Oil prices also affect oil costs
Posted by Heading Out on August 17, 2005 - 5:32am
I suspect that few of our readers have to buy a lot of the materials that go into an oil drilling operation. But those that do can tell you that the same rise in prices that is hitting your pocket is also hitting a lot of theirs. (And supply lead times are getting to be beyond a year for some metal stock). In this regard I am delighted to turn the podium back to J, for some comments both on this and the rock that oil is found in.
I plan on using that part of his post to help me explain, this weekend, why just making a hole in the oil-bearing rock does not turn out to be a good idea. Over to J:
In a comment by gabor on my last guest post was this comment
However, even beside that point, the major points of the comment are that people really do believe that if it isn't economical to produce oil at $60, then at $120 it will become profitable again, and poof! - the field is back online!
Sadly, they are skipping this one, all-important fact: once the oil is gone, it is gone, and no increase in price will make it reappear.
And they are missing the point that there are significant amounts of oil that simply will NEVER come to surface, because the permeability in the reservoir has changed since the oil first migrated, and as the rock moves it blocks the passages through which the oil was reaching the well bore! In many cases, this damage to the rock is due to the company using overly agressive high volume production methods.
Changing the price for the oil, even to $200/bbl, simply cannot fix these changes in permeability and free the trapped oil. The methods that can be used to fix the problem are already available and have been used at today's prices, but they require the one thing that is in short supply - TIME. And even when the well is restored, the recovered oil flow will never provide the high volumes of oil that we are currently operating with and used to. As a result these techniques, and the wells they are used in, are no longer qualified for the portfolios that the large corporations want to pursue.
Have any of you guys ever seen a "Christmas tree" depletion drawing? When you place a well in the middle of oil and start pulling oil out, the oil moves to the lower pressure around the well. This moving oil looks kind of like a Christmas tree, with the midline being the producing well. As pumping continues, branches get disconnected from the tree, and isolated from the rest of the big mass of oil.
Water flooding can chase some of these isolated patches to the well, but it is usually a 7/10 to 1 chase ratio – in other words it takes between 7 and 10 barrels of water to be pumped in in to produce every barrel of oil that comes out. And the barrel out is coming out WITH the 7 to 10 barrels that we used to flush it out with. Each of these gallons of now-contaminated water must be disposed of by being pumped into another, specially drilled well, which usually means it must also be trucked from the first well to the disposal one. And in-between times, the produced water must be separated from the oil, and that requires further energy input.
Due to the random nature of permeability and porosity within any sandstone reservoir, there is a certain percentage of oil that will always remain trapped. There are entire volumes of oil that will never flow to the well, because there is no effective path for them to reach it. This structural reality effectively divides the reservoir into compartments. To reach the larger, and more valuable ones, we have to drill a separate well into each compartment, and as the cost to drill climbs, larger and larger parts of the oilfield get left behind.
People will argue that CO2 injected fields CAN be put on stripper production. And yes, they just might be able to do that. But stripper wells operate at a lower than surface pressure, and the oil is manually pumped out, just like the water from a water well. What happens to the injected CO2 that we used to renew the reservoir pressure and drive the remaining oil to the producing wells? It doesn't just disappear - it has to be released into the atmosphere or injected elsewhere at high cost!! Frankly, this is a climate disaster waiting to happen.
What those who see oil production just as a process limited by price, are NOT getting is that rigs and pipe and cement and energy are all costs that oil producers have to pay. And that additional cost is also reflected in the new higher prices for everything made with oil. As we look harder and harder for more oil, this demand drives prices for the equipment and materials we use through the roof. For example the loss of the 5 jackup rigs leaving the GOM and heading for Saudi Arabia will we are estimating, drive prices for these rigs from $65,000 per day to $100,000 per day, and last year they were at $35,000!! This does NOT make the production of smaller fields more economical, because the price for oil is still too low to pay the new price for the rigs!!
