Great Expectations: Revisiting Peak Oil

Crude oil supply expectations have changed over the last twenty years. In the late 1990s, the idea of “peak oil” was gaining popularity. The theory was presented by M. King Hubbert in the 1950s and popularized in the last quarter of the 20th century. Working as a geologist for Shell, he predicted US oil production would peak in the 1970s and then decline steadily.

Until recently, it appeared Hubbert was right. Production in the US did peak in the early 1970s and started a three decade decline…a sunset industry indeed. The peak oil theory is based on the premise that the amount of oil under the ground in any geographic region is finite. As resources are produced, pressure in the reservoir decreases, produced volumes follow a skewed bell-shaped curve, and the resource is ultimately depleted. Artificial lift technologies and other secondary recovery methods are used to extend the life of a particular well, but ultimately fields deplete and wells are plugged . . . the end.

US Crude Oil Production (Million Barrels per Day) 1920-2013

Source: EIA

US Crude Oil Imports (Million Barrels per Day) 1920-2013

Source: EIA

What the theory did not take into account was the technological innovation of horizontal drilling combined with the 60-year-old technology of hydraulic fracturing to tap into shale resources that were previously uneconomic to exploit. We always knew shale formations existed and could be exploited, but until the last 10 years it was not technologically or economically viable. Higher commodity prices have made the application of advanced recovery technology viable, thus revolutionizing the industry. Since the mid-2000s, US crude oil production is up 60% and crude oil imports are down 20%.

A technology called 3-D seismic imaging has helped map the earth below the surface. Seismic data is collected and mapped by sending sound waves into the ground that reflect off of different rock layers. Some argue the “shale revolution” is temporary in nature due to the high cost to produce from such resources and the sharp decline production profile. They argue it is simply creating a second peak in production, only to return to its inevitable decline.

Another thought is that we will see “peak consumption” before we see “peak oil.” The introduction of LNG, CNG, etc. into the market could turn more and more consumers away from oil. While oil has long dominated the transportation market, if an alternative fuel comes along that burns cleaner and is just as easy to access, oil’s days could be numbered.

This brings us to the concept of recoverable resources. Technically recoverable resources include all the oil and gas that can be recovered based on current technology and knowledge of the geology. As technology advances and as we learn more about the rock, this category can expand. Economically recoverable resources are a subset of technically recoverable resources that can be produced at a profit given the current price environment. As prices move up, this subset expands, and as prices move down, it contracts. Typically the capital cost to drill and operate in a particular play moves down over time as operators gain efficiency, which expands the volume of economically recoverable resources. Commodity prices and capital cost thus work together to determine how fast and to what extent resources are developed.

The US Energy Information Administration (“EIA”) estimates the US has 223 billion barrels of technically recoverable resources. Of our recoverable resources, 25 billion is “proved reserves.” Proved reserves are the most certain category within recoverable resources that can be produced under current economic conditions. This category expands as new wells are drilled and contracts as existing wells are produced. It also expands or contracts as commodity prices change. This is the category that is typically reported by public companies and filed with the SEC.

JD - Oil and gas resource categories reflecting varying degrees of certainty

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