A new forecast that the US will surpass Saudi Arabia in oil production is unrealistically optimistic. Oil prices would have to rise far too much for unconventional oil to meet forecast levels.
The International Energy Agency (IEA) provides unrealistically high oil forecasts in its new 2012 World Energy Outlook (WEO). It claims, among other things, that the United States will become the world’s largest oil producer by 2020, and will become a net oil exporter by 2030.
Figure 1 (above) shows that this increase comes solely from the expected rise in tight oil production and natural gas liquids. The idea that we will become an exporter in later years occurs despite falling production, because “demand” will drop so much.
The oil price forecasts underlying these and other forecasts in the report are approximately as follows (see Figure 2, above left).
One reason the WEO 2012 estimates are unreasonable is because the oil prices shown are unrealistically low relative to the production amounts forecast in the report. This seems to occur because the IEA misses the problem of diminishing returns. As the easy-to-produce oil becomes more depleted, and we need to move to more difficult reservoirs, the cost of extraction increases.
In fact, there is evidence that the “tight” oil referenced in Exhibit 1 is already starting to reach production limits, at current prices. The only way these production limits might be reasonably overcome is with higher oil prices–much higher than the IEA is assuming in any of its forecasts.
Higher oil prices cause a huge problem because of their impact on the world economy. The IEA in fact mentions that current high oil prices are already acting as a brake on the global economy in its first slide for the press. Higher oil prices also mean that investment costs required to reach target production levels will be even higher than forecast by the IEA, adding another impediment to reaching its forecast production levels.
If higher prices put the economies of oil importing nations into recession, then oil prices will drop lower, reducing the incentive to invest in new oil production infrastructure. In fact, we could find ourselves reaching “peak oil” because of an economic dilemma: while there seems to be plenty of oil available, the cost of extracting it may be reaching a point where it is more expensive than consumers can afford. As a result, some oil that we know about, and have been counting as reserves, will have to be left in the ground.
The IMF has recently done modeling that is relevant to this issue in a working paper called “Oil and the World Economy: Some Possible Futures.” This analysis may provide some insight as to what the real situation will be.
The Problem of Diminishing Returns
One issue that the IEA has not properly modeled is the issue of declining resource quality, leading to diminishing returns and a rising “real” (inflation adjusted) cost of production. This situation is often described as reflecting declining Energy Return on Energy Invested (EROEI).
The reason diminishing returns are a problem is because when a producer decides to extract oil, or gas or coal, the producer looks for the cheapest, easiest to extract, resource first. It is only when this resource is mostly depleted that the producer will seek locations where more expensive, harder to extract resource is available. Thus, over time, the inflation adjusted cost of extracting a resource tends to increase.
In terms of the triangle shown in Figure 3 (see above left), producers tend to start at the top, with the “best” of the resource, and work their way toward the bottom. One result of this approach is that the cost per unit of production tends to rise, even as there are technology advances and efficiency gains, because the quality of the resource is declining.
Reserves tend to increase over time with this approach, because as producers work their way down the triangle in the diagram, they always see an increasing quantity of lower quality resources. The new reserves are increasingly expensive to extract, in inflation adjusted terms. There is no flashing light that says, “Above this price, customers won’t be able to afford to purchase this resource any more,” though. As a result, the increasingly low quality reserves get added to reported amounts, even though in some cases, the cost of products made with these reserves (say gasoline or diesel) will send economies into recession.
It should be noted that the issue of diminishing returns exists for almost any kind of resource. It exists for uranium extraction, since there is always more available, just harder to reach, or in lower concentration. Diminishing returns exists for gold, copper, and for nearly any other kind of metal. This means we often need more oil for metal extraction and processing, as we dig deeper or find ore that is mixed with a higher proportion of waste product.
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