Upon occasion, I’ve been accused of having, shall we say, an uncharitable attitude towards the self-styled "science" of economics.
I firmly believe that not all economists are Dungeons and Dragons geeks in suits or political sycophants whose only talent is covering their guesswork with a fog of intentionally obscure jargon. It’s just the 98 percent who give the rest a bad name.
However, when one stumbles on one of the rest, it’s worth noting. I’m greatly enjoying The Political Economy of World Energy: an introductory textbook by Ferdinand E. Banks. Professor Banks is like vodka: sharp, clear, and delivers a strong kick.
He has his flaws — he has a serious jones for nuclear power stations, greatly underestimating their capital costs, and is quite a bit too optimistic about hydrogen as a fuel. But he freely admits his limitations, and his writing is so good that you can forgive him his mistakes.
Here is an excerpt from his brief introductory survey of world energy. I chose this excerpt because it’s not only fun but because he makes a number of important points about how we tend to think about energy and economics. Enjoy:
I picture this chapter as a long and important review of topics that many readers will someday expand and present to students, colleagues, friends, and even enemies. For instance, imagine my surprise (and near panic) when I was severely chastised (at the 22nd international meeting in Rome (Italy) of the International Association for Energy Economics) for daring to express my belief in interpretation of the Reserve-Production (R/q) ratio for petroleum similar to that which will be presented in some detail in this book.
I also became the object of some “attitude” on the part of other delegates what I made a friendly remark about the work of Dr. M. King Hubbert [sic — Hubbard] that dealt with the ultimate availability of petroleum. Among other things, I was sanctimoniously informed that oil reserves are “dynamic,” and basically are dependent on human ingenuity (i.e., technology) — which as all thoughtful persons are supposedly aware, would ultimately come scampering to the rescue in case the energy wolf appears at the door. Finally, I was assured that economics and technology were always the correct aperture through much oil reserves should be scrutinized. Geology was taken to be of minor importance.
As a comment on the situation, the Financial Times (10 January 2005) said that Western oil consumers will be able to deal with the competition for Middle East oil by countries like the above for some [China, India, South Korea, and Japan] by turning to non-OPEC sources such as the North Sea, Gulf of Mexico, west Africa, the Caspian, and Russia. One certainly hopes that the governments of the “Western” countries do not take this kind of advice to seriously because, in about a decade, by my calculations, all of these will be greatly reduced significance where the ability to export oil is concerned. In fact the UK North Sea is already in irreversible decline.
One of the reasons why we have to suffer so many errors of judgment on the part of various observers of the oil seen is that their fundamental mode of thought is still many years in the past when the global consumption of oil was for example 50 million barrels per day (mb/d), and could fairly easily be raised an extra million barrels or so (per day) by increased exploration and drilling, and/or a wider or more intensive application of various scientific or technological improvements to existing deposits. During the year in which this is being written, however, with consumption approaching 86 mb/d and a predicted need to add well over 1 mb/d to output every year over the foreseeable future, it could be a momentous indiscretion to accept or even to contemplate theories claiming that new projects in exotic locales can sort compensate for the near stagnation in production that could take place in certain oil-rich countries if those states decided to exhibit the same interest in their own long-range economic development as they have graciously shown in ensuring an adequate quantities of this vital commodity reached their clients.
For example, both the IEA and the US Department of Energy once suggested that one of the reasons why there will not be a peaking of global oil production in the next two or three decades is because Saudi Arabia has the capacity and willingness to produce 20 mb/d of oil in the not too distant future. However, as I point out in Chapter 3 of this book, it is unlikely that the Saudis would sign up for a _sustained_output of more than 12 mb/d. As for their capacity to go much higher, even if they were willing, this is also dubious according to influential observers of the oil markets like Matthew Simmons, a Houston (Texas) investment banker and former adviser to President Bush, and one of the leading oil consultants, Hermann Franssen (2005).
