Greece joined the EU in 1981 and the eurozone in 2001 (with the  drachma abolished in 2002). This chart of Greece’s GDP growth rates from eurostat shows  the sharp reverse in the country’s fortunes (note that the forecast rates for 2012 and 2013 currently look hopelessly optimistic). Moreover, latest data for 2011, suggest the final figure will come in at around minus 7%.

A piece in The Atlantic places Greece’s predicament in the context of other recent major country recessions. On current trends, Greece has the potential to surpass the Latvian and Argentinan recessions.

The article chooses to leave the Soviet collapse out of the equation on the following rationale:

Russia’s GDP fell a spectacular 44% in the 1990s, but the dissolution of the Soviet Union is categorically different from a recession within a single country, so some analysts exclude it.

However, if we look at all these case studies of hard times, life for most did go on and the government continued to function. But throughout history there have been far worse outcomes. Joseph Tainter, in a path-breaking book called “The Collapse of Complex Societies” (1988), set out some of the conditions for when a country goes beyond depression and reaches a state of collapse:

Collapse is a fundamentally sudden, pronounced loss of an established level of sociopolitical complexity.

Symptoms include a downward spiral in law and order, a breakdown of educational systems, an inability to execute large infrastructure projects particularly the efficient distribution of food and energy, and a steep reduction in urban population concentrations.

Tainter’s book is in many ways an archeological and anthropological grand tour of deceased civilisations from the well-known like the Maya to the more obscure such as the Harrapan of the Indus Valley. His key point is that societies grow more complex (which is initially termed civilisation) to solve problems, but in so doing incur costs; in short, greater complexity requires more energy and more organisational expertise. Eventually, diminishing returns set in until the society in question implodes under its own weight or due to some external shock from outside.

Following the financial collapse in 2008, Tainter has been much in vogue as a commentator on the vulnerability of our current civilisation to collapse. Indeed, he recently wrote a book with Tadeusz Patzek called “Drilling Down: The Gulf Oil Debacle and Our Energy Dilemma” that used the metaphor of the Deepwater Horizon disaster to show how our need to resort to every greater complexity to meet our energy needs was increasing risk within the system. The book is a somewhat messy read, as it jumps between detailed descriptions of what went wrong with the Deep Horizon rig and then more theoretical treatments of complexity. Nonetheless, it contains some disquieting chapters, particularly those that look at the diminishing returns to technology.

The idea that innovation and invention will lead to limitless technological growth is so central to how we view or society that no political leader ever dares question it. It also underpins the publication of all our economic institutions such as the IMF, World Bank and OECD. In Tainter’s words:

In the conventional economic perspective, resources are never scarce. They are just priced wrong. Subscribing to what has been called the Principle of Infinite Substitutability, conventional thinkers assume that, provided that markets are undistorted, innovators will respond to price signals and develop solutions to the problems of the day–whether those problems are shortages of energy or other resources, climate change, or merely a need for a competitive product.

Tainter goes on to look at the empirical literature on investment returns to technology (including studies of his own) and shows that the the idea of an ever accelerating progress in technology is nothing more than a myth (see a presentation he gave here). His conclusions are:

• The productivity of of our system of innovation is declining, and has been for some time. (First noted in 1879.)
• To maintain an acceptable rate of innovation, we will need to allocate more and more resources (money, people) to research and development.
• Within a few years, we will be able to innovate at an acceptable rate only by taking resources from other major sectors—e.g., health care, defense, transportation, infrastructure. This cannot continue forever.

For economists, technology is the manna from heaven that supposedly never stops giving, and is the principal driver of productivity growth. If you take out productivity growth, then society as a whole suddenly loses its most powerful weapon to tackle such modern economic afflictions as an ageing society and debt (not to mention climate change).

In short, if there are more retired as a percentage of the total population, then the only way we can maintain living standards is if those working become more productive. If technology doesn’t deliver the productivity, we just become poorer. Likewise, to pay down debt ultimately requires growth.

Of course, the heavily indebted could just default. But this brings us back to the problem of complexity. As a global society, we have grown interconnected in such a way that we cannot just disengage from each other financially overnight. Most of the advanced economies have become ever more serviced orientated. Only a small portion of the things we consume are made within nation state boundaries. If the debt edifice were to topple, then no seller of goods would continue to deliver them if they believed they couldn’t get paid. Reindustrialize? That will require access to raw materials and energy—both of whose costs continue to rise to due increasing scarcity that technology has not been able to offset. It would also take time.

I would also note that energy has its own particular dynamic. As explained in my post here, the IMF is at least acknowledging the existence of alternative approaches to the importance of energy in economic growth. Economists such as Ayres and Warr make the point that much technology is predicated on the existence of cheap energy; remove the energy and you in effect disinvent the technology.

Going back to Greece, an IMF paper back in 2009 (here) shows us Greece’s situation before the crisis really accelerated. First, Greece’s demographics are the worst in Europe:

Second, the country is relies on oil for over 50% of its total primary energy supply (tpes) and 99.7% is imported. The natural gas and coal is all imported as well. Furthermore, oil imports had been exploding going into the crisis (table from an IEA paper here).

This oil dependency has been a key component in the country’s expanding current account deficit (from the IMF report).

Overall, the 2009 IMF report was relatively upbeat, expecting the economy to weather the downturn slightly better than other European countries, while at the same time acknowledging some fragilities.

Greece is feeling the downturn with some delay. Moreover, even with the staff’s weaker outlook relative to the authorities, Greece’s growth decline from peak to trough would still be milder than for the euro-area as a whole.

By late 2011, we have a completely different interpretation of Greece’s economic stability (here) and a typical package of IMF reforms is advocated: privatisation, cutting of red tape and more transparency, removal of barriers to investment and exports, higher labour market flexibility and a reduction in government spending. No surprises here. Yet one wonders if the IMF’s inability to recognise the severity of Greece’s structural problems as the crisis got going bodes poorly for such transitional measure to solve such problems. This goes beyond a Keynesian critique—in other words, in a country lacking from a chronic lack of effective demand, why would one slash public spending and thus entrench the downturn—but also encompasses issues of emerging long-term structural impediments to growth.

We appear to have created an ever more complex global economy in the pursuit of growth. Unfortunately, due to diminishing returns to technology and a looming resource constraint, such growth is becoming harder to come by over increasing swathes of the world. The danger is that, as with Greece, when growth stalls, an economy can’t easily find a new stable equilibrium without first undergoing a rapid decent. Moreover, if the descent is too rapid it could have sufficient momentum to unpick existing sociopolitical arrangements as Joseph Tainter has documented in countless cases in the past.

Luckily, we have few modern examples of Tainter-type collapse among relatively advanced economies in modern times. The state certainly survived the Great Depression in the US, and even prospered. Likewise, neither Latvia nor Argentina saw complete social breakdown during their crunching recessions. For a time, it could be argued that the old Soviet Union become socially unstitched as documented by Dmitry Orlov, but it can’t really be classed as total collapse because it was so temporary in nature—lasting just a few years.

Nonetheless, individual nations appear to have accepted a Faustian pact of becoming ever more integrated into the global economy in exchange for higher livings standards and better growth. Their economies have become less resilient to shocks in the name of efficiency. Richard Parker, an expert on Greece, summed up that country’s conundrum in a recent article in the Financial Times:

A third of its economy depends on tourism and international shipping; neither is “controlled” by Greece. “Modernisation” of its internal economy means the spread of large firms in place of micro-enterprises, a structural shift complicated for a small economy searching for a niche between the hyper-efficient Germans and the low-cost Chinese.

These sectors boomed on the back of a sea of cheap credit in the mid 2000s. At the same time, EU transfers and Greek private- and public-sector borrowing led to a construction and real estate binge that provided the other leg of Greece’s growth miracle. The miracle can now be viewed as a mirage.

The problem is compounded by the fact that an advanced economy needs a very efficient soft infrastructure to function properly in the modern global economy: a transparent legal system, lack of red tape, absence of corruption, fair and efficiently enforced taxation system and so on. The 20% peak to trough and counting decline in Greek real GDP means the there are far fewer stake holders in Greek society who see such things benefitting themselves. Personal economic relations are reasserting themselves with a vengeance as the economy spirals downward as it is only family and friends who provide a real safety net—the government having relinquished this role.

It is possible that the IMF could be right with its prescriptions for Greece: the market could ultimately clear, and a new equilibrium be reached from which to build growth (and higher living standards) anew. However, just as the IMF did not really understand the structural problems facing the global economy back in 2007, it is possible it does not understand the structural impediments to recovery that remain. The ever-rising oil price, for example, makes the point at which the Greek economy is able to clear its own imbalances more and more difficult to achieve.