When old equipment is retired, the new equipment, built with higher costs, must be purchased to replace it. With steel at a premium due to demand, these costs have risen 300%! Today, our basic costs have doubled in a single year, which matches what has happened to oil prices. So the net return on our investment is back to the same level - no change in overall extraction economics. All new projects now reflect the higher energy price inputs, and these basically equal the current price change of oil! We need a 300% increase in oil prices just to match the increased price we have to pay for steel!! (And there is a LOT of steel in the platforms like Thunder Horse).
Yes, moving the minimum price of oil from $30 to $50 for our calculations will help, but with a (roughly) 65% increase in drilling costs, it is just not a big enough offset to make companies drill for every little stranded drop. Oil prices are still too low for that.
To be blunt, no modern oil company is going to move their internal calculated price significantly until they are satisfied that Saudi Arabia is honestly into major depletion. There must be no possibility of a price collapse. This is why the oil companies are not going crazy with mega-projects and chasing every little bit of oil just yet. They are all sensing that there might still be a major collapse in the oil price, but they are unsure what it might take to trigger it.
Why are they so nervous? Because historically, EVERY SINGLE TIME oil prices have increased dramatically to this sort of relative level, they have then been followed by a severe price collapse. As the increased energy and transport costs filtered into the economy, the price pass-through let to a forced widespread inflation. When oil booms, the economy busts. This has been our bitter lesson for the entire era of oil.
When oil becomes priced like gold, then the smaller fields will become economical. At that point there may be somebody chasing every little speck of oil in every little field. But by that time, demand may be destroyed by the global economic collapse. Because OUR WORLD IS BUILT OF CHEAP OIL! If oil had been priced according to its intrinsic value as a fuel, we would not be where we are today.
So, what/who is to blame?
Technorati Tags: peak oil, oil
I plan on using that part of his post to help me explain, this weekend, why just making a hole in the oil-bearing rock does not turn out to be a good idea. Over to J:
In a comment by gabor on my last guest post was this comment
"But the profit margin is the function of the oil price! therefore if the well becomes uneconomical at $60 it will reenter production at $120! Therefore there will be backside curve. I think what you should rather look at is thermodynamical balance of exploiting oil. When it becomes zero the well must be shut up, until that point the well will resume operations as long as the price rises enough."OK - so now we have some non-engineer declaring that it is thermodynamics that controls oil exploration. AAARRRRGGGGHHHHH!!!!!
However, even beside that point, the major points of the comment are that people really do believe that if it isn't economical to produce oil at $60, then at $120 it will become profitable again, and poof! - the field is back online!
Sadly, they are skipping this one, all-important fact: once the oil is gone, it is gone, and no increase in price will make it reappear.
And they are missing the point that there are significant amounts of oil that simply will NEVER come to surface, because the permeability in the reservoir has changed since the oil first migrated, and as the rock moves it blocks the passages through which the oil was reaching the well bore! In many cases, this damage to the rock is due to the company using overly agressive high volume production methods.
Changing the price for the oil, even to $200/bbl, simply cannot fix these changes in permeability and free the trapped oil. The methods that can be used to fix the problem are already available and have been used at today's prices, but they require the one thing that is in short supply - TIME. And even when the well is restored, the recovered oil flow will never provide the high volumes of oil that we are currently operating with and used to. As a result these techniques, and the wells they are used in, are no longer qualified for the portfolios that the large corporations want to pursue.
Have any of you guys ever seen a "Christmas tree" depletion drawing? When you place a well in the middle of oil and start pulling oil out, the oil moves to the lower pressure around the well. This moving oil looks kind of like a Christmas tree, with the midline being the producing well. As pumping continues, branches get disconnected from the tree, and isolated from the rest of the big mass of oil.
