Date created: 12/4/07
Last modified:12/4/07
Maintained by: John Quiggin
John Quiggin

Here's fuel for thought

Australian Financial Review

31 March 2005

Oil is the classic example of an exhaustible resource (there’s a charming, but apparently false, belief that it comes from decayed dinosaurs) Whenever the price of oil rises sharply then, people start asking whether this is a mere market fluctuation or an indication of the impending exhaustion of the resource.

Of course, oil will never simply ‘run out’. As the supply of any commodity declines, prices increase and, for relatively low-value uses, the costs exceed the benefits. Where they are available, low-cost substitutes become more attractive.

Before the 1973 increase in prices, oil was commonly used as fuel in electricity generation and home heating. Following the increase in prices, most oil-fired power stations were converted to gas or coal. Where natural gas was readily available, the same was true of home heating. The relevant question then, is not whether oil will run out, but whether it will become so scarce as to be uneconomic in its main uses, the most important of which is as fuel for motor vehicles.

The price of oil is typically quoted in $US/barrel, for some specific grade of oil such as West Texas light sweet crude. This need not be an accurate indicator of the cost of oil in general, because of variations in the purchasing power of the US dollar and because the relative prices of different types of oil fluctuate. The current upsurge in prices is due in part to the devaluation of the US dollar against other major currencies.

Critics of predictions of resource exhaustion have plenty of history on their side. In the 19th century, the eminent economist W.S. Jevons predicted the imminent exhaustion of reserves of coal. He was wrong, as were a series of subsequent prophets of resource exhaustion, most notably the Club of Rome in the 1970s.

Time after time, scarcity has been met by new discoveries and by improvements in resource technologies that have made it economic to extract resources from sources that were once considered valueless. In the case of oil, the estimate of ‘proven’ reserves in 1973 was 577 billion barrels. The Club of Rome pointed out that given projections of growing use, reserves would be exhausted by the 1990s.

The economic slowdown from the 1970s onwards meant that the actual rate of growth was slower. Nevertheless, between 1973 and 1996, total usage was around 500 billion barrels. Yet at the end of the period, estimated reserves had actually grown to over 1000 billion barrels. This is a pattern that has been repeated for many other commodities, and should give pause to any advocate of the exhaustion hypothesis.

Yet believers in the exhaustion of oil reserves have some history on their side too. Their key exhibit is the Hubbert curve which is supposed to show that oil output from a field should peak about 25 years after discovery. The big success for the Hubbert curve was Hubbert’s 1956 prediction of the peak in US oil output around 1970.

Hubbert’s model implies that world oil output should have passed its peak a year to two ago. The current period of high prices and short supply gives some support to advocates of the Hubbert peak.

The really striking events have been those relating to reserves. For the first time, downward revisions to estimated reserves have become commonplace.

The Shell company has been the most notably affected so far, being forced to announce a series of downward revisions in estimated reserves. But there have also been suggestions of similar problems in many other oil-producing countries, either because reserves have been overstated for political reasons, or because fields have been mismanaged.

Of course, some fields are still expanding. For example, new leases are being issued for deep water prospects in the Gulf of Mexico. But the very fact that such marginal prospects are being explored is an indicator that oil companies expect high prices to persist.

Then there is the possibility that oil can be economically extracted from sources such as shales and tar sands, which contain vast quantities of oil, but have proved too costly to process. Some promising results have been reported recently from Canadian tar sands. On the other hand, the recent abandonment of plans to develop the Stuart oil shale deposit near Gladstone is an indication of the difficulties with these sources. To adapt an old saying, it seems that shale oil is the fuel of the future, and always will be.

On balance, current high prices are likely to persist and to rise over time.

John Quiggin is an Australian Research Council Federation Fellow in Economics and Political Science at the University of Queensland.

Read more articles from John Quiggin's home page

Go to John Quiggin's Weblog