big percentage of the "forested land" in some parts of asia are owned by big plantation companies that are running the palm oil business. These characters have a real potential to double dip: grow palm trees, and sequester at least some of the CO2, while simultaneously producing the palm oil. A serious threat to natural forests if there ever was one.

[Mom]

"Carbon sink" function is a only a very small part of the rain forest's value, the real riches are the biological diversity - all those hundreds of thousands of species of plants and animals that would be lost if we lose the forests: http://www.rain-tree.com/facts.htm
Another important function of the rain forest is it's climate-altering capacity (without forest, there will be less rain): http://news.mongabay.com/2005/0423-rhett_butler.html
"Recent studies by NASA have found that when forest is degraded, and cleared, fewer rain clouds are formed and less precipitation falls on the forest. The forest becomes drier contributing to a positive feedback loop where rainforest is replaced with savanna which transpires less and less moisture and is more susceptible to fires, which in themselves may alter regional climate by inhibiting cloud formation.

Since the value of the rain forest is much higher than any value that could be created by growing any crop for biofuel, then it would be wise to compensate those countries that do not turn forests into biofuel plantations accordingly - pay them more than they would make by destroying the forest. Of course, it would mean higher transportation costs for us in the other parts of the world - but we need to know the true cost of the transportation - don't we?

[MrBill]

This thread a few weeks ago talked about a graph of what future oil prices might look like.

Graph for estimated petroleum price increase?


The forward futures prices are the market's best guess, but they are all anchored to today's spot price and are therefore more accurately spread positions rather than price forecasts. Lehman Bros. made a prediction last year of a super-spike to $100 per barrel, but that was just a round number based on a scenario using a certain set of assumptions and not a crystal ball or anything.

I think any price prediction is completely arbitrary. The world economy has successfully adopted to $15, $30, $45, $60 and even $75 per barrel oil even as global GDP continued to expand by 4-5% p.a. of uninterupted growth.

That makes predicting future prices that much harder. At a certain point substutes enter the market, but if you spend any time at all here at peak oil dot com you will quickly learn there are no real substitutes to petroleum as a liquid transportation fuel. And all propsed alternatives like hydrogen, cellulosic ethanol or bio-diesel all have their own practical limitations.

Therefore, price is not the deciding factor. Availability of supply is. The world economy will not grind to a halt because of high prices because they are a net wealth transfer from the users to the producers of oil. However, many industries would quickly collapse if petroleum or a suitable alternatative was not available.

I would run any simulations using $60, $120 and $240 per barrel, and assume they are realistic price projections in nominal terms. Keep in mind that Europeans for example already pay the equivalent of $5-6 per gallon of gasoline compared to $2-3 in America and keep driving and their economy running. Therefore, $120 per barrel is just forcing America, for example, to pay what Europeans are already paying. Then with actual shortages, whether they are post peak oil depletion related or due to physical disruptions stemming from a war in the ME and the closing of the Strait of Hormuz, those prices become all of a sudden realistic assumptions.

However, those are nominal prices. If crude climbs that high then many other prices will also have to increase. There has been a pretty strong correlation between higher oil prices and higher base and precious metal as well as commodity prices. Because it takes energy to produce these commodities as well. Eventually, higher input costs will lead to higher output costs. This cuts both ways driving up the cost of exploration and extraction as well.

CO2 emisson prices may also have to increase dramatically from their current paltry levels of around 15-30 euros in Europe as the price of crude increases from $60 to $120 or $240 in nominal terms making coal irresistable as a source of energy. Whether it is in coal to liquids or in whatever form. An increase in coal use will mean more CO2 certs to offset higher emissions. This will make set aside carbon sinks that much more valuable for emerging markets.

However, I am interested about something else as well. I know countries like Indonesia and Brazil are keen to get paid as caretakers of these forests, but if and when they are illegally logged or wildfires destroy them, for example, do they then reimburse those monies paid for them as carbon sinks? Compliance must be strict and verifiable to avoid double-dipping (as mentioned above) with regards to dual-use forests. Just curious? Thanks.

[Bioman]

realistic medium to longterm price

Welcome Bioman.

If you would care to be more specific about what you mean by "medium" and "long term" we might be able to take a stab at it.