As a consequence, there is possibly a point at which a horrible negative feedback cycle sets in: the shrunken economy ceases to be able to support the sociopolitical infrastructure that the country needs to compete in the modern global economy. At that point, we have a Tainter-style collapse.

Energy, technology, productivity, specialisation within an increasingly complex global economy—none of these things are unique to Greece. So I would be none to blase if Greece does move toward collapse. It could easily be the canary in the coal mine showing the fragility of the global economy as a whole.

In February 1977, two weeks into his presidency, Carter told the American people in a fireside chat that “we must face the fact that the energy shortage is permanent”. In April 1977, in another address to the nation, Carter’s opening words were “Tonight I want to have an unpleasant talk with you”. Carter then went on to talk about the potential of the energy crisis to “overwhelm us” and that if the country didn’t act on energy “the alternative may be a national catastrophe”. Over 30 years later, to hear a politician deliver such an unrelenting stream of bad news appears almost shocking.

Fast forward a mere seven year, and the Carter gloom had the character of a long-forgotten bad dream. Ronald Reagan played against it constantly, most blatantly in his “It’s morning again in America” campaign.

I am not quite sure why Carter was quite so down beat about the US energy outlook. By 1977, it was already known that a series of new sources of petroleum were about to come on stream, most of which were in geopolitically stable areas. That year, the Alaskan Prudhoe Bay oil field commenced production, Mexican oil production was also on the cusp of passing 1 million barrels of oil per day, and North Sea oil production had just vaulted over the same mark.

And then again there was the question of markets and prices. In 1977, the US oil market was highly regulated such that oil price rises did not translate into gasolene price hikes—and thus a change in consumption habits. At its most extreme, demand was controlled by the queue. Carter, in fact, did eventually come to understand this: his moves toward deregulation set the scene for the Reagan free market revolution that followed. Even that bastion of Austrian economics the Ludwig von Mises Institute recognises a debt to Carter (see here).

Nonetheless, because Carter ‘cried Wolf’  for so long and so loudly (and so wrongly), energy conucopians have been citing his administration as proof of the absurdity of the idea of resource constraints ever since.

And so we come to Barack Obama. In his January 24 State of the Union Address (full text here) we see this passage on energy and natural gas:

But with only 2 percent of the world’s oil reserves, oil isn’t enough.  This country needs an all-out, all-of-the-above strategy that develops every available source of American energy.  (Applause.)  A strategy that’s cleaner, cheaper, and full of new jobs.

We have a supply of natural gas that can last America nearly 100 years.  (Applause.)  And my administration will take every possible action to safely develop this energy.  Experts believe this will support more than 600,000 jobs by the end of the decade.  And I’m requiring all companies that drill for gas on public lands to disclose the chemicals they use.  (Applause.)  Because America will develop this resource without putting the health and safety of our citizens at risk.

The development of natural gas will create jobs and power trucks and factories that are cleaner and cheaper, proving that we don’t have to choose between our environment and our economy.  (Applause.)  And by the way, it was public research dollars, over the course of 30 years, that helped develop the technologies to extract all this natural gas out of shale rock –- reminding us that government support is critical in helping businesses get new energy ideas off the ground.  (Applause.)

Nearly 100 years supply of natural gas? Well that is a large supply—but is it true? Let us start by studying how much natural gas the US is currently consuming. Again, the democratic information commons that is the internet allows us to go straight to the original data when evaluating a political pronouncement. For consumption, let us go to the US government’s Energy Information Agency data (for where else would Obama get his numbers), and more particularly their early release Annual Energy Outlook published in January 2012. In this report, we find that the US consumed 24.1 trillion cubic feet (tcf) of natural gas in 2010.

For reserves and resources, the most respected source of reliable data is the Potential Gas Committee, which publishes a benchmark biennial assessment of the US technically recoverable US natural gas endowment. The last report came out in April 2011, and a summary can be found here and power point presentation covering the report here. The suggested gas supply available is shown in the chart below:

Now if we take the bottom-line number of 2,170.3 tcf of future gas supply and divide by the current consumption of 24.1 tcf, we get around 90 years. It is not 100 years, but close enough in political terms to give us a nice, round talking point for the State of the Union Address.

Next let’s look at the different categories of future gas supply. We have 272.5 tcf of proved reserves according to the EIA. These are known gas reserves that can be exploited with existing technology at existing prices.  The EIA provides a somewhere dated breakdown (as of 31 Dec 2008) here. For me, the most interesting part of this EIA analysis is that shale gas was still a relatively minor part of proved reserves as of 2009. The next update on proved gas reserves is due from the EIA in April 2012, and it will be very interesting to see how the steep decline in natural gas prices, coupled with the advance of technology and investment in the space, has altered the situation.

The Potential Gas Committee also provides a figure of 1.739.2 tcf for traditional gas resources (and please note that ‘traditional’  includes shale gas under their definition). Note the word ‘resource’  not  ’reserve’. Resources (unlike EIA’s proved reserves) include gas that is a) as yet undiscovered, b) uneconomic to extract at present prices and c) cannot be extracted using current technology.

In addition, the PGC breaks down total resources to those that are probable, possible and speculative. Using these number, we can roughly see that we have 10 years current consumption of EIA proved reserves, 20 years of PGC probable, 30 years of possible, 20 years of speculative and 7 years of coal bed methane. So what are the PGC’s definitions for probable, possible, and speculative? The methodology behind these definitions is highly complex but a description can be found here. The key point is that as we move from proven, to probable, to possible to speculative the likelihood that the gas will actually reach the market diminishes.

Art Berman, a vocal critique of what he terms the shale bubble, emphasises that a large percentage of the PGC resources will never get reclassed as reserves. In his words:

Much of this total resource is in accumulations too small to be produced at any price, is inaccessible to drilling, or is too deep to recover economically.

Berman suggests that only half of the ‘probable’  resources will likely get upgraded to reserves, or around 275 tcf. Add this to the EIA’s 273 tcf and we have about 23 years worth of current consumption. A good summary of Berman’s view can be found here and a podcast here (start at 3:30). While that may be rather too pessimistic, the idea that all resources are equal appears hopelessly optimistic.

We most also remember that the president wasn’t content to keep natural gas consumption constant; he also said the following:

The development of natural gas will create jobs and power trucks and factories that are cleaner and cheaper, proving that we don’t have to choose between our environment and our economy.

Let’s just deconstruct this statement for a second. To ‘power trucks and factories that are cleaner’  requires natural gas to take market share from oil (since we currently aren’t powering trucks with either electricity or gas in any meaningful quantities at the current time), and to take market share from coal (since cleaner factories must mean factories powered by electricity generated from gas not coal). And if  ’we don’t have to choose between our environment and our economy’  then I presume Obama believes the economy will grow, in which case gas consumption will rise regardless of whether it takes any energy market share from coal or oil. So the 100 years of supply makes no sense whatsoever if we premise it on a level of gas consumption that gives us cleaner factories and trucks (and all at a cheaper price).

In conclusion, my feeling is that President Obama’s spinning of irrational optimism presents a far greater danger than Carter’s morose pessimism. It may be politically impossible to sell the possibility of an energy crisis to the American people any more, but that does not mean the pipe dream of an endless stream of natural gas should be sold instead. I also think it is a politically naive strategy.

Like climate change, resource scarcity is not an ideology. If you wish, you may persuade someone that abortion is unethical, and little information will emerge to prove this view right or wrong. By contrast, if you tell the nation that a resource scarcity doesn’t exist, in due course the market will pass its own judgement through price (and ultimately availability). If that happens, even the most soaring of rhetoric will provide you with no place to hide.

Interestingly, there is not that much difference between the aggregate energy numbers produced by the major organisations that predict energy supply and demand into the future (IEA, EIA, OPEC, BP and Exxon Mobile). I think that this is because they generally start with a GDP growth (and energy intensity) assumption and then work backwards to produce supply and demand forecasts. (The question of whether growth drives energy or energy drives growth is a topic for another post.)

Another thing to note is that BP uses million tonnes of oil equivalent (mtoe) as its unit of comparison (and occasionally billion toe) rather than quadrillion British thermal units (Btu) which the EIA uses (and which I referred to in my previous post). To convert from quadrillion Btu to mtoe you can roughly multiply by 24 (a good energy unit of measure comparison table can be found here). Given that BP is using mtoe, I will stay with that unit of measure for the rest of this post.

