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Proven reserves of failed predictions:  The debate over peak oil

By Peter Anderson
web posted October 27, 2014

This year, a prediction that was posited 11 years ago was disproven.  It was not as though this were some random prediction either:  this was the International Energy Agency's official prognostication for Peak Oil.  Set in 2003, it has been false ever since.  Each year the world's proven oil reverses expanded and 2014 was no exception.  The IEA was wrong.  But they were not the first to suggest such a hypothesis.  John D. Rockefeller's former business partner predicted that the oil fields found in Pennsylvania were a small discovery that could only last a few years.  He left the enterprise and it was Rockefeller alone who reaped the rewards of his gamble.  Peak oil is an elusive guess for the year that oil production will stop increasing and begin to decline.  Starting with predictions from the mid-19th century about running out of coal, well respected scientists, geologists, businessmen and economists have projected a possible date for the end of the oil boom.  It has yet to arrive.  Milton Friedman, in his lecture, The Energy Crisis:  A Humane Solution argues that peak oil is nowhere in sight.  Despite the fact that he presented this speech almost thirty years ago, his theory is no less true today.  First, he presents a measurement of peak oil, or how we can know when we have reached it.  Second, he points out that ever improving technology has benefitted the oil industry in the past and will continue to do so in the future.  Taken together, these demonstrate that we are nowhere near peak oil, and almost certainly will not be by the end of our lifetimes.

Before we can debunk a theory about slowing oil production, we need an objective criterion to find out whether or not we're there, in much the same way as our inability to know for certain whether a particular train has arrived without actually seeing it pull into the station.  Friedman's indicator is price.  Not just price at the pump-- that fluctuates daily.  In order to truly see a long term trend we need real price, price, adjusted according to other prices and taking into account inflation.  His rationale is as follows:  if there were a known date oil supplies would be consumed, oil companies would be much less likely to sell oil today.  Likening the situation to the price of diamonds, Friedman notes that if the owner of a diamond thinks the price of diamonds is as good now as it's going to get, he'll begin extracting and selling diamonds.  But if, on the other hand, there's an indication that those diamonds might be worth much more ten or twenty years from now due to increased scarcity, the owner will most likely leave them in the ground, to be removed at a later date.  Applied to the oil industry, if drilling companies believe that reserves are running low, a natural shortage will result.  Viewed from a supply and demand perspective, quantity supplied will drop, forcing prices up.  If this is the case, oil companies will conserve their oil, waiting for prices to rise sufficiently for them to make a better profit.  Of course, all prices must be adjusted for inflation.  And what Milton Friedman noted was truly amazing:  to the average consumer's eyes, oil prices rose steadily between 1950 and 1970.  But he realized that the real price of oil, adjusted against the prices of other goods and inflation, had actually declined during that twenty year period.  Now we have an objective measure for the point of peak oil. 

Unfortunately, one factor upsets the beautiful price criterion:  government influence.  It wasn't necessarily the US government, although that did play a role.  More importantly, it was the Organization of Petroleum Exporting Countries (OPEC) established in 1973.  OPEC oil ministers can set artificial prices of oil by restricting oil sales creating a lack of quantity supplied which drives up prices of gas at the pump.  This enables them to make a much larger profit.  It also makes it hard to judge oil's real price.  However, in spite of OPEC, real price gives us a way to determine an end to reserves.

According to Friedman, one branch of the oil industry has allowed us to continue increasing energy production:  technology.  Due to a long series of technological improvements, oil companies find more efficient ways to extract oil than ever before.  The latest of these advances is hydraulic fracturing, also known as fracking.  Just as Whitney's cotton gin revolutionized the cotton industry, this new technique enables energy companies to remove more natural gas than ever.  Fracking hadn't been invented when Friedman gave his speech.  But it's one of a number of new technologies, like horizontal drilling, multilateral drilling, complex path drilling and enhanced oil recovery, which have enabled people to extract more fuel at a lower cost with less environmental impact than was previously believed possible.  Technology is the real catalyst behind our continuing fuel supply.

When it comes to peak oil, determining the actual date is very difficult.  Many predictions are formed each year.  Each year many more are proven false.  However, we will know when we reach peak oil, thanks to Friedman's criterion of real price, and we can assume that oil production is going to continue to expand for a long time yet, thanks to countless technological advances each year in addition to the discovery of new oil reserves. ESR

Peter Anderson is a high school Junior who lives outside of San Francisco, California.  This essay was written for an AP Macroeconomics class in October, 2014.  He can be reached at ptranderson1355@gmail.com

 

 

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