Well, it would be interesting to have the projected price at the "peak" and then 10 and 20 years later. We need a sufficiently large time horizon, because the plans for avoided deforestation as they're being envisioned today, work with periods of 10, 20 and 30 years time (actually longer, but the controls against the original baseline would be carried out at decadal intervals).

a hectare of forest would bring in much more money if converted into biomass plantations than if it were to be valued merely as a carbon sink

These characters have a real potential to double dip: grow palm trees, and sequester at least some of the CO2, while simultaneously producing the palm oil. A serious threat to natural forests if there ever was one.

But in order to establish a new plantation you'd have to cut down trees, which releases vast amounts of CO2 (assuming they're burned, as is most often the case).

You're right if the trees that are cut down to establish the plantation would be sold and used as solid biofuels (woodchips/pellets or as a feedstock for bio-oil).

But the Brazilian and Indonesian critique is often misunderstood; they're not intending to raze down forests, they just want 'compensated reduction' schemes to show the 'real' opportunity costs, which, they think, are higher than the potential income from carbon trading. It's a bit of a virtual exercise really.

[MrBill]

Bioman wrote:

Well, it would be interesting to have the projected price at the "peak" and then 10 and 20 years later. We need a sufficiently large time horizon, because the plans for avoided deforestation as they're being envisioned today, work with periods of 10, 20 and 30 years time (actually longer, but the controls against the original baseline would be carried out at decadal intervals).

Some say the peak was in 2005. Some say it is today. Some say it will be in 2010? Take your pick. $60, $120 & $240 are as good as any forecast, anywhere. At least good enough to run your models. NO ONE can tell you what the real nominal price will be. Perhaps why the companies that have to invest their own capital are so conservative?

[seldom_seen]

Large investments are being made in the bioenergy sector in the developing world. For example Indonesia has set-aside 5 million hectares of land, and the EU is looking into 86 million hectares in Africa and Brazil for the production of biomass feedstocks.

Indonesia has not 'set-aside' any land. They have been burning the rainforests of Borneo and Sumatra to the ground to raise a mono crop of palm. Endangered Orangutans are literally being burnt alive in their rainforest homes. There is no 'set-aside' going on here. This is a wholesale assault on what remains of the lungs of the planet. The smoke from the fires can be seen from space.

With this in mind, a coalition of 13 developing countries has asked the UNFCCC to include a mechanism to protect forests. The idea is called 'compensated reduction' or 'avoided deforestation'.

This is a dumb idea created by someone who spends too much time inside, at a desk. Most of the deforestation in the Amazon is not taking place through any sort of legal framework. Illegal cattle operations are slashing and burning and disappearing. The forest fires in indonesia are mammoth and not controlled or managed.

Furthermore, the west is not going to pay the developed world to keep their forests intact. Even if they wanted to, they soon won't be able to afford it.

So does anyone know where I can find realistic medium to longterm price projections for oil, preferrably written by Peak Oil advocates?

realistic? you may want to toss some dice, or find a dartboard. We've entered uncharted territory when it comes to oil prices. One thing you can bet on though is volatility.

[Bioman]

Therefore, price is not the deciding factor. Availability of supply is. The world economy will not grind to a halt because of high prices because they are a net wealth transfer from the users to the producers of oil. However, many industries would quickly collapse if petroleum or a suitable alternatative was not available.

Thanks for your insights. Brazil and Indonesia's insistence on a correct estimation of opportunity costs is in fact based on what you describe here. Price is not the most determining factor, but the (security of) physical supplies is. That's why they think the value of their forest lands and the (virtual) biomass potential embedded in them, must be based on the potential of counter-acting demand destruction.

I would run any simulations using $60, $120 and $240 per barrel, and assume they are realistic price projections in nominal terms. Keep in mind that Europeans for example already pay the equivalent of $5-6 per gallon of gasoline compared to $2-3 in America and keep driving and their economy running. Therefore, $120 per barrel is just forcing America, for example, to pay what Europeans are already paying. Then with actual shortages, whether they are post peak oil depletion related or due to physical disruptions stemming from a war in the ME and the closing of the Strait of Hormuz, those prices become all of a sudden realistic assumptions.

We've ran several simulations with a max of $120pb. But we now wanted some "sources", names, just to make sure the report's bibliography shows a diversity of views (Peak Oil authors differ radically from the more conservative estimates of the energy establishment).

However, those are nominal prices. If crude climbs that high then many other prices will also have to increase. There has been a pretty strong correlation between higher oil prices and higher base and precious metal as well as commodity prices. Because it takes energy to produce these commodities as well. Eventually, higher input costs will lead to higher output costs. This cuts both ways driving up the cost of exploration and extraction as well.