Looking at the chart above, it is obvious that changes in the energy mix are only taking place at the margin: 2030 does not look a whole lot different from 2010 percentage share-wise. Natural gas has gained share from 23.7% to 26.1%, and oil is down from 32.2% to 27.2%. But critically, the real action is taking place within each energy category. While oil’s share of total energy is down, in absolute terms oil production has increased by 15.3%. Natural gas production, meanwhile, has grown by 50.2% and coal by 22.6%.

In the previous post, I mentioned how some observers believe shale gas would help solve energy scarcity, security and environmental problems. Accordingly, to the BP numbers, however, scarcity will only be solved if every category of energy production is able to grow. Only in this way will total growth in energy consumption of 1.6% per annum between now and 2030 be achieved.

Turning to security, BP sees greater reliance on Middle Eastern oil supplies rather than less as the left-hand chart below shows.

Unconventional gas supply is seen jumping in the United States, and North America is seen becoming a net LNG exporter by 2030 (see chart below). However, the quantities involved appear to be almost a rounding error compared with overall global gas consumption. Dieter Helm, the energy academic and government policy maker, envisages US shale gas production as being a game changer from a security perspective, but this is nowhere to be seen.

For Europe and China, natural gas imports will pose a security risk equivalent to that for oil as these countries will become increasingly dependent on overseas (in reality Russian and the Middle Eastern) supplies by 2030. Unconventional gas production, including shale gas, is seen rising outside of the US but the amounts involved are almost an order of magnitude less than for conventional gas.

Finally, for shale gas in particular, or natural gas in general, a major contribution to the reduction of carbon emissions can only be made if gas displaces coal in the production of electricity. Unfortunately, BP’s numbers just don’t see this happening. Total global coal production is up 22.6% by 2030. Not surprisingly therefore, CO2 emissions continue to grow. We are not even close to the International Energy Agency’s required trajectory to keep atmospheric C02 concentration below 450 parts per million (a guideline threshold for dangerous climate change).

Of course, the BP predictions are just one view, and it could be argued that they are backward looking and don’t take account of the most recent developments in unconventional gas production. The problem with this argument is that it fails to recognise the supertanker nature of world energy production: in other words, it takes decades to steer the energy mix from one configuration to another.

To highlight this conundrum it is worth looking at another scenario analysis, the IEA’s special report entitled “Are We Entering a Golden Age of Gas?” published in 2011. At over 100 pages long, it is exhaustive in nature and covers every aspect of the production and consumption of natural gas, which somehow is never referred to by the promoters of shale. The premise of the report is one under which everything that could go right with gas in the energy mix does go right.

The Golden Age of Gas Scenario (GAS Scenario) takes the WEO-2010 New Policies Scenario as its starting point, and adopts new assumptions that have the effect of building a more positive future outlook for natural gas to 2035. These new assumptions include a more ambitious policy for gas use in China, lower growth of nuclear power, greater production of unconventional gas and lower gas prices.

Unlike in BP’s scenario, the IEA’s Golden Age of Gas scenario see natural gas overtake coal to become the second largest source of energy but still just behind oil—but we are seeing changes in the order of one or two percent. As the charts below show, the major volume increases are coming from conventional gas sources despite the fact that we see huge increases in unconventional gas production in the US and China.

Unfortunately, it is an inconvenient truth that coal is a lot cheaper than gas in many key countries such as China, and a transformational change will only take place through a regulatory response. Furthermore, the idea promoted by Dieter Helm and other observers that oil and gas are fungible (close substitutes) is just not true.

Oil and gas have different attributes in terms of energy density, storability and transportability (as do coal, nuclear, hydro, wind and solar). To make gas vaguely fungible will require vast infrastructure investment and a decades long cycle of replacement iof our current oil-orientated transport stock.

Nevertheless, let us say, for the sake of argument, that technological progress coupled with massive infrastructure investment solves the fungibility issue and allows gas to substitute for oil. This would, in turn, mean we would need a lot more shale gas if it is to significantly reduce oil’s share of total global energy demand. Indeed, we would need to see a monumental ramp up beyond anything projected to date. To reduce oil’s share by an additional one percentage point by 2030, say from 27% to 26%, would require 170 mtoe of replacement energy beyond that currently projected. The BP outlook currently sees North American shale gas providing around 550 mtoe by 2030 (up from about 150 mtoe now). So to get just one percentage less oil in the world energy mix, we would need to see nearly another 30% more US and Canadian shale gas production in 2030.

Against this background, the conclusion can only be that shale is important at the margin, but it is not a game changer. As such, the global economy will remain highly vulnerable to scarcity, security and environmental shocks for the foreseeable future, and anyone who discounts such risks through a religious belief in salvation from shale is just not on top of the numbers.

America’s soaring natural-gas production has already helped cut our share of oil consumption met by imports to 47% last year from 60% in 2005, according to the Energy Information Administration. The shale-gas revolution, with proper safety practices, can be expected to continue this trend while addressing three longstanding concerns of the energy business: energy scarcity, energy security, and environmental risks. In a word, we have a chance to remake our energy future.

Note that an awful lot is being asked of shale gas if it going to help solve scarcity, security and environmental risks all at once. We are in effect asking it to do three things: 1) allow total energy consumption from all energy sources to grow in order to solve the problem of scarcity, 2) enable us to switch away from coal in the generation of electricity in order to blunt (but not stop) CO2 emission growth and so ameliorate environmental risks, and 3) facilitate a transport revolution that allows us to stop importing oil from geopolitical hotspots.

If shale gas is to achieve all this, then it does indeed deserve the moniker ‘game changer’ or, indeed, ’revolution’. But where is the proof? Well it is usually couched in terms of reserves. In other words, we have X amount of reserves, therefore we can satisfy Y years of consumption. Unfortunately, such analysis generally makes no mention of cost and price (and the impact price has on demand and economic growth). This is somewhat ironic, since the most evangelical advocates of shale gas see it as a prime example of the redemptive power of the market. Moreover, the years of production are usually calculated by taking current gas consumption rather than the quantities of consumption that will be needed to produce the revolution.

The key question then is whether shale gas can be made available at the right price and within the right time frame and in the right amount to make the challenges of peak oil and anthropogenic climate change redundant (or at least give us a bridge to a new generation of non-carbon fuel technologies).

To put some hard numbers on what is needed, the starting point must be the US Energy Information Agency (EIA) data, since their consumption numbers will allow as to, in effect, calibrate the scale of shale gas roll-out needed to truly transform the US energy landscape. Fortunately, the EIA has just published the early release of its Annual Energy Outlook 2012 with lots of fresh data on shale gas; you can find it here. And this is the consumption outlook:

What strikes me about this chart is that a revolution in gas is nowhere to be seen. Natural gas accounts for 25% of energy consumption in 2010 and, wait for it, 25% of consumption in 2035! Coal has hardly budged, so we haven’t managed to secure an environmental dividend from gas; and any decrease in oil dependency in the economy has come through renewables and liquid biofuels.

How could this possibly be? Are the EIA bureaucrats totally unaware of the shale gas revolution that is promoted so breathlessly in the op-ed columns of the world’s financial press? Well actually the EIA are all over the shale gas story as the chart below shows:

The critical point here is that, as with every other fossil fuel, you need to run just to stand still. Yes, shale gas production has exploded, and is expected to keep growing rapidly, but a large portion of this growth is needed just to replace the fall-off in conventional gas production. Furthermore, if we believe in the EIA’s ‘business as usual’ annual average GDP growth forecast of 2.6% through the forecast period, then aggregate gas production (conventional and unconventional) has to grow just to maintain the same share of the energy cake.

Moreover, all this is premised on a very rosy EIA forecast of a continued improvement in GDP energy intensity.

Energy use per 2005 dollar of GDP declines by 42 percent from 2010 to 2035 in AEO2012 as the result of a continued shift from manufacturing to services (and, even within manufacturing, to less energy-intensive industries), rising energy prices, and the adoption of policies that promote energy efficiency.

To date, much of the energy intensity improvement has been achieved through the US outsourcing its energy heavy industries to China. Whether this can continue 25 years into the future is highly contentious. If the energy intensity gains are not forthcoming then either a) we must find more energy or b) growth will be forced to match the energy available through the mechanism of a rising price.

The EIA has also held down oil consumption in its central scenario through seeing a continued steep increase in the price of oil (WTI), to $145 per barrel in real 2010 dollars ($230 per barrel in nominal, non-inflation adjusted terms). Gas prices, meanwhile, are reasonably well-behaved up until 2023 at less than $5 per thousand cubic feet in real terms, but then start rising to around $6.50 as cheaper, conventional sources of gas fall out of the mix.

