In March 1998, two geoscientists by the names of Colin Campbell and Jean Laherrere wrote an article in Scientific American titled “The End of Cheap Oil” which explained that a peak in conventional (cheap) oil would occur within the next 10 years, leading to higher oil prices. The general public in the USA pretty much ignored the statements of this article (at their peril, by buying SUV’s and Hummers in the early 2000s), but we can see now, looking back, that Colin and Jean were correct! In April 2007, some oil company CEO’s even admitted that the age of cheap oil was over. In this post I will delve into the economic costs of oil exploration and extraction in this new age of the oil industry (this post grows out of Points 1 and 4 of my first post). I will not go into the social and environmental externalities of oil extraction, as there is enough there for hundreds of posts, and indeed entire books have been written about these externalities (e.g. Crude World by Peter Maas).
Exploration and extraction of crude oil has come a long way technologically from the days when Edwin Drake drilled the first commercial oil well in 1859. Today (2014), oil & gas companies use extremely sophisticated methods to explore for and extract crude oil from the Earth’s crust. These technologies include the use of supercomputers to create 3-D and 4-D (3-D over time) seismic models of oil and gas reservoirs to optimize exploration of new fields and optimize exploration of the peripheries of old fields. Extraction technologies include horizontal drilling and the notorious hydraulic fracturing method; which was developed in the 1940s (http://fracfocus.org/hydraulic-fracturing-how-it-works/history-hydraulic-fracturing).
Now, with the incredible rate of technological development over the past 155 years, not to mention increasing economies of scale, one would think that it would be easier and cheaper to extract oil from the crust than it used to be. However, this is obviously not the case, as the break-even price for developing shale (tight) oil wells ranges from $60 to $80 a barrel, not to mention the high costs facing deep-water oil wells and oil sands development (these are other examples of unconventional oil).
This is sobering. All of the incredible technological development in the oil industry has resulted in increasing oil prices over time, not decreasing. Yes, the USA is definitely extracting a lot more oil than before the boom began in 2009, but this oil is expensive, a lot more expensive than the conventional oil produced at the previous peak of oil extraction in 1970.
So why is the shale oil boom in the USA even occurring? If it is so expensive to drill for, couldn’t a company make more money by drilling conventional (i.e. cheap) oil? Well, yes, of course! The break-even price for Iraqi oil is only $20, as conventional oil is much more easy to produce than unconventional oil (think of the oil gusher scenes in the movie Their Will Be Blood). So we have a problem. The problem is that there aren’t really any large conventional reservoirs left in the USA to develop! That’s why the shale oil boom is happening now. Decline of conventional crude oil extraction caused world oil prices to rise making it attractive to drill in shale. The hydraulic fracturing technology has been around since the 1940s, but back then there were more than enough conventional oil fields to develop so the process was not widely used until around 2003 (when oil prices started rising).
Why do you think oil companies are trying to drill in the Artic or are drilling even deeper than the Macondo well (2010 BP Blowout) in the Gulf of Mexico? Why deep-water oil off of Brazil and Africa? Why oil sands? It’s because oil prices are high and the discoveries of cheap oil reservoirs have declined. There could be 5-8 trillion barrels of crude oil in the Earth’s crust, but at what cost and rate can we extract it, and how much of it is actually recoverable? We’ve already extracted around 1.2 trillion barrels of the easy stuff! If it costs $75-100+/bbl to develop the remaining oil then economies will try to switch to a different energy source for transportation, and the world economy will probably struggle to grow in the process. Which, interestingly, would be a good thing for controlling CO2 emissions.
Evidence for High Costs and Difficulties
Here are some articles indicating the difficulties and high costs facing oil companies in their race to extract the remaining crude oil from the crust:
Many oil companies are finding it very difficult to even explore for oil in the basins of the Artic Ocean, let alone extract any of it:
The Kashagan oil field in the Caspian Sea off of Kazakhstan was the largest conventional oil field discovery in the past few decades (discovered in 2000). Its development has been extremely problematic over the past 14 years:
Brazil’s pre-salt oil field discoveries were hailed as game changers by the media in 2007/2008 and yet 6 years later it is still hard to get oil out of them, though, very recently (summer 2014) the development of these fields maybe turning a corner; albeit at a very high cost:
Shell pulled out of oil shale (Note: different from shale oil) research and development last year after 31 years trying to figure out how to make the economics work; if they can’t do it at $100/bbl, what price do they need?:
Last but not least, Saudi Arabia, the king of conventional, cheap oil is now looking for oil and gas fields in the Red Sea:
Saudi Arabia has (supposedly) 268 billion barrels of reserves (virtually all conventional oil, cheap to produce) but they are now looking into the deep-water regions of the Red Sea for expensive-to-produce oil? That should be concerning, as maybe their supergiant conventional fields (e.g. Ghawar) are finally starting to show some wear.
Even the oil majors (IOC’s) admit that the easy oil is gone, yet they deny Peak Oil extraction will occur anytime soon. As such, they are presumably betting that the world economy is willing to pay $100-$150+ per barrel for the next few decades. That may not be the case as people are trying as hard as they can to give up fuel-intensive cars and trucks and looking for alternatives (electric cars, hybrids, public transportation, etc). In addition, global economic growth maybe hindered by triple-digit oil prices for the foreseeable future, thereby impacting demand for oil.
It seems to me (and to a lot of “experts”) that oil companies the world over are stuck between developing increasingly expensive oil and dealing with a world economy that is ready to shift to a different transportation fuel or method as soon as it becomes widely available (maybe cheap, driverless, electric cars?). All in all, the world oil companies will probably have to at some point give up spending more and more money on extracting expensive, unconventional oil and just become natural gas companies (this may already be happening due to the cuts in capital spending that many IOC’s are currently making).
If we include social and environmental externalities in the costs of extracting oil, then oil is truly becoming very expensive as we try to tap unconventional reserves like shale oil and oil sands. For unconventional oil there is just more social and environmental impact per barrel produced (e.g. CO2 emissions per barrel produced). It will be interesting to see how long the world economy is willing to put up with these increasing economic, social, and environmental costs.