Water flooding can chase some of these isolated patches to the well, but it is usually a 7/10 to 1 chase ratio – in other words it takes between 7 and 10 barrels of water to be pumped in in to produce every barrel of oil that comes out. And the barrel out is coming out WITH the 7 to 10 barrels that we used to flush it out with. Each of these gallons of now-contaminated water must be disposed of by being pumped into another, specially drilled well, which usually means it must also be trucked from the first well to the disposal one. And in-between times, the produced water must be separated from the oil, and that requires further energy input.
Due to the random nature of permeability and porosity within any sandstone reservoir, there is a certain percentage of oil that will always remain trapped. There are entire volumes of oil that will never flow to the well, because there is no effective path for them to reach it. This structural reality effectively divides the reservoir into compartments. To reach the larger, and more valuable ones, we have to drill a separate well into each compartment, and as the cost to drill climbs, larger and larger parts of the oilfield get left behind.
People will argue that CO2 injected fields CAN be put on stripper production. And yes, they just might be able to do that. But stripper wells operate at a lower than surface pressure, and the oil is manually pumped out, just like the water from a water well. What happens to the injected CO2 that we used to renew the reservoir pressure and drive the remaining oil to the producing wells? It doesn't just disappear - it has to be released into the atmosphere or injected elsewhere at high cost!! Frankly, this is a climate disaster waiting to happen.
What those who see oil production just as a process limited by price, are NOT getting is that rigs and pipe and cement and energy are all costs that oil producers have to pay. And that additional cost is also reflected in the new higher prices for everything made with oil. As we look harder and harder for more oil, this demand drives prices for the equipment and materials we use through the roof. For example the loss of the 5 jackup rigs leaving the GOM and heading for Saudi Arabia will we are estimating, drive prices for these rigs from $65,000 per day to $100,000 per day, and last year they were at $35,000!! This does NOT make the production of smaller fields more economical, because the price for oil is still too low to pay the new price for the rigs!!
When old equipment is retired, the new equipment, built with higher costs, must be purchased to replace it. With steel at a premium due to demand, these costs have risen 300%! Today, our basic costs have doubled in a single year, which matches what has happened to oil prices. So the net return on our investment is back to the same level - no change in overall extraction economics. All new projects now reflect the higher energy price inputs, and these basically equal the current price change of oil! We need a 300% increase in oil prices just to match the increased price we have to pay for steel!! (And there is a LOT of steel in the platforms like Thunder Horse).
Yes, moving the minimum price of oil from $30 to $50 for our calculations will help, but with a (roughly) 65% increase in drilling costs, it is just not a big enough offset to make companies drill for every little stranded drop. Oil prices are still too low for that.
To be blunt, no modern oil company is going to move their internal calculated price significantly until they are satisfied that Saudi Arabia is honestly into major depletion. There must be no possibility of a price collapse. This is why the oil companies are not going crazy with mega-projects and chasing every little bit of oil just yet. They are all sensing that there might still be a major collapse in the oil price, but they are unsure what it might take to trigger it.
Why are they so nervous? Because historically, EVERY SINGLE TIME oil prices have increased dramatically to this sort of relative level, they have then been followed by a severe price collapse. As the increased energy and transport costs filtered into the economy, the price pass-through let to a forced widespread inflation. When oil booms, the economy busts. This has been our bitter lesson for the entire era of oil.
When oil becomes priced like gold, then the smaller fields will become economical. At that point there may be somebody chasing every little speck of oil in every little field. But by that time, demand may be destroyed by the global economic collapse. Because OUR WORLD IS BUILT OF CHEAP OIL! If oil had been priced according to its intrinsic value as a fuel, we would not be where we are today.
So, what/who is to blame?
Technorati Tags: peak oil, oil
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Geology and oil reservoirs. Always was and always will be. EOR (CO2, H20 injection) versus EROEI. And finally, when it's over, it's over.
I think, HO, that you overestimate the power of Saudi Arabia here. What could they possibly add, 2, 3, even 4 million b/d over the next 5 years? So what? And I doubt they can even do that. I'd be looking at Africa (Nigeria, Angola) and unconventional sources. By the way, I had announced on a previous thread that Trinidad was coming online 4th quarter this year to alleviate our pain, but nobody paid attention. 8)
Looking to Saudi Arabia is old thinking now.
