More thought on oil economics

Through the wonders of modern technology you can actually track the current positions of the cars in the North American Solar Challenge by GPS and see where they are in almost real time. What with that, and the new Harry Potter . . . .

Actually I would like to continue the dialogue that Econbrowser started, and which continues both there and in comments there and here. I am helped a little in this by an article in todays St Louis Post Dispatch, to which I will refer in a bit.

Rather however, this time, responding to specific comments Econbrowser has made, I would like to review the history of oil production to emphasize three points, which may clarify the issue. If I appear to oversimplify, please feel free to help us out in this debate, but I want to talk about the reasons for the Texas Railroad Commission and OPEC; that oil companies drill with your money not theirs; and that, once a well starts producing, owners will keep it going even if they lose money. (and along the way try and answer JimBobRay on the open thread).

When oil first came on the market there was not enough to go around, and prices were attractive enough to encourage many people to sink oilwells and get on the bandwagon. The first Texas oil well began production in 1866, but it was not until Spindletop was brought in during 1901 the price of oil fell to $0.34 a barrel. This led the Texas legislature eventually, since oil flowed in pipelines, to declare pipelines common carriers and to give jurisdiction over them to the Texas Railroad Commission in 1917. This responsibility rapidly grew to include "the conservation of oil and gas, forbidding waste," (1919). This gradually gave the commission increasing power over the oil industry and in 1927
First voluntary proration in Texas is accomplished by limitation of production to a figure below the capacity to produce, and attended by a distribution of allowable production among the operators in the Yates Field. By agreement of the operators with the blessings of the Railroad Commission.
Gradually this proration went from being voluntary to being ordered by the Commission and in 1930
Railroad Commission issues first Statewide Proration Order with effective date of August 27, 1930 to limit the production of the state to 750,000 barrels per day. This order represents a cut in the production from previous year of some 50,000 barrels, and is based on the reasonable market demand formula.
From then on the Commission controlled production to ensure that it met demand while allowing keeping the price at a level that made it profitable for the oil industry to pump the oil.

However to steal a quote from Kenneth Deffeyes book "Hubbert's Peak" (via Green Car Congress
Hubbert's prediction was fully confirmed in the spring of 1971. The announcement was made publicly, but it was almost an encoded message. The San Francisco Chronicle contained this one-sentence item: "The Texas Railroad Commission announced a 100 percent allowable [i.e., produce full out] for next month." I went home and said, "Old Hubbert was right."

With Texas, and every other state, producing at full capacity from 1971 onward, the United States had no way to increase production in an emergency. During the first Middle East oil crisis in 1967, it was possible to open up the valves in Ward and Winkler Counties in west Texas and partially make up for lost imports. Since 1971, we have been dependent on OPEC.
And of course OPEC, had the same purpose. From "The End of Oil" by Paul Roberts
"On September 14, 1960, Venezuela persuaded Iran, Iraq, Kuwait and Saudi Arabia to form the Organization of Petroleum Exporting Countries, or OPEC, a political entity that would bring new meaning to the idea of oil as a political commodity – and in the process utterly reshape the world political order. No longer would the major oil companies dictate the price of oil. Over the course of the 1960's OPEC – which eventually included Algeria, Indonesia, Libya, Nigeria, Qatar and the tiny United Arab Emirates – began collectively raising the price of oil and forcing the majors … take back some of the burden of adjustment."
They discovered their power in 1973 when
First OPEC unilaterally raised oil prices by another 70% to $5.11. Next, in response to the 1973 Arab-Israeli war, OPEC's Arab members embargoed oil shipments to the United States and the Netherlands. . . . . . .the West could only sit and watch as oil prices more than quadrupled to well over $20 a barrel.
But in those days OPEC also got greedy, not recognizing at the time that there were other producers, demand could be reduced and other fuel sources could be developed. And so by 1986 world oil demand had fallen by 5 mbd.

