Sunday, November 11, 2012

Does the IMF believe we have a peak oil problem?

Does the International Monetary Fund (IMF) believe we have a peak oil problem? The precise answer is that the IMF is currently studying how constraints in world oil supplies might affect economies around the world in two so-called working papers, "The Future of Oil: Geology versus Technology" and "Oil and the World Economy: Some Possible Futures."

We are admonished by the IMF that opinions expressed in working papers are "those of the author(s) and do not necessarily represent those of the IMF or IMF policy." But the fact that the organization has produced two papers on the subject this year gives some indication of how seriously it is taking the issue. One of the co-authors for both papers, Michael Kumhof, a senior researcher and deputy division chief for the fund, hasn't been keeping his concerns secret. In a presentation, he outlined his reasoning for why the price of oil would have to nearly double in real terms in order for oil production to increase the measly 0.9 percent per year projected by the U.S. Energy Information Administration between now and 2020.

Part of the problem is that we have already extracted the easy-to-get oil. Now comes the hard stuff: deepwater drilling, tar sands, arctic oil, and tight oil (often referred to erroneously as shale oil) which is produced by expensive hydraulic fracturing or fracking, something that typically costs millions to perform on a single well.

The new model presented in "The Future of Oil" takes into account both geologic constraints and the effect of price changes on oil production. The model has proven much better at explaining trends in oil production and prices than conventional economic analysis which assumes no long-term geologic production constraints. Standard economic theory--in which oil supplies always increase in response to high prices--has been unable to explain the apparent plateau in world oil production from 2005 onward in the face of record high oil prices.

(IMF researchers are interested in the global picture for oil production and have therefore not been taken in by the hype over recent marginal gains in U.S. oil production, gains that have been offset by declines elsewhere in the world. Because oil can be shipped to wherever the price is highest, it is world output which matters.)

All of this begs the question about how record prices and oil supply constraints are affecting the world economy. Kumhof and his IMF colleague Dirk Muir modeled several scenarios in which oil supplies actually fall for the next 20 years in their paper, "Oil and the World Economy: Some Possible Futures." In their baseline scenario they assume a small, but persistent decline in oil supplies from year to year. As a result oil prices rise by 200 percent in real terms over a 20-year period. GDP shrinks at a rate of 0.2 to 0.4 percent per year in the United States and the Euro area. Surprisingly, the declines are steeper in oil exporting countries. It is a situation that is difficult but not impossible to manage.

The authors then imagine a world economy much more capable of adjusting to declining oil supplies through, for example, switching to other fuels. That scenario would be less distressing for all economies and could lead to continued economic growth in countries other than oil exporters, the United States and Euro area countries.

A third scenario posits just the opposite, an economy which has increasing difficulty substituting other fuels and feedstocks for oil. The assumption is that the easy and obvious substitutions will be made first and subsequent substitutions will be harder to find and deploy. Under these conditions, oil prices increase by 300 percent in real terms over 20 years.

A fourth scenario assumes that oil is so intertwined with the world economy that its contribution to world output is far higher than the 5 percent its cost contribution suggests for what are called "tradeables," items that are easily exchanged in trade (which is most of the things we make) or the 2 percent cost contribution for what are called "nontradeables," items not easily shipped across an ocean for trade. (Public drinking water supply would be an example.) Instead, Kumhof and Muir assume that oil's true contribution is 25 percent and 20 percent respectively. The authors argue that "oil is an essential precondition for the continued viability of many modern technologies." They believe that many processes simply won't work and many devices can't be produced below a minimum supply of oil. They also assume that substitutes are difficult to make. This outlook spikes the price of oil by 400 percent in real terms over 20 years.

The negative economic effects of scenarios three and four are indeed profound. But, the authors recognize that such price increases are probably not realistic, even under the scenarios they posit. They assume that such extreme price outcomes imply "nonlinear effects on GDP" which the model cannot express. Translation: The world economy crashes before prices ever get that high.

There are other scenarios, each more grim than the previous, as problems detailed in earlier scenarios are essentially added to one another and to some new scenarios.

The point of the exercise is not to predict a specific outcome. Rather, the authors want to explore just how sensitive the world economy may be to oil supplies and highlight the uncertainties surrounding those supplies. While there has been much talk about how the world economy is becoming less oil-intensive per dollar of output, the researchers turn this observation on its head:

[I]f it really only takes a one third of one percentage point increase in oil supply per annum to support additional GDP growth of one percentage point, then it must also be true that it would only take a one third of one percentage point decrease in oil supply growth to reduce GDP growth by a full percentage point. And the kinds of declines in oil supply growth that are now being discussed as realistic possibilities are far larger than one third of one percentage point.

The IMF researchers also note that while an energy transition away from oil certainly seems possible, the extent to which oil is critical in the functioning in the world economy implies that such a transition will be costly and may require several decades. They wonder whether we have that kind of time, given that oil supplies have essentially been stagnant since 2005 and that some analysts believe a persistent decline in world oil production may begin within this decade.


Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he writes columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin, The Oil Drum, OilPrice.com, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at kurtcobb2001@yahoo.com.

8 comments:

Anonymous said...

Well that was quick.....the headlines this morning right after your question in your essay ....scream that the IEA claims "US oil output to overtake Saudis Arabia by 2020"

http://www.bloomberg.com/news/2012-11-12/u-s-to-overtake-saudi-arabia-s-oil-production-by-2020-iea-says.html

Extremely confusing information
Who to believe?

Torbjörn Larsson, OM said...

Well, I'm glad if IMF got so hot and bothered by the erroneous "peak oil" models that they decided to make their own research. The real outcome of a plateau is what the null hypothesis (random walk) has predicted all the time I take it. Good riddance with what IMF results implies was demagouge terminology all along!