I am reminded again of the observation by Michael Cembalest, the CIO of JP Morgan, that unconventional is a euphemism for expensive. Technology may dull the pain of the transition to unconventional, but it does not eliminate it. You can get a better idea of the cost dynamics (original data from a Deutsche Bank report) if you look at the chart below taken from a quite bullish presentation by Jean-Marie Bourdaire, the Director of  Studies at the World Energy Council here.

The key point is that every time you try to force another 5 million cubic feet of gas per day into the market you push the price of gas up substantially. But because price is set at the margin, all consumers must pay the market clearing price (although this will take time, as much supply is on long-term contracts that will only get repriced when they expire).

For this reason, gas it not able to drive coal out of the energy equation. Look at it another way, in 2010 coal provided 20.8 quadrillion Btu of energy consumption in the US, or 21% of the total. Coal currently costs somewhat less than $2 per million Btu and the EIA sees it rising modestly (presuming no carbon tax) to $2.51 by 2035 (real 2010 dollars). Let’s turn to gas. We have a pretty active market for natural gas, both spot and futures, and if you write op-eds in the Wall Street Journal then this is something you can relate to. So let’s take a look at natural gas prices at the CME here. We find that natural gas is currently trading at around $2.5 per million Btu. But wait a minute, as we look at the longer contracts a few years out we find that gas is trading over $4 dollars per million Btu. If you are a techno-optimist, this is not right: technology is supposed to inexorably drive the cost curve down. The critical point here is that the market is saying that the emperor (technology) has no clothes and coal is not about to be driven into oblivion. (If you think the market is a fool, then you can sell long-dated natural gas contracts and make an absolute killing.)

So if natural gas is not about to deliver us from anthropogenic climate change through displacing coal, will it lead us to the salvation of energy security? Well, the media is abuzz with the idea that the US will become a natural gas exporter. But what does that actually mean in overall energy terms?

Let’s start with how much natural gas was actually imported into the US in 2010. It came to 2.7 quadrillion Btu, which is equivalent to 2.7% of total energy consumption in that year. How will things look according to the EIU in 2035? In that year, they see the US exporting 1.4 quadrillion Btu, whch will then be equal to 1.3% of total consumption. Keeping in mind that over this period there will have been no radical changes in coal and oil in the energy mix, does this amount to a ‘revolution’ or ‘game changer’? Furthemore, in the natural gas arena, who is the US actually becoming independent of? In truth, it is those dangerous Mad Mullahs of Ottawa. True, under the EIA projections, overall oil dependency is declining over the next 20 years, but shale gas is irrelevant to this trend.

The story moves from being purely silly to sureal when we see that such a high-profile academic as Dieter Helm (who has the ear of governments across Europe) claiming that US shale gas will not only transform the US but Western Europe as well (here).

The implications for prices are already being felt: the US is, in effect, ceasing to be a gas importer, so that LNG capacity built with US demand in mind is now effectively redundant. The excess LNG capacity that results at the global level, therefore, has to find other markets—including Europe. Europe no longer faces US competition.

And

Given that there is no physical shortage of fossil fuels, peak-oilers have to rely on demands for energy which rely overwhelmingly on oil. For practical purposes, that means transport. Peak-oilers assume that oil is essential to transport, and will not be substituted by other fossil fuels (or indeed other non-fossil fuels). The prospect of the electrification of transport undermines this claim. The electricity can be produced by abundant gas (and coal), and shale gas pushes aside any serious notion of ‘peak gas’.

When I look at these statements, I don’t know whether to laugh or cry. Shale gas in the US will add roughly 10 quadrillion Btu of energy potential over the next 20 or so years while at the same time conventional gas sources will decline by around half that amount and overall demand linked to GDP will keep growing. Five quadrillion Btu of energy is not to be sneezed at but it not an energy ’revolution’. Liquid fuels in the US give us currently 37 quadrillion Btu of energy for transportation. The bottom line is that to electrify transportation in the US alone we are talking about tens of quadrillions of Btu to make a transformational difference.

Do the promoters of a shale gas revolution believe that the EIA is tens of quadrillion of Btu short of potential? To answer this question, I searched to see if I could find any backer of shale who attached energy production (as opposed to reserve numbers) to their forecasts. Frankly, I came up with a blank (please comment if you beg to differ).

There are  shrills for shale gas but they don’t contain any hard production numbers. For example, this by the Global Warming Policy Foundation (authored by Matt Riddley with a foreword by Freeman Dyson). The Global Warming Policy Foundation is chocked full of the great and the good of the English aristocracy. The board of trustees boasts five Lords, one Baroness, a Knight and a Bishop. I feel as if I have time wharped back to Downton Abbey. But if you read the report you will find no actual firm numbers. Only statements such as this:

Shale gas is proving to be an abundant new source of energy in the United States. Because it is globally ubiquitous and can probably be produced both cheaply and close to major markets, it promises to stabilise and lower gas prices relative to oil prices. This could happen even if, in investment terms, a speculative bubble may have formed in the rush to drill for shale gas in North America. Abundant and low-cost shale gas probably will – where politics allows – cause gas to take or defend market share from coal, nuclear and renewables in the electricity generating market, and from oil in the transport market, over coming decades.

Well what do we mean by ‘probably be produced both cheaply and close to markets’? How much shale gas will take what share and over what time from coal and oil, both in the US and globally? These are the questions we want answered. Anything less is mere tooth fairy economics.

As I mentioned in my last past, it adds nothing to the debate when many mainstream economists begin their analysis by misconstruing the arguments of their opponents. Take a careful note of three things that modern Peak Oil theorists are not suggesting: they emphatically are not stating that 1) price doesn’t matter, 2) there are no more reserves to be found and 3) technological advances are irrelevant. If you don’t believe this statement, then I urge you to actually read the landmark article by Campbell and Laherrere in Scientific America (here) that brought the topic of Peak Oil back into the public domain. Or, at the very least, read the excellent summation of Peak Oil thought that ends their article:

The world is not running out of oil—at least not yet. What our society does face, and soon, is the end of the abundant and cheap oil on which all industrial nations depend.

Nonetheless, while the strawman arguments of neo-classical economists can be ignored, they often have other far more interesting things to say. A good example is the paper in the Oxford Review of Energy Policy by the influential academic and policy advisor Dieter Helm that I highlighted in my last post. If you don’t have the time to read this paper, then a condensed version of Helm’s thinking can be found in an article in the Prospect Magazine (here). Stripping down his thesis to the core, Helm believes he can land two knock-out blows against the Peak Oilers. The first concerns technology and supply:

In much of the peak oil literature, the scope for technical change in fossil fuel production is downplayed. Yet there is very little basis for this assumption: indeed, more resources have been devoted to fossil fuel technologies than renewables for some time. The development of offshore oil is recent, spurred on  by the OPEC price shocks in the 1970s. Much of this is based not on exogenous discoveries, but on investment. Looking ahead, it isto be expected that there will be significant results in the new areas of unconventional gas and shale oil, and in offshore E&P.

In his Prospect Magazine article, Helm goes on to credit technology with the ability to ultimately abolish any fossil fuel resource constraint:

The result is that, for policy purposes, we can assume that the supply of gas is almost infinite, and there are large-scale deposits of shale oil, coal and tar sands. The earth’s crust is riddled with carbon fuels. Contrary to the peak oilers, there is no physical shortage of fossil fuels—and that’s the problem.

The second killer punch (from Helm’s viewpoint) relates to technology and demand for oil. From the article in the Oxford Review:

What fatally undermines the peak-oilers’ case is fungibility and substitution on the supply and demand sides.

And

The peak oil argument rests on limited supply and expanding demand, all based on existing technologies. The next step in unpacking the peak oil argument is to relax the technological constraints—in particular, allowing for substitution between fossil fuels to satisfy the assumed growth in demand. As gas reserves have multiplied, and as the prospect of the electrification of transport has grown, the underlying assumptions about both supply and demand are gradually being turned on their heads. Abundant gas may increasingly provide the fuel for electricity generation, which in turn may displace oil in transport.

In the language of economics, we can illustrate Helm’s overall argument through the use of two graphs: one for supply and one for demand.

In the first, the supply curve for natural gas production moves sharply to the right, from S1 to S2, overwhelming the decline of conventional gas resources (which by themselves would have pushed the curve from S1 to S3). This is due to the development of fracking technology and other advances.

In the second, we can see that technology is making sources of energy more fungible (allowing us to substitute electricity in place of gasoline). Accordingly, the long-term demand curve for oil will grow more elastic. Thus in the future, if gasoline prices go up, consumers are able to flee into electric cars (that have sourced their electricity from gas-fired power stations).

Is this view of the world possible? Well yes, it is possible, since we are unable to effectively forecast the future.

