One of these ‘pieces’ dealt with a new book by a Canadian scholar that featured an upbeat outlook on the use and availability of fossil fuels, while the other was a reproduction of a Newsweek article by Leonardo Maugeri (a senior vice president of ENI, the largest firm in Italy) implicitly suggesting that most oil geologists and executives are wrong, while high-flyers like himself are on the right track. The excellent Mr. Christensen also implied that my work was unworthy of consideration by top-drawer academic publications. Upon reading this I naturally assumed that he is a resident of the Kingdom of Sweden, which led me to invite him and about ninety other energy professionals and semi-professionals to my next lecture at the Royal Institute of Technology (Stockholm). In the event that he honors me with his presence, I promised to pay close attention to any input that he and/or his friends felt obliged to offer. At the same time I felt compelled to hint that there are limits to my generosity, but this is hardly the place to explain exactly what this may involve.
Professor Christian Azar of the Chalmers Institute of Technology (Gothenberg, Sweden), is another of those scholars gracing the Swedish academic horizon whose expertise – if that is the correct word – is of the appointed kind: it was graciously bestowed on him by a jury of his peers. Not too long ago that gentleman took the liberty of declaring himself an energy oracle, and in that capacity bluntly informed Professor Kjell Aleklett that he should reckon with the presence of adequate oil for another 100 years. (Aleklett, along with the important petroleum geologist Colin Campbell, has been a chairman of the Association for the Study of Peak Oil and Gas.) 100 seems to be a fashionable number where this topic is concerned, because not too long ago Professor Bjorn Lomborg – of ‘Copenhagen Consensus’ fame – also alluded to 100 years of copious oil, and I have been informed that Professor Mark Jaccard of Simon Fraser University (Canada) shares this bizarre fantasy.
In any event, there are many individuals whom I purposely or otherwise neglected to invite to my gig. At the top of my non-grata list is another of the few remaining oil optimists in Sweden, Professor Marian Radetzki, who still pictures the long-run oil price on a declining trend. Of course, he wouldn’t have come anyway, nor for that matter would Professor Milton Friedman, the superstar Nobel Laureate who – shortly after the first oil price shock – arrived at the conclusion that OPEC was going to collapse, and the oil price would end up at less than ten dollars a barrel.
I like to think however that Professor Radetzki might be inclined to join us if my (hypothetical) invitation had included a plane ticket, because Sweden happens to be a country where the academic colleagues find complementary air travel irresistible, regardless of the occasion. In the same vein, three front row seats that, in happier circumstances, would be reserved for a trio of prominent energy celebrities – a UK academic; a Pulitzer prize author and highly influential energy professional from the United States; and last but not least perhaps the most articulate ‘oil optimist’ of the last decade – will probably be occupied by run-of-the-mill students. In some ways this is regrettable, but at least we will not have our intelligence insulted by being told that a distinct peaking of global oil production is unlikely, and instead there will be an “undulating” plateau.
For what it is worth I can point out that an “undulating” plateau is something that could last from a few months, to many years. Saudi Arabia is probably a good example of the latter, however that is not much consolation for those of us on the buy side of the energy market, since given the existing and expected demand for oil we require a sustainable expansion in output.
At the present time it is not useful to spend a great deal of time and gusto wrangling over how much exploitable oil there is in the crust of the earth (i.e. reserves), which is a specialty of the more prominent oil optimists. The really crucial issues are price and production. The thing that everyone should be aware of is that with the oil price in the mid-sixties, a ‘spike’ of ten dollars or more that lasted for a couple of weeks might provide the impulse for a macroeconomic disruption and/or a financial market meltdown. It also appears that obtaining this spike requires nothing more drastic than a marginal decline in the global supply of oil.
If by some miracle the latter of the three non-invitees mentioned above appeared at my lecture, I am sure that he would waste no time informing me that the as yet unexploited Norwegian field ‘Goliath’ may contain five times as much oil as previously calculated. Everything considered, I would be not be inclined to thank him for this news, although I might suggest that this is likely the kind of bunkum that is often circulated by energy companies in order to boost the price of their shares. What I would definitely say however is that oil production in the Norwegian North Sea has peaked, and this peak will not be recalled regardless of the amount of oil that various official and unofficial publicists say is contained in Goliath. Thus we are finally arriving at that point in history where the entire North Sea – which in the fantasies of certain oil experts in the U.K. has always been considered a kind of ‘buffer’ for the large oil consuming countries – is now on the downward slope of its depletion curve.