Browsing the 1st paper ever so slightly, it seems they use a supply model because econometrics can't capture "shocks" (fast disruptions) well. That seems like a funny deficit, given that they capture supplies over larger times. (I'm no economist, obviously.) It may be that they don't consider the delay for new technology to catch up in their basically steady state approximations of price elasticity.

One could as well say that they have replaced whatever doesn't work fast enough in earlier models, but it could as well still be econometrics in disguise. No doubt it helps to use the natural production curves of a zero elasticity case.

If oil prices doubles over the next decade without any risk that those non-linear effects kicking in as Kumhof predicted, this means there will be a lot of previously stalled technology kicking in nicely. I just read that they are already reviving the century old oil-making bacteria technology. (Rather, it makes raw material for making fossil-like oil.) Gas is an excellent carrier for energy, plastics from oils are much more flexible materials, and one can now safely predict that oil will always be with us.

Anonymous said...

Great article, again! Thank you for writing this blog. I find your articles well-reasoned and a must-read.

Kurt Cobb said...

The first anonymous is rightly confused. But he/she should take note that the Bloomberg story is talking ONLY about U.S. production, NOT world production. And, as I say in the piece, it is world production that matters since oil can be shipped wherever the price is highest. World production remains flat as declines elsewhere offset minor American gains. Even if the U.S. achieves these large projected increases in production (doubtful, in my view), Americans will still pay the world price and they will still NOT be free of imported oil.

The IEA does not say exactly what those production numbers include? Is it just crude oil? Is it crude oil plus natural gas plant liquids? If it is the latter then we're not really talking about oil. And the IEA projection is at odds with the U.S. Energy Information Administration projection which indicates a peak for crude plus lease condensate (the real definition of oil) about around 6.7 mbpd in 2020. That may turn out to be a bit low. But it does show the distance between the two projections.

Mr. Larsson missed the point of the IMF papers which is that standard economic models have failed to forecast oil supplies correctly for the last decade. Nor have they correctly characterized economic activity. The IMF is experimenting with putting oil in the model and this reduces the error rate significantly. The newer model provides a much better forecast. Mr. Larrson is right that oil will be with us for a long time. The main question is a what rate of production. This is the key question and he ducks it.

Peter Speckmayer said...

Dear Mr. Cobb,

I am following your blog closely and I enjoy the technical knowledge you bring into the discussion.

I stumbled today over the following article:
http://www.thegwpf.org/american-oil-find-holds-opec/

In that article, the image is created, that the production of shale oil is already happening since years, and that it is just an economical issue (it can only be done once the oil price is larger than 65$). On the other hand I read your postings from which I learned, that the production of shale oil is not that easy as oil industry wants us to think.

Do you think, that there has been a technological breakthrough which makes oil shale production now easier than before and we will be swamped with oil from the US (and thanks for the climate change), or is this again just a message to persuade people to not think of renewable energies replacing oil?

Kurt Cobb said...

Peter,

You are right to be skeptical about so-called oil shale. (This is different from tight oil that is often erroneously called shale oil, but is really conventional oil obtained through hydraulic fracturing).

We've been promised that oil shale would become profitable to mine and process at $30, then at $60, then at $100. But it never seems to become profitable because it depends so heavily on energy from existing fossil fuel supplies to extract and process it. As those energy sources rise in price, it becomes ever more costly to use them to extract the kerogen (see below) from oil shale. It's what has been called the problem of receding horizons which I covered in a piece some time ago.

Promoters of oil shale have had 30 years to work on technology that would improve the economics and reduce the resources needed to extract and process it profitably. So far they've failed, and even one source in the article says that commercial production is 15 to 20 years away. But that's what promoters thought 30 years ago.

The writer of the piece doesn't understand the difference between reserves (which have been proven by the drillbit and economical at current prices using current technology) and resources which are just a rough estimate of what might be in the ground based on sketchy evidence at best. He thus erroneously takes a resource estimate (3 trillion barrels) for an estimate of what is recoverable. Even the U.S. Energy Information Administration puts the technically recoverable amount at around 750 million barrels. That's still a lot, but it says nothing about whether it will economically recoverable.

The writer also appears unaware that oil shale contains no oil, but rather kerogen, a waxy long-chain hydrocarbon that requires enormous energy and water resources to convert to what we call oil.

For more on why we should be skeptical of all claims made by the industry about unconventional oil resources see my recent piece entitled "Tar sands, oil shale, and heavy oil: Why the conventional wisdom about unconventional oil is likely to be wrong."

Anonymous said...

Dear Kurt:

Shale oil (kerogen) research as well as coal liquefaction all got canned when oil prices collapsed multiple times in the 1980s. Most of the companies pursuing liquefaction and thermochemical technology went bankrupt or got bought out (w/r&d shelved). How do I know this? Well I cherry picked some of their liquidated assets and have an r&d lab as well as field pilot facility for pennies on the dollar. Why aren't these technologies developed in America? Well we don't have an energy plan in USA. Check out Sasol (South Africa) - they've got this technology - that America dropped the ball on by inconsistent funding that hired R&D staff dropped them off on the side of the road. Additionally, China now has this technology as well and is funding it to start developing several projects in USA to use our cheap-ass coal to make high-value oil to then sell to Americans & China. With companies looking only at the next quarter earnings for manager's profits and salary bonuses it's no wonder we (America) dropped the ball & our competitors (countries) are now ahead of us. It will be very very difficult for the USA to compete with 50 yrs or applied R&D & industrial work that South Africa & China have invested in on top of the lack of quality engineers & scientists in our country... fat & happy is getting taken to the butcher shop

World Oil Prices said...

Renewable energy would be a great replacement for oil use but it is being set aside since big oil companies will be affected, no wonder why it is pretty expensive to have it installed.