Is it probable (and thus should it be taken as the central scenario for policy making)? For this to be true, we must be highly confident that shale gas can grow sufficiently to, first, compensate for the decline in conventional gas in many parts of the world including the United States; second, fulfill increased demand in its traditional fields of use (heating and electricity for mostly non-transport purposes) as the world economy grows; and, third, progressively take over from oil in the transport sector.

Does Helm give us a route map over how such a quantum leap in gas production could be achieved? Does he show how the explosion in electric car producion will take place? Does he reference any of the forward-looking studies by the International Energy Agency (IEA) and US Energy Information Agency (EIA) that tackle these issues? Unfortunately, the answer to all these questions is ‘no’. The assumption is that the oil price begets technology and technology begets an alternative energy supply than that provided by oil. Indeed, it appears as if Helm believes the market’s delivery of a solution is so obvious that the provision of mere data to support this proposition is regarded as entirely superfluous.

I can only describe such an approach as quisi-religious. Unfortunately, the economics literature appears rife with such thinking whenever such topics as Peak Oil and climate change are addressed. Critically, the economics literature rarely if ever references the scientific literature whenever it considers such issues; the scientific literature appears another country that is not worthy of investigation.

Moreover, the vast majority of articles in the press in recent months reflect this view of the world: in short, the recent media spin is that the magic of technology is on the brink of delivering a new energy saviour in the form of shale gas. So we should, therefore, all go about our business on the assumption that anyone who believes that a resource constraint could materialise is a crank.

In my next two posts I will attach some figures so we can see if this proposition could be true. The first will address the question of whether there is enough gas out there (conventional and unconventional) for us to take out oil as a transport fuel. The second will address the question of whether gas generated electricity could become fungible for oil.

Nonetheless, many economists appear to believe that they have a unique and superior understanding of how scarcity evolves through time (using the tools of supply, demand and price); and they often also behave as if no non-economist could ever hope to gain such insights. As such, we may criticize them for being arrogant—but not as necessarily wrong (and at this point I have to declare that I am an economist by training). But wait a minute, if the arguments of mainstream economists are so evidently correct, why do many of them appear to have a pathological need to misconstrue the arguments of their opponents?

Probably the most enduring urban legend (or urban myth if you prefer the term) of them all in the study of resources is the common interpretation of The Limits to Growth report to the Club of Rome published in 1972. Surely, everyone knows that the report’s forecast of resource exhaustion by the year 2000 turned out to be nothing but a huge joke. And if we don’t know this directly ourselves (having not read through the report because frankly who has the time, and where would we find a copy anyway these days), we know because high profile journalists and media pundits have told us of the report’s spectacular failure on TV, in newspapers or over the internet (or someone in a pub or bar said that is what the report said).

And even if we are of a skeptical, distrustful disposition, we may take comfort from the fact that leading economists tell us about the intellectual bankruptcy of The Limits to Growth authors in the academic literature.

Furthermore, no review by a mainstream economist of Peak Oil thought appears complete without a reference to The Limits to Growth. This book appears to be Exhibit A for the prosecution’s case that anyone who argues that we are running out of anything is an idiot.

Let us take a concrete example from a recent article entitled “Peak oil and energy policy – a critique” by the highly influential economist and government policy advisor Dieter Helm. Early in the paper Helm introduces that all-purpose emotive word ‘alarmist’, which immediately puts me on guard.

The literature on peak oil is vast and much of it is alarmist. The aim here is to identify the main strands of the various hypotheses rather than to provide a comprehensive analysis—to identify the central building blocks and assumptions, in particular in respect of technology, substitution, and reserves.

As usual, ‘alarmist’ is not clearly defined, but presented as a term of abuse. To me, this is a red flag for any piece of analysis: when someone uses the word ‘alarmist’ it usually means that I am in for an exceptionally sloppy treatment of risk. At best, ‘alarmist’  could be used to mean the incorrect calculation of the probabilities associated with unlikely outcomes. Nearly always, however, it suggests that the study of unlikely outcomes is without merit.

Soon after the insult ‘alarmist’ is used, Helm references The Limits to Growth.

The starting point is geology, and this chimes with a wider environmental view that the earth is a fixed factor of production, which has (known) physical depletion limits.

Which leads to the footnote:

The Club of Rome in the 1970s set out this position and made what turned out to be a series of spectacularly erroneous predictions about the depletion of a host of minerals (Meadows et al., 1972).

Now Meadows et al 1972 is The Limits to Growth I referred to above written by Donella Meadows, Dennis Meadows, Jorgen Randers and William Behrens. My edition is titled in full “The Limits to Growth: A report for the Club of Rome’s project on the predicament of mankind”. Unfortunately for Helm, if you actually read the book you will find that it did not make “spectacularly erroneous predictions about the depletion of a host of minerals”. Don’t believe me? Then buy a copy of the book (there are numerous second-hand copies available via Amazon).

Helm is referring to hearsay about Table 4 in the book (attached below is the second half of the table showing the resources ‘m’ through ‘z’: click for larger image), which is the only place in the book that you will find concrete figures attached to particular non renewable resources. Now what this table is not showing is a list of predictions. What it does show is a series of ‘what if’ mathematical calculations.

It is basically a comparison study of linear and exponential growth rates—the kind of thing a not particularly bright high school student could now do on an Excel spreadsheet on a Sunday afternoon. But back in 1972, such calculations required some serious computer power to perform (which no individual had access to then, although you could have laboriously cranked out the relevant curves with a pen, graph paper and slide rule if you had the time).

As an illustration, take petroleum (oil). There are three relevant columns: 3, 5 and 6. In column 3, we see how many years petroleum would last if current known reserves did not increase and usage rates stayed constant (which the authors call the static reserve index). In column, 5 we see the same calculation performed but the usage rate increased exponentially based on current trends (which they call the exponential reserve index). And finally in column 6, we see how many years petroleum would last if reserves expanded fivefold and usage rates grew exponentially. How do we know these are illustrations not predictions? Because the authors explicitly say so in the text on page 63 following the table!

Of course the actual nonrenewable resource availability in the next few decades will be determined by factors much more complicated than can be expressed be either the simple static reserve index or the exponential reserve index. We have studied this problem with a detailed model that takes into account the many interrelationships among such factors as varying grades of ore, production costs, new mining technology, the elasticity of consumer demand, and substitution of other resources.

The most interesting insights from this section of the book do not relate to the naive reserve indices found in Table 4 above, but rather the authors’ explicit treatment of the relationship between the advance of technology and extraction cost.

This treatment is presented as a case study of chromium, which they calculated had a static index of 400 years and an exponential index of 95 years. A more advanced model for chromium was also described in the book which takes into account the extraction cost per unit of resource, the advance of mining and processing technology and the fraction of the original reserve that is shifted to a substitute resource. The book then explains how consumption of chromium will move through time:

At first the annual consumption of chromium grows exponentially, and the stock of the resource is rapidly depleted. The price of chromium remains low and constant because new developments in mining technology allow efficient use of lower and lower grades of ore. As demand continues to increase, however, the advance of technology is not fast enough to counteract the rising costs of discovery, extraction, processing and distribution. Price begins to rise, slowly at first and then very rapidly. The higher price causes consumers to use chromium more efficiently whenever possible. After 125 years, about 5% of the original supply is available only at prohibitively high cost, and mining of new supplies has essentially fallen to zero.

Critically, a neoclassical economist may be able to find fault empirically (perhaps The Limits to Growth is too pessimistic about the advance of technology), but they cannot criticise them for being unaware of price or substitutability. It is also important to be note that the authors are not actually saying chromium will “run out” after 125 years. In their words, the “use of the resource is economically feasible” for 125 years—so after 125 years the resource becomes economically unfeasible to extract even if it still remains in the ground (ie it hasn’t actually run out).

Another important observation the authors make is that if you double the size of the existing chromium reserves, it only adds 20 years to the period of economically feasible extraction. This observation is almost identical to the one made by Steve Sorrell (see my post here) over dates of peak oil production based on the discovery of larger reserves; that is, the peak is remarkably insensitive to large increases in reserves.

Finally, in this whole section of the book we don’t find the use of the words ‘forecast’ or  ’prediction’. The closest we get is the following passage (which the authors wrote in italics for emphasis):

Given present resource consumption rates and the projected increase in these rates, the great majority of the currently important nonrenewable resources will be extremely costly 100 years from now.

Now let me see. So that’s 1972 plus 100. Um, doesn’t that mean the jury is still out on this one? The authors then added this very interesting statement:

The above statement remains true regardless of the most optimistic assumptions about undiscovered reserves, technological advances, substitution, or recycling, as a long as the demand for resources continues to grow exponentially.