The researcher to whom I am referred at the beginning of the previous paragraph would almost certainly attempt to supply interested parties with statistical tidings countering this point of view, however in the 40 years since large oil deposits were discovered in the North Sea, there is probably not an area in the world that has been more thoroughly prospected. The interesting thing for me and perhaps a few other observers is that if the Norwegian North Sea had been managed with the benefit of Norwegian citizens in mind, considerably less oil might have been produced in the past.
According to the important petroleum journalist Björn Lindahl, oil production in Norway spiked to 3.4 mb/d in 2001, which is well in excess of today’s production, while another observer – Gunnar Örn of the Swedish business daily Dagens Industri – once asked me what kind of economics was being practiced when one of the richest countries in the world (Norway) felt it necessary to overproduce a depleteable resource? I don’t recall whether I replied at that time, but if anyone is interested, my answer to that question is the kind of economics that originates in the great world of Scandinavian politics, where almost everything that is not raving nonsense is capable of being labelled desirable or brilliant.
I have heard it expressed that the reason for Norwegian over-production was the belief by influential movers-and-shakers in that country that much more oil would eventually be located, which they thought would depress the oil price, and adding to this misfortune would be the appearance in large quantities of substitutes in the form of unconventional oil. They now realize that this is not the case, and the same is probably true of their colleagues in Russia. As a result, Russia might become considerably less liberal with its oil export policy.
THE BEST BRAIN IN THE WORLD
If you meet someone at a party who says that he is
Napoleon, you don’t start discussing cavalry tactics at Waterloo.
-Professor Robert Solow
Well, that depends. If he’s the gentleman who gave the party, and you want another invitation from him, you might be forced to explain that if his boys had been riding elephants or dinosaurs instead of horses, he might have enjoyed another few years in wonderful Paris instead of being turned over to that nasty Sir Hudson Lowe on St Helena.
Until recently it was the oil optimists who gave most of the parties – or at least supplied the music. It is highly significant that we don’t encounter very many of them any more, although it is still annoying when we suddenly find ourselves confronted with humorless pundits who reject mainstream economics and geology, and perhaps even more discouraging, now choose to ignore the oil market realism that is belatedly being supplied by our sterling media. Notice the expression “realism”, because until a few years ago anybody checking out the prime-time news might be told that even if not another drop of oil was discovered, there was still 40 years of comparatively inexpensive oil in our future: this was because 40 years was – and perhaps still is – the global reserve-production ratio (R/q). The significance of a possible peak in the global oil production (and therefore the irrelevance of the R/q ratio) was completely ignored, although in almost every major oil producing region on the face of the earth except the Middle East, output had either peaked or was about to peak. A little street-corner mathematical induction should then have made it clear that a peaking of world oil is unavoidable, which to my way of thinking is not something to look forward to because it could result in a very ugly political and/or economic scene, particularly if large oil consumers elected to compete for remaining supplies with the aid of military assets.
The question can thus be asked how John von Neumann – often called the best brain of the 20th century – might have approached this issue. This is not the place to discuss game theory, but I often told my students that if von Neumann had thought that the later contributions of e.g. game theorist and Nobel Laureate John Nash were of great import, he might have devoted a few minutes of his time to deriving them for the book he wrote with Oscar Morganstern (1944). (Nash’s life and work were turned into a moronic burlesque in the film called ‘A Beautiful Mind’, to which he apparently gave his approval.)
Accordingly, I can picture von Neumann saying that the present day oil market game is something where a transfiguration of his famous maximin theorem might be applicable. A student once grandly informed me that the maximin theorem strictly applied to two-person conflicts-like situations where the interests of players were in strict opposition, but it happens to be true that von Neumann intended his two-person scheme to be the cornerstone of a comprehensive theory in which there were many players, and in addition there could be a certain amount of cooperation. This being the case, under an expanded von Neumann scheme, and given the convictions of the elite of geologists and oil company executives on this issue, the ‘school solution’ would almost certainly conclude that the views of the oil optimists should be pointedly ignored.
