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Are IEA oil forecasts unrealistic?

19 Dec 2012 - {{hitsCtrl.values.hits}}

The International Energy Agency (IEA) has provided an unrealistically high oil forecasts in its new 2012 World Energy Outlook (WEO) according to Gail Tverberg and reported in the Oil Voice Magazine of December 2012.

The IEA claims that the US will become the world’s largest oil producer by 2020 and will become a net oil exporter by 2030.

One reason that the WEO 2012 estimates are unreasonable is because the oil prices shown are comparatively low relative to the production amounts forecast in the report. This is mainly because easy –to –produce oil becomes depleted and when more difficult reservoirs are tapped, the cost of extraction will increase.

The economically extractable oil referred to as “tight oil” is already reaching its production limits, at current prices. The only way these production limits are to be overcome is with high oil prices much higher than the IEA forecasts.

High oil prices cause a serious problem because of their impact on the world economy. IEA has stated that the current high oil prices are already affected the global economy .Accordingly higher oil prices also mean that investment costs required to reach target production levels will be even higher than forecast by IEA which is another impediment in reaching its forecast production levels.

If higher prices put the economies of oil importing nations into recession, then oil prices will drop lower, reducing the incentive to invest in new oil production infrastructure. Accordingly we will find ourselves at the peak of oil extraction termed “peak oil” because of an economic dilemma: while there seems to be plenty of oil available, the cost of extracting it may be reaching a point where it is more expensive than consumers can afford. As a consequence, some oil that we have discovered and counted as reserves, will have to be left in the ground.

The IMF has recently done modeling that is relevant to this issue in a working paper called “Oil and the World Economy Some possible Futures” This analysis may provide some insight to the real situation.

Problem of diminishing returns
It has been revealed that the IEA has not properly modeled the issue of declining resource quality, leading to diminishing returns and a rising “real” (inflation adjusted) cost of production. This situation is referred to as declining Energy Return on Energy Invested (EROEI)

The reason for the problem of diminishing returns is because when a producer decides to extract oil, or gas or coal, the producer looks for the cheapest easiest to extract resource first. It is only when this resource is depleted that the producer seek locations where more expensive, harder to extract resource is available. Thus over time, the inflation adjusted cost of extracting a resource tends to increase.

The issue of diminishing returns exists for any kind of resource. It exists for uranium extraction, gold copper and other kinds of metal as we need more oil in extraction and processing as we go deeper to find ore that is mixed with a higher proportion of waste products.

The problem of diminishing returns also holds for renewables. The first bio fuel developed was ethanol from corn, since the process of making alcohol has been known for ages. Newer methods such as ethanol from biomass and bio fuel from algae tend to be more expensive. Accordingly when we add new biofuel production, it is likely to be more expensive and if we want it, we need increasingly high subsidies.

Wind energy where Sri Lanka is trying to embark on is also subject to diminishing returns. Onshore wind was developed first and is far less expensive than offshore wind, which was developed later. Early units of wind added to an electric grid do not disturb the electric grid to a great extent. Later units of wind energy add increasingly large costs: long distance transmission lines, electrical storage and other balancing –something generally overlooked in making cost analyses.

Shale Oil
Shale oil also referred to as “Tight Oil” according to the IEA is the oil savior of the US and the best known examples are the Bakken and Eagle Ford.
It has been reported that drilling wells in the Bakken already seems to be reaching diminishing returns. The choicest locations appear to have been drilled first, and the locations being drilled now give poorer results as average well in Bakken now requires a price of US$ 80 to 90 barrels, which is closer to the recent selling price.

Oil extracting cost growth rate
Bemstein Research recently published information showing that the marginal cost of oil production was US $ 92 barrel in 2011 for non OPEC countries, non Former Soviet Union oil producers at the 90 percentile of production The cost is increasing at 14 % per year( or about 12 % a year in inflation adjusted terms)

If we take $92 barrel cost in 2011 at the 90thpercentile of production and increase it by 7% a year the real cost will be $169 per barrel in 2020.and $467 a barrel in 2035.

IEA WEO 2012
It is also recorded that IEA has not analyzed three more issues in a realistic manner.
w Rising Real Need for Fuels : the analyses of real need for fuels according to the changing economic factors have not been attempted. The need for fossil fuel will rise with increase in infrastructure such as roads bridges etc, building of schools, hospitals etc. Most of these fuel services will need to come from fossil fuels rather than renewables. Renewables especially from biological sources are limited to the needs of 7 billion humans.

Substitution for Oil: the time factor for such substitution is not real as given by IEA. The development of new plants to use the new fuel or conversion of one type of fuel to the other has also adds to the demand for fossil fuels. Only the heavier portion of natural gas liquids can be added to directly to gasoline. Most of the natural gas liquids are used for other purposes or making liquid petroleum gas (LPG) used for cooking and operating vehicles that have been designed to use it.

Efficiency gains The IEA has assumed that efficiency gain can have a big impact on the need for oil. However when a device is made more efficient, the usual effect is that it can be operated more cheaply. This means more people can afford it , and demand may increaseAnalyzing all the above issues it is clear that the IEA oil estimates are too high unless prices are much higher. However higher prices will cause the economy to go into recession .As a result production both for the US and the rest of the world is likely to be much lower than forecast by the IEA.
A better estimate of the world oil forecast and energy outlook could be studied by adapting the indications of a new IMF working paper titled “Oil and World Economy :Some Possible Futures” This paper considers some unknown time , between now and 2020, when the rate of increase in oil supply is assumed to increase by 1%While it is not stated in the report it appears to Gail Tverberg that this is similar to what really happened about 2005, when the rate of oil production increase dropped from 1.3% annual increase to 0.1 %a 1.2% decrease and certain adjustments to the IMF model have been suggested.

In conclusion Gail Tverberg has given the following views:

World crude oil production seems to have hit a plateau, starting about 2005 dependent on the economy with varying effects over time. The major effect at this point of time seems to be on the finances of governments that import oil.

As the price of oil rises, the price of food and commuting tend to rise. Both these are considered essential by most consumers, so they cut back on discretionary spending, to have sufficient funds for the essentials. This leads to layoffs in discretionary industries, such as vacation travel and restaurant eating. The rise in laid off workers leads to an increase in debt defaults, and problems for banks. Housing and commercial real estate prices tend to fall , because of reduced demand, further adding to debt default problems.
Governments of oil importers (such as Sri Lanka) gets effected in many ways (1) Their revenues are reduced because they receive less tax revenue from people who are laid off from work and from businesses with less sales (2) They are asked to prop up failing banks, and to stimulate the economy (3) They are asked to pay workers who have been laid off from work.
The total sum of all this is the governments of many oil importers find themselves with huge budget deficits, and declining ability to fix these deficits. This pattern is precisely what is seen today in many of Euro zone countries, US and Japan.

The IEA WEO 2012 statements about rising oil production in the US are just a distraction. Diminishing returns mean that US oil production will never increase very much. Oil costs will remain high, and this will be the real issue disturbing economies around the world.

(The author is a retired Economic Affairs Officer, United Nations ESCAP and can be reached via [email protected] )

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Are IEA oil forecasts unrealistic?

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