From the above, I hope it is crystal clear that Dieter Helm’s description of The Limits to Growth’s  ”spectacularly erroneous predictions about the depletion of a host of minerals” is incorrect. We can interpret this in either of two ways. First, Helm could have been fully aware that his statement was incorrect and as such was using the urban legend as a piece of propaganda. If so, how are we to judge the rest of his arguments? Which are pieces of propaganda that blatantly tell untruths and which are well-reasoned arguments?

Second, perhaps Helm is unaware that he is repeating an urban legend because he hasn’t followed proper academic practice and checked his sources. I will give Helm the benefit of the doubt and assume this is the correct interpretation. Nonetheless, it still leaves a nasty taste in the mouth, especially as Helm’s paper also contains a number of straw man arguments similar to those put forward by Daniel Yergin (that I wrote about previously in a post here).

In conclusion, the introduction of falsehoods undermines Helm’s later interesting arguments in the article concerning the substitutability of natural gas for oil (which I will return to in a future post). It may be a forlorn hope, but I expect academics to hold themselves to a higher standard.

• 1945. Oak Ridge National Laboratory nuclear physicists Weinberg and Soodak predict that nuclear breeders will be man’s ultimate energy source; a decade later, the chairman of the US Atomic Energy Commission predict it would be “too cheap to meter”

• 1973. “Let this be our national goal: At the end of this decade, in the year 1980, the United States will not be dependent on any other country for the energy we need to provide our jobs, to heat our homes, and to keep our transportation moving.” Richard Nixon

• 1978. “Through modeling of supply and demand for over 200 US utilities it was projected that, by the year 2000, almost 60% of US cars could be electrified, and that only 17% of the recharging power would come from petroleum.”

• 1979. An influential Harvard Business School study projects that by 2000, the US could satisfy 20% of its energy needs through solar

• 1980. Physicist Bent Sorenson predicts that 49% of America’s energy could come from renewable sources by the year 2005

• 1994. Hypercar Center established, whose lightweight material and design would yield 200 mpg cars with a 95% decline in pollution

• 1994. InterTechnology Corporation predicts that solar energy would supply 36% of America’s industrial process heat by 2000

• 1995. Energy consultant and physicist Alfred Cavallo projects that wind could have a capacity factor of 60%, which when combined with compressed air storage, would rise to 70 – 95%

• 1999. US Department of Energy hopes to sequester 1 billion tonnes of carbon per year by 2025

• 2000. Fuel cell companies announce 250-kilowatt production plants that can fit into a conference room and produce energy at 10 centsper kilowatt hour, with the goal of 6 cents by 2003

• 2008. “Today I challenge our nation to commit to producing 100% of our electricity from renewable energy and truly clean carbon-freesources within 10 years. This goal is achievable, affordable and transformative.” Al Gore

• 2009. Gene scientist Craig Venter announces plans to develop next-generation biofuels from algae in a partnership with Exxon Mobil

His somewhat acid summary as to ‘how have things turned out’ goes as follows:

There are no commercial nuclear breeders on anyone’s horizon; global nuclear capacity is only 20% of the Atomic Energy Agency’s 1970 forecast; the Hypercar is nowhere to be seen; solar and wind make up a miniscule portion of US electricity generation; wind capacity factors range from 20%-30%; the US is reliant for 50% of its oil from foreign sources; 70% of US electricity generation comes from coal and natural gas; fuel cells haven’t worked as expected; hybrids are 2% of US car sales; “clean coal” is mostly a blueprint; and Venter announced that his team failed to find naturally occurring algae that can be converted into commercial-scale biofuel (they will now work with synthetic strains instead).

Cembalest draws the obvious conclusion:

From a broader perspective, the era of cheap oil appears to be over. As shown below in the first chart, almost the entire future increase in oil supplies projected by the EIA are based on unconventional supplies (tar sands, deep-sea drilling, enhanced oil recovery, oil shale, etc.), with the word “unconventional” being shorthand for “more expensive”.

Rewind to the famous Peak Oil article by Colin Campbell and Jean Laherrere in a 1998 edition of Scientific America that I highlighted in a previous post here. These were the words that Campbell and Laherrere finished their article with:

The world is not running out of oil— at least not yet. What our society does face, and soon, is the end of the abundant and cheap oil on which all industrial nations depend.

The difference is minimal. I noted in a previous post that ‘Peak Oil’ was no longer viewed as a province of cranks. As yet though, it remains the preserve of a relatively small band of advocates, while a few enlightened elites, such as Cembalest at JP Morgan and the head of the International Energy Agency Dr Fatih Birol, are starting to see the disappearance of cheap oil (the best definition of Peak Oil) as a legitimate risk .

For the wider global poplutation, individual narratives have been built on increasing energy availability—and politician have just reflected this perception. The idealised American Dream is as much one of energy abundance as political freedom; but while one may remain free to own an automobile, can one afford the gasoline to drive it?

Faced with this conundrum, the majority of the population faces a problem of cognitive dissonance: to admit that energy could constrain both growth and living standards is to admit that the stories we tell of how our lives, and the lives of our children, will unfold are not true. The common psychological reaction is to ignore the counterfactual. Thus if oil remains above $100 a barrel, or even heads higher, the pre-programmed response is to assume that the shock is temporary and, as such, irrelevant.

A recent article in the Telegraph on the economic slump in Ireland provides an illustration of this reaction: a perceived reality was believed to be the only true one (of rising house prices)—until it was impossible to maintain this fiction any longer. Cognitive dissonance ultimately translated into ruined lives.

True, we cannot equate oil equally with energy, but by increasing the cost of oil radically (which makes up 33% of the globe’s total energy demand), we do change the aggregate energy outlook. And energy is not fungible: oil energy is dense, electricity stored in a battery is not. One is not a perfect substitute for the other. We also don’t know the timing nor severity of any likely oil shock. If it comes slow and late, the global economy may have the resilience to absorb it. If a supply shortfall comes quick and soon, it will be very difficult for the global economy to respond without a new recession or worse.

To give credit to Cembalest of JP Morgan, he demonstrates that ‘this time is different’. If the shock comes fast and early, I am not sure he quite realises how different it will be.

On the longer-term supply side, the central scenario in the IMF report is for an annual average growth rate in oil production of 1.5%,  while the the alternative ‘Peak Oil’ scenario (called Scenario 2 in the report) is for a decline of 2% per annum. How exactly these figures have been arrived at is left somewhat vague. The supply growth scenario appears an extrapolation of recent trends, while also being broadly consistent with the forecasts of the International Energy Agency (IEA). For the contraction scenario, a reference is given to a paper by Sorrell et al but no further details are provided. In other words, the IMF deftly avoids going into the peak oil controversy but just plucks out a couple of scenarios: 1) consensus oil cornucopia and 2) a mild oil descent.

The lack of an explicit treatment of the long-term supply side is somewhat puzzling, given that the IMF’s study feels able to put numbers onto the demand side (albeit with large caveats). In short, no light is shed on how price can introduce more capital expenditure and thus call forth more oil supply over the longer term and no information is given on how the supply curve moves through time due to the impact of technology.

Nonetheless, if you access the paper led by Steve Sorrell that is referenced by the IMF (here) you can find a treasure trove of information about a range of possible long-term oil supply outcomes, both optimistic and pessimistic. Unfortunately, the article is behind a pay wall (and costs $19.95 through the Science Direct website) but most of the contents are freely available in other publications Steve Sorrell has co-authored—particularly the The Global Oil Depletion Report from the UK Energy Centre—and in video and powerpoint presentations.

If you want to understand the main points Sorrell wishes to communicate directly, then I suggest you watch the video below (as the powerpoint charts are barely visible in the video, it is worth running this Powerpoint presentation concurrently as most of the slides overlap). For those time constrained, I have pulled out the most interesting points and charts in the rest of the post.

If I had to sum up Sorrell’s key messages, they would be these:

• Consensus reserve estimates of oil reserves may be accurate (thus falsifying the claims of high profile Peak Oil exponents such as Colin Campbell), however this makes only a relatively small difference to the timing of a peak in production.
• The critical issue is how easily (and cheaply) we can access resources rather than their ultimate size.
• There is a significant risk that oil production will peak before 2020.
• The assumption of a peak beyond 2030 appears at best optimistic and at worst implausible.

Sorrell starts his analysis by defining conventional oil as a combination of crude oil, condensates and natural gas liquids.