Exactly, and this is one of the reasons why Brazil/Indonesia are dissatisfied with current assessments of the viability of compensated reduction. Their claim: biofuels made in their countries require much less energy inputs than those made elsewhere (their energy balance is far better); so if it ever comes to high crude prices, they can offer an immediate alternative the production of which would not suffer too much under these high oil prices.

That's exactly the reason why they stress the purely physical, agronomic fundamentals: high photosynthetic efficiency of their crops, suitable agro-climatic conditions to grow them, etc...

CO2 emisson prices may also have to increase dramatically from their current paltry levels of around 15-30 euros in Europe as the price of crude increases from $60 to $120 or $240 in nominal terms making coal irresistable as a source of energy. Whether it is in coal to liquids or in whatever form. An increase in coal use will mean more CO2 certs to offset higher emissions. This will make set aside carbon sinks that much more valuable for emerging markets.

You point out the crux of the matter. But the problem is that the price correlation between oil and CO2 is weaker than that between liquid biofuels and oil. There's not much research on this yet, just a few studies, quoted ad nauseam by the Brazilian and Indonesian negotiators.

However, I am interested about something else as well. I know countries like Indonesia and Brazil are keen to get paid as caretakers of these forests, but if and when they are illegally logged or wildfires destroy them, for example, do they then reimburse those monies paid for them as carbon sinks? Compliance must be strict and verifiable to avoid double-dipping (as mentioned above) with regards to dual-use forests. Just curious? Thanks.

These are just two of the many fundamental problems with compensated reduction:

1. the issue of "permanence" and of the risks of natural disasters (wildfires; in the tropics, lightning often causes huge forest fires); against natural disasters, you can get insurance.
But permanence is a problem from an investment point of view; you need to keep the forest intact (or the agreed deforestation rates low) for years and years on end; this requires huge up-front investments in institutional capacity building (monitoring against illegal loggers, investments in new and highly accurate remote sensing, even investments in good governance will be required, etc...) and in compensation (only a mix between paying up front and paying after an agreed period would work).

Not many investors are willing to put up so much money up front; the return is guaranteed but risky and can turn out to be lower than expected (nobody knows how effective investments in capacity building will be; nobody knows where carbon-markets will be in 10 years time).

2. the issue of "carbon-leaking" and of "social leaking"; put simply: if you keep a forest intact, this means communities cannot convert it into agriculture, so you'd have to import/transport fuel, food, fiber, etc... over long distances to these communities; this brings CO2 with it (carbon-leaking); many of this type of side-effects will occur.

Same story with "social leaking": communities might have to be physically moved, some fear, because it will take a long time to actually pay them for not cutting down trees; this can turn out to become a very repressive, even anti-poor type of scheme (they could basically be kicked off their lands or lose their traditional forest-based livelihoods); also, like you say, it's a top-down scheme, and you know what that means in developing countries, especially in Africa; lots of the cash never reaches those who should receive it.

The biofuel option is entirely different, at least in principle. It would be producer-driven, it's bottom-up, and you get the cash instantly. It's also a much more flexible option.

[MrBill]

Bioman wrote:

These are just two of the many fundamental problems with compensated reduction:

1. the issue of "permanence" and of the risks of natural disasters (wildfires; in the tropics, lightning often causes huge forest fires); against natural disasters, you can get insurance.
But permanence is a problem from an investment point of view; you need to keep the forest intact (or the agreed deforestation rates low) for years and years on end; this requires huge up-front investments in institutional capacity building (monitoring against illegal loggers, investments in new and highly accurate remote sensing, even investments in good governance will be required, etc...) and in compensation (only a mix between paying up front and paying after an agreed period would work).

Not many investors are willing to put up so much money up front; the return is guaranteed but risky and can turn out to be lower than expected (nobody knows how effective investments in capacity building will be; nobody knows where carbon-markets will be in 10 years time).

2. the issue of "carbon-leaking" and of "social leaking"; put simply: if you keep a forest intact, this means communities cannot convert it into agriculture, so you'd have to import/transport fuel, food, fiber, etc... over long distances to these communities; this brings CO2 with it (carbon-leaking); many of this type of side-effects will occur.

Same story with "social leaking": communities might have to be physically moved, some fear, because it will take a long time to actually pay them for not cutting down trees; this can turn out to become a very repressive, even anti-poor type of scheme (they could basically be kicked off their lands or lose their traditional forest-based livelihoods); also, like you say, it's a top-down scheme, and you know what that means in developing countries, especially in Africa; lots of the cash never reaches those who should receive it.