Roberts goes on to describe how Saudi Arabia then went on to get control by OPEC, first by cutting its own production from 10 mbd in 1980 to 2.5 mbd in 1985, and when this did not work, then flooding the world market with oil.

This had several effects, one of which was to stop almost all research into alternate fuels, since there was, in the short term, no longer any need of them.

And since then, until the last year, OPEC controlled production from their members, and to a large degree, also the world price of oil. But now, in the same way as happened to Texas, OPEC members can sensibly produce flat out and the quotas set are being over-ridden without any meaningful action.

Thus we have the major producers in the past making decisions about oil production and price for reasons that extended beyond just the immediate need to make money.

To move on to the second point. Which is that, in many cases, the oil companies drill with other folks money, rather than their own. What is not commonly discussed is the risky nature of the oil business. Even in the North Sea the current success rate for a well is only about 1 in 8, while in America it used to be 1 in 15, and may well now be worse. Thus, from the time (mentioned yesterday) that Howard Hughes Senior charged folk $30,000 per well to rent his drills, the industry has had a habit of using other folks money to drill with, rather than their own. Consider for example, the story from today's Post Dispatch
If oil producers need inspiration, they need look no further thanBen Webster and his Deep Rock Energy LLC.

On March 16, 2002, Webster made Illinois' biggest oil find in decades. The company partnered with Ceja Corp., based in Tulsa, Okla., and drilled Warren No. 1, a $1.6 million wildcat that went 3,900 feet vertically and about 250 feet sideways under Forbes State Park.

Briefly, it was the biggest producing oil well in the lower 48 states at about 3,800 barrels a day. It made Webster a celebrity in his hometown of Salem, Ill. So far, the well and others drilled in the same field have produced more than 1.5 million barrels. It has benefited not only Webster and his family but 140 royalty owners, including the state.
But the story contains within it the answer to JimBobRay.
Today, though oil is still being pumped from the Oblong Field, which began producing in 1908, Illinois' total annual production stands at just over 10 million barrels. That's less than 1 percent of the U.S. total.

Most wells in Illinois are known as stripper wells, run by mom-and-pop operators that produce about 2.5 barrels a day. Only a few produce more than 1,000 barrels a day.
Many oilwells cost over a million dollars to drill, and most of the existing oilfields have lost pressure so that they can only now be pumped to produce these low numbers. At these low rates the well can continue to provide this amount of oil for decades, at the bottom end of the production curve. There is no longer the higher reservoir pressures that made the oilfields self producing, but the lower volumes can be sustained much longer.

And the final point is another quote from the same article:
Two crashes devastated the petroleum industry. In 1986, oil prices tumbled to $11 from $26.50 a barrel. In December 1998, the price bottomed out at $8.64 a barrel - below the cost to produce it.

Still, many companies continued operating at a loss, because they didn't want to lose their leases, labor and equipment.

"It's unbelievable what this industry went through," said Richard Straeter, president of Illinois operations for Enid, Okla.-based Continental Resources Inc., one of the region's biggest producers. "Numbers had to be reduced so drastically that office staff had to go out in the field."

Many small producers and oil field service companies fell behind and eventually went out of business.
It is a very good article and well worth the read as it explains what has happened and is happening in the Illinois Oil Basin, and pointing out some of the problems that the industry is facing, as well as the riches.
Technorati Tags: ,

> that oil companies drill with your money not theirs;

I think it's slightly misleading.

> the industry has had a habit of using other folks money to drill with, rather than their own.

Is more correct. This peticular issue is not a good one to use when trying to express a position for positive energy policy change. Realistically, who doesn't use someone elses money for business ventures or even everyday folks when they take out a loan for a house or small business capital.

JimBobRay & other readers,

This is a great example of how "they" spin you mind around even the simplest of concepts.

Your mind can easily understand how a single oil well goes through the phases of high pressure gusher, followed by ever slowing rates of extraction. It never totally runs out. There is always one more drip leaking through the spigot, albeit not as vigorously as the one before it.