I began this paper on a Friday, when the price of oil had suddenly spiked to $67 per barrel. When the share markets opened in Europe on the following Monday morning, the tension was palpable. The great fear was, of course, that given the inherent volatility of oil prices, there was a disturbing probability that this price could ascend to something in the mid seventies or above. This raises quite a different prospect for the international macroeconomy than if that very important price suddenly moved from the upper twenties to the middle thirties. For example, it could mean a rise in the inflation rate that, according to contemporary macroeconomic logic, might cause the rate of interest to accelerate to or toward something in the vicinity of the historical average – which is something that I think is inevitable. Exactly how the U.S. central bank (i.e. the Federal Reserve System) would react to this is uncertain, but given the weakness of the share market in that country, the outcome of this drama might be considerably less attractive than those presented in your favourite macroeconomics textbook.
Something else that von Neumann would likely suggest is that players on the sell side of the physical oil market should never be judged irrational. Among other things this means that they are unlikely to make the investments in increased capacity that certain people are dreaming of them making, because in reality it is not in their economic interests to make these investments. He could also point out that regardless of the huge amount of reserves in the possession of OPEC, their spare capacity at the present time is at most 2 mb/d, and most of this in Saudi Arabia. This is not good, because as just emphasized by the economics department of Deutsche Bank, there is a clear pattern of weakness in the oil output of Iran, Iraq, Nigeria and Venezuela, all of whom are important producers. Thus we understand why these countries, and others, are constantly being told that the presence of foreign producers/investors is essential for their future economic health – which (ceteris paribus) happens to be an exaggeration for which they may not have a great deal of sympathy.
MODEL, MODEL: WHO’S GOT THE MODEL?
A former student, colleague or ‘something’ from the University of Grenoble once informed me that a long paper of mine on natural gas was of little value because of the absence of a “model” (2003). I’m not sure that he was correct, however it was hardly an accusation worth a great deal of reflection on my part. The gas and oil market games, if I can call them that, have very little to do with models of the kind that we were constantly plagued with in the learned economics literature, many of which incorporate results without the slightest scientific value. Note the term “we”, which happens to be a small minority of professed readers, because regardless of what you may hear on the academic grapevine, or elsewhere, the learned economics literature mostly goes unread, and among the most pretentious non-reading scholars and researchers, the editors and ‘referees’ of several academic energy economics journals deserve special attention.
In his survey of non-cooperative game theory, Professor David Kreps (1990) says that a good test of the usefulness of game theory is to compare the forecasting success of economists who use game theory with the achievements of those who abstain. A similar test might involve persons who approach the future of the oil or gas prices via models, as compared to those who use basic business acumen, or for that matter common sense, but who possibly have access to a certain amount of geological expertise.
As Professor Kreps makes clear, this is not a very easy experiment to carry out, but where the present subject is concerned, I think that we can go at least part of the way. To begin, it needs to be emphasized that even in the theoretical economics literature, formal models dealing with oil are a declining fad. The most important energy conferences are the international meetings of the International Association for Energy Economics (IAEE), and of the hundreds of papers presented at the last few meetings that I attended, I can only remember two or three treating oil in a conventional or quasi-conventional academic economics fashion. This is in great contrast to the arrangement ten years ago, or more, when both the conferences of the IAEE and its journal – The Energy Journal – often featured some variant of the scientifically lightweight Hotelling model (1931) as the theoretical background for a forecasting exercise.
Going back almost exactly a decade, the best paper that I encountered on oil was by Teitelbaum in the business publication Fortune (1995). Four multi-millionaires, and later billionaires, were cited as going ‘long’ in oil properties. These were Philip Anschutz, Marvin Davis, Carl Icahn, and Richard Rainwater. Of this cash-strong foursome, Mr Anschutz declined to be interviewed, however I suspect that he is the kind of investor who prefers to let his money do his talking, since it is an open secret that he has been on several big-ticket shopping missions in the oil and gas markets.