The biofuel option is entirely different, at least in principle. It would be producer-driven, it's bottom-up, and you get the cash instantly. It's also a much more flexible option.

Bioman, these are not abstract concepts, but cut to the heart of any compensation schemes. Offest programs are not a free-bie! As we have seen, time and time, and time again, the developing world has been been used to ripping off aid donors with false promises and NO actual follow through! Why should carbon set asides be any different?

[Bioman]

Large investments are being made in the bioenergy sector in the developing world. For example Indonesia has set-aside 5 million hectares of land, and the EU is looking into 86 million hectares in Africa and Brazil for the production of biomass feedstocks.

Indonesia has not 'set-aside' any land. They have been burning the rainforests of Borneo and Sumatra to the ground to raise a mono crop of palm. Endangered Orangutans are literally being burnt alive in their rainforest homes. There is no 'set-aside' going on here. This is a wholesale assault on what remains of the lungs of the planet. The smoke from the fires can be seen from space.

True, but their argument is primitive in return: "the West has cut down its own forests long ago, allowing it to develop. They shouldn't tell us what we should do with ours".

There's nothing much we can do against this argument. Compensated reduction is seen as one of the few options we have left.

With this in mind, a coalition of 13 developing countries has asked the UNFCCC to include a mechanism to protect forests. The idea is called 'compensated reduction' or 'avoided deforestation'.

This is a dumb idea created by someone who spends too much time inside, at a desk. Most of the deforestation in the Amazon is not taking place through any sort of legal framework. Illegal cattle operations are slashing and burning and disappearing. The forest fires in indonesia are mammoth and not controlled or managed.

But what's the alternative to compensated reduction? We know consumers in the West are not willing to give up their opulent lifestyles. They're responsible, though. The farmers in the tropics cut down their forests to satisfy our demand for meat and food.

Compensated reduction would create a shortcut: states from the wealthy west pay the poor in order to avoid deforestation. To compensate themselves, these same states can then for example put an eco-tax on meat products.

Furthermore, the west is not going to pay the developed world to keep their forests intact. Even if they wanted to, they soon won't be able to afford it.

It will be very costly indeed, but the question is: do people from the West want to keep rainforests intact? If so, they have to compensate the farmers. If not, they should stop their hypocrisy and only blame themselves for the deforestation. - That's what Brazil and Indonesia are saying.

Coupling the value of a forest to the value of carbon could be one strategy. But it probably won't suffice.

So does anyone know where I can find realistic medium to longterm price projections for oil, preferrably written by Peak Oil advocates?

realistic? you may want to toss some dice, or find a dartboard. We've entered uncharted territory when it comes to oil prices. One thing you can bet on though is volatility.

I understand that long-term oil price projections are a bit futile, but most energy institutes (EIA, IEA, etc...) do make them. We want to run some simple simulations using numbers from an alternative discourse, namely that of Peak Oil.

[EnergyUnlimited]

Hi Bioman,
Are you Lorenzo of the past?

[AirlinePilot]

I think any price prediction is completely arbitrary. The world economy has successfully adopted to $15, $30, $45, $60 and even $75 per barrel oil even as global GDP continued to expand by 4-5% p.a. of uninterupted growth.

I beg to differ here. I believe that we only barely scratched the surface concerning what we "adapted to". I would submit to you that official claims and numbers concerning GDP and economic indicators are flawed when it comes to energy costs. Hell, here in the state they dont take into account the price per gallon at the pump.

We are in a grand experiment once we go above right about where we are now. Anything above 60 is going to be detrimental over the long haul. We only touched the mid 70's for a short period, hardly what i would call "adapting". Its obvious that this did put a dent in things and would have caused far worse problems if we hadnt seen the price come down as quickly as it did.

Speculating on the price of crude, I'd say its a safe bet the chart increases will get worse as time goes on rather than better. The dips and highs will be farther apart each time too. Volatility, it's the trademark of an uncertain market.

I think the trend set over the last 4-5 years continues barring any large geopolitical event or weather problem.

[MrBill]

AirlinePilot wrote:

I beg to differ here. I believe that we only barely scratched the surface concerning what we "adapted to". I would submit to you that official claims and numbers concerning GDP and economic indicators are flawed when it comes to energy costs. Hell, here in the state they dont take into account the price per gallon at the pump.