The nay sayers of Peak Oil try to change the question. They demand that YOU prove that ALL the oil wells ALL over the world are simultaneously follwing this path and that after YOU have added up ALL the flow rates from all those wells, you can show there was a magical day on which "peak" extraction occurred. And even if you did it, they would say so what, you've proved nothing.

Your mamma may have told you about "proving the negative",
that it can't be eaily done. (Probably after explaining about life and the box of chocolates at Mr. Wonka's factory.)

The reason why it is next to impossible to prove the negative is because to do so you got to turn over every single stone in the ENTIRE universe all at once and show it ain't under this rock. Your focus should be on the word "entire".

That is why world-wide Peak Oil is a tough concept to grasp or prove. No one can race all around the globe and verify the situation at ALL the wells ALL the time. They got you chasing after your tail. One well at a time is good enough.

Let "them" prove that each new well was not the last great one of its class.

If we have diminishing finds, which we do, that indicates that we are sliding down the slippery slope. If we have to go to harsh places like ANWR, that proves we are getting desparate.

I think trying to 'prove' Peak Oil to people is an excersise in wasted energy. More effective (and easier) is to talk about the current problems that exist and then guide the discussion toward where these current problems will lead to in the future.

Discuss how gas prices are so high (for everyone) and
how that seems to be related to the price of oil (for everyone) and
why the heck oil and gas are so expensive now (for everyone) and
maybe China/the rest of the world has something to do increase on demand and
big oil companys are not expecting supply to go up

All things that average people can see for themselves.

Talking about the future implications becomes much easier then.

Speaking of economics,
if you have access to NewYork Times (free registration)
check out Krugman's editorial today (7-18-05): Hello Houston, Our Gauges Are Not Working --unemployement gauge is green but all other gauges say its lying.

"Thus we have the major producers in the past making decisions about oil production and price for reasons that extended beyond just the immediate need to make money."

I don't see your examples as demonstrating this principle. Forming cartels is purely motivated by making money. Trying to break or dominate a cartel as the Saudi's did in the 80s is also about making money.


It is not just about "proving" Peak Oil to them
It is about how you warn them at all
Will they listen or glaze over?

Imagine this scene:

White Feather?

It is I.

Smokes with BS.

Sorry to hear.
I've had "a vision".

Tell me.

I call it
..... Lemmings on the Ledge.
Go on.

The Great Herd moves on, grazing off what the ground gives them.
There are many.
6 Billion by one count.
Those in the front are fat and happy, having first found the easiest grasses.
They look only at the feast in front of their faces.
Those in the back look forward, hoping to get a better slice of the pie in the future.
Near the advance fringe, a scout comes back. Worry wears on his face.
"I have found a large ledge," he begins.
So what? asks another.
There are no grasses beyond the ledge.
We will find alternatives, says a third.
I fear there are no alternatives this way.
What are you saying?
The herd is moving this way and it is a ledge with no future.
They will see it shortly and turn on their own.
What if they do not?
Who cares?
They will push us off with their momentum!
They are many and we are few. Their sheer mass will shake the earth and push us over!
Oh. Good point.
Well, then. We will just tell them.
We do not know how to speak to the masses.
How hard can it be?
They are short in attention and great in greed.
OK. We will break them in slowly.
First we will warn them that an important message comes their way.
Yes. Good idea.
We will speak in simple words.
We will tell them someone who knows the futures stands here.
Pass it back.
Tell them, "Great Prophet Ahead".
Go it.
Hey you guys, Great Profit Ahead !!!

The point is that programming the masses to even hear the message correctly is a great challenge.

My emphasis was on the word immediate in that, by dropping the price of oil, the Saudi's killed the justification for funding alternate energy sources and so while they lost money in the short term, there was a possible longer term gain (although that is also a debatab le issue).