Where the others are concerned, the late Mr Davis and Mr Rainwater were very much up front as to why intelligent investors should take a bullish attitude toward oil. In fact Mr Davis supplied one of my favourite quotations on the subject: “You don’t have to be a cockeyed genius to see this coming”. Rainwater was also explicit where his belief about the oil future was concerned: The increased global demand “paints a picture for me that doesn’t have any other outcome. The price of oil is going to have to come up”.
The interesting thing about these investors is that all of them were cognizant of the demand for oil that was going to originate in China and India, and apparently long before this matter was considered a worthy topic for mainstream energy economics publications, conferences and those drowsy seminars where amateurs do their song-and-dance. Everyone is now talking about China and its requirements, but few observers realize that India is also going to have a huge appetite for oil. The interesting thing here is that the four gentlemen mentioned about increased their activity in the petroleum market when the price of oil and gas were zooming down, and even people like Sheikh Yamani were informing anyone who would listen that oil would soon be in the same situation as the stones that he seemed to think were precious during the Stone Age.
Something else needs to be made clear. Economic growth in China is breaking all sorts of records, but I see no reason to believe that it can be maintained at the present level. However even if this is not the case, if we combine the demands for oil by China and India, the present growth rate – or higher – for oil could persist for a long time in the future. When I eventually revise my oil and finance books (2000, 2001), I intend to emphasize that where oil is concerned, the key issue at the present – that is to say in the short run – is not reserves, but factors such as production, price, excess capacity, and demand.
A FINAL OBSERVATION
Mike Lynch, an oil optimist of considerable repute, points out that despite a widespread belief, the geometry of M. King Hubbert is not characteristic of that observed with most real world oil wells, deposits, fields, or what-have-you (2003). He means that production (i.e. frequency) curves for oil do not have a bell-like appearance. This claim ties in with the sub-title of his article, which is ‘Debunking Hubbert Modelers’, however I think that if Dr Lynch paid the movers-and-shakers at Davos (in the ongoing World Economic Forum) a visit, and presented his case in discussions dealing with oil, he would encounter very many well-heeled and influential, knowing or unwitting Hubbertites who are even more adamant on this subject than Messrs Aleklett and Campbell.
I’ve heard the opposite of Lynch’s claim, but it hardly makes any difference. What we see when we observe these curves is that they go up on the left, and they go down on the right, and regardless of what happens in between, that is enough to claim that something very unpleasant could eventually take place with the global supply of oil, which in turn could play havoc with the global macroeconomy and the financial markets. Or less dramatically, in the short run what happens between the present ‘up’ and ultimate ‘down’ is not very important in the real world just now, although perhaps it might be of interest in the kind of seminars referred to above. I can add that with the price of oil liable to spike to $75/b at any time, not many sceptics will feel debunked.
REFERENCES
Banks, Ferdinand E. (2006). ‘Logic and the oil future’. Energy Sources (Forthcoming)
_____. (2005). ‘Some further aspects of the world coal market’. (www.energypulse.net).
_____. (2004). ‘A new world oil market’. Geopolitics of Energy (December).
_____. (2003). ‘An introduction to the economics of natural gas’. OPEC Review (March).
_____. (2002). Global Finance and Financial Markets. Singapore and London:
World Scientific.
______. (2000). Energy Economics: A Modern Introduction. Boston and Dordrecht: Kluwer.
Hotelling, Harold (1931). ‘The economics of exhaustible resources’. Journal of Political
Economy (April).
Kreps, David M. (1990). Game Theory and Economic Modelling. Oxford: Clarendon Press.
Lynch, Michael C. (2003). ‘The new pessimism about petroleum resources: debunking the
Hubbert model (and Hubbert Modellers)’. Minerals and Energy (Vol 18, No 1).
Teitelbaum, Richard S. (1995). ‘Your last big play in oil’. Fortune (October 30).
Von Neumann, John, and Oscar Morgenstern (1944) . The Theory of Games and Economic
Behavior. Princeton: Princeton University Press