Furthermore, although one well-known oil optimist is correct when he repeatedly points out that “we keep looking for more oil, and finding more oil,” he invariably forgets to note that, in terms of quantity, the aggregate amount of oil discovered is on a falling trend. Nearly 365 billion barrels of oil were discovered in the 1960s, about 275 billion barrels in the 1970s, 150 billion in the 1980s, and the figures I’ve seen for the 1990s suggest that less than 40 billion barrels were put on the books. My lectures on oil always begin with this unpleasant piece of information. At the present time, only one barrel of oil is being discovered for about every three being consumed, which I choose to interpret as the worst possible news for anyone on the buying side of the oil market, regardless of the relationship they may have to goods and services using oil.
It should also be noted that even if it were true that technology is “overwhelming natural depletion” — as some oil optimists still claim — and reducing costs all along the line, without an increase in the amount of oil discovered, preferably in the form of larger deposits, production cannot continue to rise. This is one of the major results derived from the work of M. King Hubbert [sic], and clearly explained in this book as an economic as compared to a geological phenomenon. It is probably worth mentioning that few, if any, executives of the major oil companies in any part of the world expect a major alteration in the existing supply-demand picture, regardless of what they may say when the TV cameras are turned in their direction.
Put as simply as possible, some firms are to all intents and purposes looking harder than ever for oil, and it is not unthinkable that they will succeed in finding more; but collectively they are moving farther away than ever from finding enough. Take as an example the Russian Federation. It was recently announced that the largest discovery in 10 years has been made in the Caspian Sea. what this “find” comes to in production terms might eventually be 100,000 b/d which is paltry: it amounts to only slightly more than 1% of present production. (I can add that with economic growth picking up in Russia, and additional energy required for electric power and vehicle fuel, the position of that country as oil exporter is destined to weaken.)
The fallacy of composition comes to mind here — the simple fact that if something can be done on a small scale, it causes inattentive observers to jump to the conclusion that it can be done on any scale; however, you can be confident that the persons in the executive suites of the large firms are active in places like North America, the Caspian region, the Gulf of Mexico — or any other region or golf — are not confused by incidental statistics, nor the fallacies to which they may give rise. With a huge number of wells drilled, every large firm in the US, as well as the government of that country, now realizes that even a much higher success ratio cannot keep the (domestic) production/import ratio of the US from descending. During the period reviewed above, US imports of crude and refined products moved from being important to being crucial.
Some attention can now be paid to the R/q ratio (which actually ties in with the work of M. King Hubbert [sic]). The concepts that are presented below are gradually being understood to the extent that they deserve, although not fast enough as far as I’m concerned, which is one of the reasons I make it my business to repeat them as often as I can. An irritating problem here is that even many outstanding microeconomic textbooks to which our students have access insist upon treating the production of depletable resources in terms of an almost completely inappropriate model developed by a brilliant economist, Hotelling (1931). This exaggerated and scientifically meaningless respect for elegant irrelevance is one of the major reasons why academic economics is increasingly subjected to ridicule. “Narrow rationality” is what the superstar physicist Murray Gel-Mann has termed this kind of behavior, which features (easily) quantifiable nonsense being rated far above non-quantifiable plausibility.
A few observations were offered earlier about the comparatively low recovery factor of oil reserves from oil-in-place. This is not a satisfactory state of affairs, but there is not much that can be done about in the short run. The production of conventional oil involves reservoir fluids flowing under pressure out of reservoir rock into a production well (or borehole). Initial production tends to be constant for a period ranging from several days to several years. Then, as pressure drops in the oil has to move a longer distance through the reservoir rocks in order to reach a given borehole, the output will tend to decline — ceteris paribus. One of the things that will reduce the pressure is a too-rapid depletion. This can result in the deposit being damaged, which in turn makes the oil more difficult to extract (for the same cost), as well as decreasing the ultimate recovery factor. Now we see why the R/q ratio is so important: when operating below the crucial R/q ratio … we are overworking the deposit. Something else that should be recognized is that petroleum engineering is a serious profession, and few economists have the background to understand the more abtruse facets of oil production. Thus, for economists, levels and changes in the R/q ratio can, if properly interpreted, sum up considerable important geological information.
(Of course, in the great world of neoclassical economics, it is unnecessary to worry about this kind of dilemma, because a comprehensive set of perfectly competitive spot and futures markets are theoretically capable of providing rational producers and consumers with the scarcity prices needed to make perfect decisions. As noted in a later chapter, in the real world we do not have — nor will we expect to have — anything approaching this ideal.)