Sorrell notes that true unconventional oil currently accounts for only 3% of total ‘all liquids’ production and is projected by the IEA to only be a little over 10% by 2030 (the IEA’s Current Policies scenario sees 11.3 million barrels per day of unconventional oil production in 2030 out of a total of 103.9 mbd in their 2011 World Energy Outlook report). The IEA defines unconventional liquids to include biofuels plus unconventional oil which includes oil sands, extra heavy oil, gas to liquids (which is different from natural gas liquids), coal to liquids and kerogen oil.

Against this background, Sorrell stresses that if conventional oil depletes more quickly than expected, non-conventional oil will not be able to make up the difference over a 20 year time span. He then focuses on the supply dynamics of conventional oil, particularly on the physical constraints on production, and notes the following points:

• Each individual oil fields follows a pattern of rise, peak, plateau and fall
• Most production in a region originates from larger fields
• Larger fields are relatively easy to find than smaller ones and are thus generally found first

The UK oil industry is used by Sorrell as a typical example. The largest fields such as Brent and Forties were found in the early stages of exploration. Further, the much smaller fields most recently discovered both peak earlier and decline quicker as well as produce less oil overall. Note that the recent numbers from the latest BP Statistical View of World Energy show UK oil production at 1.3 mb/d in 2010, down from 2.7 mb/d in 2000.

Economists please note (and I am one by training): during the period of UK oil production decline, the oil price has risen radically and deep sea drilling and extraction techniques have continued to improve. Nonetheless, the decline in production has been impervious to both price and technological trends. What is more, numerous other countries are now in the position of recording relentless output declines.

Sorrell then looks at the concept of ultimately recoverable resource (URR). In his words

The URR is the sum of cumulative discoveries, future reserve growth at known fields and the volume of oil estimated to be economically recoverable from undiscovered fields—commonly termed the yet-to-find (YTF).

Current estimates for URR are between 2,000 and 4,300 giga barrels (Gb), with giga meaning billion. If we take out what has already been produced, that leaves us with between 870 Gb and 3,170 Gb left to recover. (The IEA in its 2011 WEO report puts recoverable conventional oil resource at 2,800 Gb, and thus a URR of around 4,000 Gb.) Sorrel then goes on to make the critical observation that the year of peaking is remarkably insensitive to the actual URR:

Now you can alter the shape of the curve to delay the peak, principally by a) decelerating your oil production ramp up, or b) putting your peak off but at the expense of having oil production fall off a cliff at some point in the future. But neither action is a free lunch economically.

Sorrell then went on to analyse 14 forecasts of oil production out to 2030. Of these 14, five forecast no peak before 2030; these forecasts came from the IEA, OPEC, US Energy Information Administration (EIA), ExxonMobil and Meling (Statoil-hydro). The non-peak forecasts arrived at their conclusions through a combination of having higher URR estimates and assuming larger post peak declines:

The next critical question then is how realistic are the no-peak-before-2030 forecasts? Sorrell implies that such forecasts should not be judged as central scenarios but rather as at the edge of all possible outcomes for a number of reasons.

First, historical experience suggests that production curves are asymmetric—but not to the right of the peak but rather to the left. In other words, we see a fast ramp-up and then slow decline. Sorrell notes that of the 37 countries that have already experienced a peak, the peak took place at 26% (production weighted) of their URR (ultimate recoverable reserves). The more optimistic forecasts—like those of the IEA, EIA and OPEC—are implicitly looking for a peak at a much higher percentage of URR.

Second, the more optimistic studies assume that discovery trends will remain in place despite the fact that they have been on a long-term downward decline (although the IMF’s New Policies Scenario has quite conservative discovery rates of 8 Gb per year through 2035).

Third, many forecasts such as those by the IEA suggest that oil can be extracted from the newly discovered fields at a rate that has no historical precedent.

Following on from this analysis, Sorrell and his co-authors ended the paper cited by the IMF with this statement:

Given these complexities, we suggest that there is a significant risk of a peak in conventional oil production before 2020. At present, most OECD governments are failing to give serious consideration to this risk, despite its potentially far-reaching consequences.

From a risk perspective, this appears very sensible. We just don’t know when the actual conventional oil peak will take place and attaching a single point estimate appears a futile exercise. However, we do know that it could appear early or late. If early, this would imply that we have very little time to put in pace either non-conventional supplies or renewables. The result of a supply side conventional oil shock could thus inflict a major blow to global GDP (and, potentially, global political institutions).

In the non-fiction book The Long Emergency, Kunstler gives an explanation of how the global economy could reverse as oil production peaks. But for me, Kunstler’s fiction leaves a more enduring memory. In the World Made by Hand series we see society shrinking in upon itself. The death of distance lauded in the 1990s has become a cruel joke:  the principal means of transport are reduced to foot, horse or boat (bicycles even fall by the wayside through a  lack of tires). And political relationships relapse to those existing in the pre-modern period. We are faced with feudalism: medieval free towns, lords of the manor (or their scrap-yard equivalents), serfs, self-contained religious sects and marauding bands of muggers.

At its best, life appears to resemble an Amish country idyll but with a lot more sex. At its worst, the break-down in social order and frequent bouts of extreme violence place us in the pages of Cormac McCarthy’s ‘The Road’.

For the majority of neoclassical economists, such visions are nothing but dystopian fantasies: doomer porn for those with a disposition toward the depressive. Nonetheless, the historical record gives one pause f0r thought: economies do suffer from shocks, which can in turn lead to political dislocations. Within living memory, we saw an economic discontinuity in the 1930s lead to social mayhem throughout Europe and the death of around six million Jews. People still living became unwilling participants in adaptations of Schindler’s Ark and Sophie’s Choice.

So is there any way to get from the existing economic consensus to the type of economic breakdown that Kunstler professes to see?

In my last post, I argued that there was no inherent contradiction between Peak Oil and neoclassical economic thought from a theoretical perspective. The argument was purely over the shape and dynamics of supply and demand curves. To take us into Kunstler’s ‘World Made by Hand’ would require a massive economic contraction sufficient to fracture our global political institutions, in turn setting off a second round of economic deterioration that demolishes our domestic political and social structures. Can Peak Oil take us into the first stage of this process? To do so, a neoclassical economic analysis would be looking for three things: 1) highly inelastic supply and demand curves for oil, both in the short and long term, 2) a supply curve that moves to the left and 3) a key role for oil in economic growth.

Surprisingly, the IMF published a section (entitled “Oil Scarcity, Growth, and Global Imbalances“) within its flagship Word Economic Outlook back in April 2011 that set out some scenarios that indirectly dealt with all these three things.

As regards the elasticity of oil demand to price, the IMF was not the first international organisation to warn of the world’s vulnerability to an oil price shock. In the International Energy Agency’s flagship 2010 World Energy Outlook report, the Executive Summary had a section entitled “Will peak oil be a guest or the spectre at the feast?” which led off with the following paragraph:

The oil price needed to balance oil markets is set to rise, reflecting the growing insensitivity of both demand and supply to price. The growing concentration of oil use in transport and a shift of demand towards subsidised markets are limiting the scope for higher prices to choke off demand through switching to alternative fuels. And constraints on investment mean that higher prices lead to only modest increases in production.

What this statement means is that the oil supply and demand curves are looking highly inelastic. In other words, when the oil price goes up there is not that much room to either substitute out of oil into alternative sources of energy or bring more oil into production.

For the demand elasticity, the IMF went further and applied some numbers to the problem. Over the short term, the IMF sees the demand curve as almost vertical. In their words “a 10 percent increase in oil prices leads to a reduction in oil demand of only 0.2 percent”. This is a pretty frightening statement: it says we have almost no ability to adapt to an oil price shock over the short term. So god help us if a) Iraq plummets into an internecine civil war, b) Israel attacks Iran or c) Nigeria descends into internal chaos. The short-term supply elasticity is also seen as very low at between 1 and 10 percent, and mostly consists of the production buffer held by Saudi Arabia. Should this buffer go, the short-term supply curve becomes in effect vertical (no increase in supply at any price).

Nonetheless, this is not the core of the peak oil doomer scenario; for us to approach collapse, we must see viciously steep long-term supply and demand curves, against which both substitution and technological invention appear ineffectual. And this, in effect, is what the IMF at least suggests on the demand side. It calculates a long-term price elasticity of oil demand (long term defined as a 20-year time horizon) of 7%. This again appears incredibly small. You can double the price but you can hardly make a dent in demand. How could this happen?

For this, we must understand the unique attributes of oil: energy density and transportability. These characteristics are incredibly difficult to replicate. Accordingly, where it has been possible to substitute out of oil, much of the transformation has already taken place. In other words, the shift to gas and coal for electrification previously provided price elasticity for oil, but that has now gone.