BC wrote:

[1] Discuss [with average Joe] how gas prices are so high (for everyone) and

[2] how that seems to be related to the price of oil (for everyone) and

[3] why the heck oil and gas are so expensive now (for everyone) and

[4] maybe China/the rest of the world has something to do[with] increase on demand and

[5] big oil companys are not expecting supply to go up
[6] etc
[7] etc

[8] All things that average people [average Joe] can see for themselves.

Dear BC.
There lies the problem.
Average Joe is not listening or looking.
You see it. But he does not.
You start to talk. His eyes and ears cut you out.

There are many mechanisms for denial and delusion.

You say: [1] "Joe! Attention!!! Gas prices rising !!!!"
He says, "So what? They've always gone up. It's called inflation, stupid."

You say: [2] "Joe! Attention!!! It's related to oil !!!!"
He says, "Really? I don't believe you. They've always found alternatives. Heck there is coal gasification. They did in WW II, they'll do it again. There's tons of tar sands in Canada."

You say: [3] "Joe! Here boy. Attention again!!! Why the heck are oil and gas so expensive now? Answer that, hah."
He says, "Really? I hadn't been watching. Who cares? The markets will correct themselves. Now go away. I'm feeding here. You are annoying me. You are ruining my good times. I don't want to hear anymore of this doom and gloom sh*t. You've got tin foil around your head. You are the carzy one. Get a shrink. Get a life."

Got it?
Get it?

this site is a real treasure of info and links. thanks prof goose.

thanks Oz, we do what we can...
...but don't just thank me. imho, my colleagues are the reason this thing works.

I think anybody who has ever started their own business (without money from some trust fund or other windfall) gets investors and operates on other peoples money. The oilfield is no exception, although it has seen some extremes. But then so has the software, internet and computer biz world.

Using other peoples money is just about the only way to allocate losses with those type of dry hole ratios. Thank goodness there are always people looking for a tax loss carry forward - or else a lot of smaller oil companies wouldn't be here today.

I just hope that we don't have another oilfield economic bust - from what J has told us, it might just cripple our ability to move forward in the future.

It is difficult to see what, apart from a major world recession, would trigger such a bust at this time. World demand continues overall to increase and supplies are limited. As I mentioned before, one of the things that might be limiting some exploration and production development is this fear of getting stuck out on a llimb, but as this year has progressed there is a growing recognition, I belive, that the bust is becoming less likely.

No "oilfield economic bust" anytime in the future. I wish I had a "Mom & Pop" oil well, even an old one with some extractable stuff still left in the ground....

Re stepback:

I haven't had any problems discussing gas prices, oil prices, energy shortages with layfolks. My occupation gives me a bit of credibility in this regard, but I still think that most people can be lead to a realistic view of where we are and where we are going.

I agree with you that most people "can be" led to a realistic view on PO, on global warming, etc..

The question is whether they will be led to such a view *in sufficient time* so as to avert major catastrophes.

Obviously, when the sky finally is falling directly on your own head there is no more plausible deniability for the situation.

I guess people in Phoenix are starting to wonder whether denial of GW is still a realistic position:

Hopefully, most PO-aware folk do not want matters to degenerate to the catastrophe stage.

I do not see the joy in saying, "I told you so."

There are huge numbers of lay people who are still in deep denial regarding oil, gasoline, global warming, and other such matters.

stepback -

My guess is that until it becomes really painful to part with the money to fill an SUV up, most people will not want to know. My life experience has shown me that until women (mothers in particular) regard it as a very important issue, it will just sit there. Once it threatens the welfare or future of the children, it suddenly becomes very important, and then women take up the cause.

I am NOT trying to piss off the fairer sex. It is just that my experience leads me to inherently believe that when the female consciousness takes on an issue en masse, it is suddenly one that our patriarch government is forced to deal with... Women, whether we like it or not, tend to work together, communicate with each other rapidly and almost inutitively... this gives them a certain strength when things become important to them.

I know nothing motivates me or gets my attention like my wife on a tear or a rant about something. Thus my consciousness is forced to recognize and deal with things she views as critical or important.

Maybe this is what is missing in getting PO onto the radar screen?