We are in a grand experiment once we go above right about where we are now. Anything above 60 is going to be detrimental over the long haul. We only touched the mid 70's for a short period, hardly what i would call "adapting". Its obvious that this did put a dent in things and would have caused far worse problems if we hadnt seen the price come down as quickly as it did.

Oil prices rose from $15 per barrel to $78.40 in six years that coincided with uninterupted economic growth. World GDP grew during that period of time between 4-5% p.a. with Asia's growth much higher than average even though countries like China with some of the highest growth rates 9%+ p.a. use more oil per unit of output. A 500% increase in the price of oil did not dent world growth. As a matter of fact many developing countries that produce commodities, base metals and energy have benefited, while the developed world adapted quite well to higher prices.

Europeans pay on average more than double what American motorists pay for gasoline. Much of their retail price of gasoline is taxes. The price of crude oil only accounts for about 50% of the price of gasoline in America. The rest are the costs of refining and distribution. Therefore, if Europeans can experience the same level of growth as America (taking into account variables such as a shorter work week and longer vacations) more or less with energy costing them more then the price of energy is obviously just one factor of economic growth.

If they so desired, and they show no signs of doing so, European governments could in fact reduce the state's share of taxes on gasoline in response to higher pump prices caused by higher costs of crude oil. In fact energy is still so cheap that governments feel they can even afford to tax bio-diesel and ethanol at higher rates to make them more comparable with normal gasoline (benzine) and regular diesel. So prices more than double the average of America are not slowing European growth, but governments are sufficiently complacent that they feel they can squeeze more taxes out of their citizens.

Do not confuse American consumers in debt due to over comsumption and large mortgages with high fuel prices and what you think they can afford to bear. Anyone who can buy an SUV for $50.000 plus can afford an extra $1250 a year in gasoline. If they cannot afford the gasoline they cannot afford the SUV. An average commute of 15.000 miles per year in a car that gets 30 mpg uses 500 gallons of gasoline per year. At $2.50 per gallon that is $1250 per year. A doubling of the price of gasoline would cost $2500. If the average income is $40.000 then commuters will not abandon their cars for an extra $1250 per year, but it will affect disposable income on other non-essential purchases.

It is not a God given right for one person to commute 30.000+ miles per year in a full sized SUV that gets 22 mpg. They could at least have the common decency to car pool!

Do not confuse poor business models with high fuel prices. If airlines have a bad business model that has not covered their cost of capital for the past several decades in an industry plagued with over-capacity then higher jet kerosene prices can push them over the edge naturally, but their business models were sick in the first place. Starting with the unionized wages pilots earn. There is a reason why point to point discount airlines are having the major airlines for lunch.

Many airlines around the world are actually adding new planes to their routes, expanding service and earning money even with high fuel prices.

Do not confuse America with the rest of the world. High commodity, base metals and energy prices are a wealth transfer from consumers to producers. Those producers have more money to save, to spend and to invest now that prices are high. If prices go higher they will have even more. That implies higher real costs and falling living standards for consumers and higher profits for producers. Those producers will be willing and able to buy whatever assets those tapped out, indebted consumers can no longer afford.

So do not tell me that the world will grind to a halt with crude oil prices above $60 because it will not. If you want to run simulations you can use $60, $120 and $240 as realistic nominal prices. Of course, as the price goes higher you have more scope for alternatives which itself keeps the price of crude lower. And all that is not to say that crude price of $120 or $240 per barrel will not cause real pain and hardship to certain groups of consumers and segments of society. Obviously they will.

Fuel scarcity is the real issue, not nominal prices.

[Mircea]

We've ran several simulations with a max of $120pb. But we now wanted some "sources", names, just to make sure the report's bibliography shows a diversity of views (Peak Oil authors differ radically from the more conservative estimates of the energy establishment).

If your still looking for a source to quote, this document,

HEARING BEFORE THE SUBCOMMITTEE ON ENERGY AND AIR QUALITY OF THE COMMITTEE ON ENERGY AND COMMERCE HOUSE OF REPRESENTATIVES ONE HUNDRED NINTH CONGRESS FIRST SESSION DECEMBER 7, 2005 Serial No. 109-41

projects $160 per barrel.

The original source of that material was:

Hirsch, R.L. Shaping the Peak of World Oil Production. World Oil. October 2005.

It was probably obtained from data compiled in June 2005 from calendary year 2004, so it's about 2 years old.

You could bring it up do date by making modifications to the data he used based on more recent data.