Now the IMF’s  baseline scenario for oil production is for 1.5% annual growth. However, in Scenario 2 of the report a contraction in supply of 2% per annum is also considered. The 2% decline number is taken from a paper by Sorrell et al in Energy Policy (that is unfortunately behind a pay wall). In this scenario, we move into a world where the supply curve is moving to the left as opposed to a cornucopian view of the world where technology always pushes the supply curve to the right.

Moreover, if you take this Peak Oil decline scenario and combine it with the IMF’s previously calculated demand and income elasticities, global capitalism suffers a significant shock. In their words:

The most striking aspect of this scenario is, however, that supply reductions of this magnitude would require an increase of more than 200 percent in the oil price on impact and an 800 percent increase over 20 years. Relative price changes of this magnitude would be unprecedented and would likely have nonlinear effects on activity that the model does not adequately capture. Furthermore, the increase in world savings implied by this scenario is so large that several regions could, after the first few years, experience nominal interest rates that approach zero, which could make it difficult to carry out monetary policy.

It should be noted that ‘several regions’ are already experiencing nominal interest rates approaching zero. Thus if we are already entering the foothills of a Peak Oil shock, monetary policy is already incapably of easing the blow over large swathes of the globe including the United States.

Unfortunately, the IMF’s Scenario 3 paints an even bleaker picture since it recognises some of the more recent work on energy’s role in GDP growth. Under traditional approaches, the contribution of oil to economic output has been pegged at around 5% for the tradeables sector and 2% for the non-tradeables based on the cost of oil within the economy. New methodology suggests that these figures could be as high as 25% and 20%, respectively. The argument runs thus: certain technologies are premised on access to energy. Reduce the access to energy and the technology becomes defunct.

As an example, take the first Newcomen steam engine, developed around 1710, that allowed water to be pumped out of coal mines; in so doing, mines were opened up to exploitation at a hitherto unprecedented scale. But the Newcomen engine relied on a bountiful supply of coal. If the coal hadn’t been there, the steam engine could not be operated. The machine technology and the energy can therefore be thought of as a single package: remove one and you cease to have the other.

In a more up-to-date context, think of a sophisticated airline routing algorithm that minimises the number of empty aircraft seats and reduces ticket prices. Doubling the price of jet aircraft fuel not only reduces the number of planes in the air but also reduces the optimisation potential of the algorithm, so setting off second round effects. Oil scarcity can therefore lead to what is, in effect, the disinventing of technology.

Overall, a neoclassical framework built on a slightly more pessimistic premise can have some quite alarming implications. In the words of the IMF:

But if the reductions in oil output were in line with the more pessimistic studies of peak oil proponents or if the contribution of oil to output proved much larger than its cost share, the effects could be dramatic, suggesting a need for urgent policy action.

Nonetheless, even if we pile an oil supply contraction (IMF Scenario 2) on top of a greater role for oil in the economy (IMF Scenario 3), we still are not reduced to the existence of Kunstler’s post apocalypse Amish. The IMF does not give a compound figure for one scenario placed on top of another, but for the US we are probably looking at a 20-25% decline in GDP over a 20 year period against trend and a lot steeper drop for emerging Asia. Assuming trend is for modest growth, this type of oil shock would flat line growth overall.

The relatively benign worst-case outcome of no growth (but no descent), however, assumes that massive price and income shocks can be smoothly absorbed both within and between societies. Unfortunately, we have already seen financial systems struggle with shocks an order of magnitude smaller.

In conclusion, the IMF’s formal neoclassical analysis could easily take us to the brink of Kunstler’s descent, but we would still need something beyond a traditional economic shock to push us over. For that we would need to turn to the science of complex systems or to geopolitics, topics that I intend to return to in future posts.

Glance a couple of results down and you will see one headline titled ”Peak Oil is Stupid”. If you follow the link, you will end up at a post by Tim Haab, blogger at Environmental Economics and an economics professor at Ohio State University. What does he have to say about Peak Oil:

Must be time to update my semi-regular ‘peak oil is stupid’ rant.  So here goes…

I don’t care when oil (OR COAL) peaks, I care when we run out, which we won’t because, as production declines, prices WILL rise. As prices rise, people WILL figure out alternatives. They might not be happy alternatives. They might not be as productive alternatives. They might not support the same lifestyle to which we are accustomed. But there WILL be alternatives, forced by higher prices–and no other mechanism is that powerful.

Well that has put the Peak Oilers in their place then! But just in case, let’s see what two of the most famous Peak Oil advocates, Colin Campbell and Jean H. Laherrere, had to say back in March 1998 when  they wrote a a high profile article (here) for Scientific American (when oil cost $12 a barrel):

The world is not running out of oil – at least not yet. What our society does face, and soon, is the end of the abundant and cheap oil on which all industrial nations depend.

Furthermore:

From an economic perspective, when the world runs completely out of oil is thus not directly relevant: what matters is when production begins to taper off. Beyond that point, prices will rise unless demand declines commensurately.

Thus from a theoretical standpoint, there is in reality not much difference between Campbell and Laherrere, on the one hand, and Haab on the other.

And now a plea from me: could everyone please keep their straw men in the barn. If we only seek out the views  within the opposing camp of the extremists, or the outdated, it is relatively easy to knock down their arguments—but it doesn’t further the debate. Few Peak Oilers now say that one day there will be oil and the next it will be gone; most prescribe, like Campbell and Laherrere, to the idea of peak ‘cheap’ oil and the theory that an oil production growth constraint could increasingly impact on wider economic growth and human welfare.

More broadly, I mentioned in my last post that Peak Oil theory would need to overturn the neoclassical economics consensus. Actually, this claim needs refining somewhat, since I wasn’t referring to the theory of neoclassical economics but rather the empirical world view of most neoclassical economists. Mark that these are two very different concepts. Advocates of a biophysical economic view of the world do look at the world differently (look at the graphic below  from Question Everything). However, I would argue that the viewpoints are not contradictory; rather they are more like very different artistic interpretations of the same object: the earth system.

The critical point here is that biophysical approaches to economics warn of the tyranny of the second law of thermodynamics: energy and matter will tend to entropy (disorder). From a neoclassical perspective, this, translates into increased scarcity and an upwardly sloping supply curve that moves continually to the left. This contrasts starkly with the neoclassical cornucopian paradigm that as technology advances the supply curve moves inexorably to the right.

Put bluntly, the peak resource advocates see stuff getting progressively more scarce and thus more expensive; traditional neoclassical economists see stuff getting ever more accessible (through the magic of technology) and thus cheaper.

And so back to oil. A strong proponent of the magic of markets and technology over the years has been Daniel Yergin the cofounder of Cambridge Energy Research Associates and the author of a number of highly influential books on the oil industry, the most recent of which—”The Quest”—was a mainstay of my Christmas reading. If you don’t want to read the book, then I recommend an Op-Ed piece he wrote for the Wall Street Journal here.

The article, again, is built around a straw man, in this particular case the ideas of the earth scientist Marion King Hubbert, the father of Peak Oil:

Hubbert insisted that price didn’t matter. Economics—the forces of supply and demand—were, he maintained, irrelevant to the finite physical cache of oil in the earth. But why would price—with all the messages that it sends to people about allocating resources and developing new technologies—apply in so many other realms but not in oil and gas production? Activity goes up when prices go up; activity goes down when prices go down. Higher prices stimulate innovation and encourage people to figure out ingenious new ways to increase supply.

Hubbert is certainly a towering figure in the Peak Oil movement, and Campbell and Leherrere likely built on his intellectual foundations. But schools of thought (at least good ones) evolve, and it is no different with the advocates of peak oil. Thus, if one is to criticise Campbell, it cannot be because he ignores price (even though M. King Hubbert certainly held the market system in little esteem).

If one reads Daniel Yergin after reading the Campbell and Laherrere article, what jumps out at me is how little new is in “The Quest”, despite 12 years elapsing between the two publications. (Is that why Yergin had to reach back decades earlier for his straw man?) For example, Campbell and Laherrere recognised that technology is having an impact:

A second common rejoinder is that new technologies have steadily increased the fraction of oil that can be recovered from fields in a basin—the so-called recovery factor. In the 1960s oil companies assumed as a rule of thumb that only 30 percent of the oil in a field was typically recoverable; now they bank on an average of 40 or 50 percent. That progress will continue and will extend global reserves for many years to come, the argument runs.

Theoretically, these unconventional oil reserves could quench the world’s thirst for  liquid fuels as conventional oil passes its prime. But the industry will be hard-pressed for the time and money needed to ramp up production of unconventional oil quickly enough.

If advanced methods of producing liquid fuels from natural gas can be made profitable and scaled up quickly, gas could become the next source of transportation fuel.