More oil ranting

Let's run with this for a bit. The IEA (a French NGO I think that deals with energy issues) has offered some forecasts showing that peak oil could potentially happen as many as 120 years form now, in 2125. A forecast such as this is based on very conservative estimates of increasing demand and very generous discoveries of new oil reserves over this period of time. Other forecasts show it could happen as soon as 2013, or even November of this year! Peak oil in two weeks? Probably not. Even if oil production can exceed supply for a period of time longer than expected, don't count on the cost of oil staying down.

I thought of this analogy/example at work the other day (finally a slow week!). Imagine you were lucky enough to to have a money tree in your backyard. This is not an ordinary tree, this is a giant redwood sequoia sitting on your property. Unlike normal trees, once the money leaves were plucked from the branches, they never grow back. So you have this wonderful new source of wealth and you want to start using it to buy things you used to be able to not afford. Where would one start grabbing the money leaves from the tree? Nobody would climb all the way to the top of a massive 200 + ft. tree to get the cash. They would start with the money that is easiest to obtain: the crisp clean $500 bills growing in abundance at the bottom. You can stand on the ground and pluck all the money-leafs you can hold. You might need a small ladder to reach some of it after a while. Then once that is gone you might need a big extension ladder to be able to get within reach of the money. Pretty soon the bottom of your tree looks as bare as a branch at the end of autumn.

Now it is no longer an easy process of grabbing the money-leafs. There are a few options available. You could spend some of the money you already took to go buy a cherry picker to get even higher into the branches or if you are adept at climbing trees you could scale up the trunk. The former option requires capital expenditures and the latter requires some serious risk taking. No matter how good at tree climbing on might be, the risk always exists of falling down to the ground. It is no longer "free" to go and take the money from the tree, i.e. there is a cost of retrieval. As you get higher and higher the cost of retrieval becomes more and more. You may need to hire other people to assist you in the recovery process, you might need to buy more elaborate and technologically advanced equipment to reach new heights. These new methods of recovery are always becoming more and more expensive and generate ever decreasing sums of money-leafs; as you go up the tree taking the money-leafs the branches are spread out more and more. The trunk is narrower at the top than the bottom and thus does not allow for the same amount of leaves at the bottom. You are always willing to spend capital because you can still see there are millions and millions of dollars waiting to be taken from the tree, but no one can reach them.

Eventually you come to a point where you can see there is some amount of money left (say one million dollars) to recover but to reach it you have to have some new piece of special equipment or technology. You go to the store to get this equipment and see the price tag of 1.2 million dollars. You do not need to be a financial analyst to conclude that the remaining one million dollars on the tree us unatainable. You forgo purchasing the equipment and let the tree sit in your back yard, occassionally looking up at the remaining cash at the very tip of the tree knowing it is not economically recoverable.

This is my very simple analogy to oil production over the last 60 years. Private enterprise and Nationalised companies went after the cheapest and easiest to obtain oil right away. There were some parts in the world where it was flowing out of the ground on its on will. For a long time oil drilling consisted of mainly sticking a big pipe in the ground and letting the massive natural pressure of oil wells push it into billions of barrels. This kind of drilling and production no longer exists. We are presently about halfway up the tree. Oil is becoming more difficult to produce and discover. The extremely high quality oil we are producing these days is running out and the oil we are discovering is of a much lower quality. I think it is safe to say that another oil myth is the belief of most people that a barrel of oil produced in Saudi Arabia is the same as a barrel of oil produced in Norway is the same as a barrel produced in Indonesia is the same as a barrel produced in Texas is the same as a barrel produced in Venezuela. Fields and reservoirs within 250 miles of each other contain very different qualities, let alone fields and reservoirs from different countries. Low quality oil (the heavy sours) is far more expensive to refine into usuable products than our current production of high quality oil (the light sweets).

We have extracted an esitamted half of total world reserves. This half was the easiest and cheapest to produce. The second half is in much more difficult-to-extract locations within borders where the governments are authoritarian and have a general dislike toward the Occidental, oil consuming countries. A heavy price will be paid to obtain this oil. There is no swing producer that can match an unexpected surge in demand with a similar surge in supply. Price gouging is a completely different issue which deserves attention and investigation by the government.