Not this time. Where the hell is this new supply going to come from? Maybe I've misunderstood where you're coming from here?
Well, to clarify -- start-up costs for production of small fields are basically the same as start-up costs production of big fields. You still have to put in mostly the same infrastructure, but there's just a lot less URR under the ground.
As Bubba has posted on some previous threads, these Big Oil guys are working really hard to cover their ass. When the price goes way up, as it will, smaller fields will be profitable. I mean, WAY UP. Start-up costs will have be evaluated versus recoverable reserves at a "reasonable" price. But the current oil companies, as Bubba has pointed out, are dinosaurs waiting for the asteroid to hit. This is another way of saying that they will be, after sufficient time has passed -- a few decades at most -- extinct.
Not to mention climate change.
Today, our basic costs have doubled in a single year, which matches what has happened to oil prices. So the net return on our investment is back to the same level - no change in overall extraction economics.
This can't be right, at least, not in the long term.
If steel prices go up due to higher energy costs, then steel consumers pay more for steel, and the bulk of that extra money goes to energy producers.
However, energy producers are only a small fraction of worldwide steel consumption. So if the energy industry can't possibly be paying nearly as much extra for steel, as the set of all steel consumers are paying extra to the energy industry. The higher cost of steel is paid for partly by energy companies, but it's also paid for by auto manufacturers, construction companies, etc. So overall the energy industry should still be much better off.
Right? Am I missing something?
I heard a nice explanation about this (and the EROEI issue behind it)
Suppose you want to drink a glass of water
How much are you willing to pay for it?
- 1 dollar
- 2 dollar
- 100 dollar
- maybe a piece of bread
- or something else
But you will never pay 2 glasses of water for it.
That's basically the EROEI issue.
Regarding steel prices: Saying that 'steel will increase in price' is correct, but doesn't reflect the full reality of what will happen. A more correct statement is that "as energy prices increase, the _value of money_ will decrease". Since money is fundamentaly just a representation of energy/work, a dollar that can buy 200 megajoules of energy is of greater value than a dollar that can only buy 50 megajoules.
Economists are going to call this "inflation", which is absurd. The value of money has BEEN inflated, ever since the discovery of fossil fuels. As the Earth's energy reservior runs out the value of money will return to its true level, which is about one third of one percent of the value of money in the US currently. That means if it costs you 20 minutes of labor to pay for the food you eat every day, in a world without fossil fuels it would cost you 111 hours of labor.
About the smaller fields becomming profitable at higher oil prices:
I don't know much about actual costs, but this thought struck me recently:
If a small field costs 1 million to develop and will return oil worth 50 million, with a 50% chance (because you never know before hand how much will actually be produced) , many will want to invest
If a small field costs 10 million to develop and will return oil worth 150 million, with a 50% chance (because you never know before hand how much will actually be produced) , some will want to invest
If a small field costs 50 million to develop and will return oil worth 200 million, with a 50% chance (because you never know before hand how much will actually be produced), few will want to invest, because chances are 50% you loose a good deal of the 50 million
etc.
my 2 cents
"When oil becomes priced like gold, then the smaller fields will become economical. At that point there may be somebody chasing every little speck of oil in every little field. But by that time, demand may be destroyed by the global economic collapse. Because OUR WORLD IS BUILT OF CHEAP OIL! If oil had been priced according to its intrinsic value as a fuel, we would not be where we are today.
So, what/who is to blame?"
J, are you asking what/who is to blame for oil not being priced according to its intrinsic value as a fuel because of its ultimate scarcity/rarity like gold? The same might also be said of coal and natural gas.
I would answer that "western cultural psycholgy" is the culprit: The cave of jewels was so enormous that the vast numbers of gleaming gems dazzeled the eye and helped the brain to forget that caves aren't infinite regardless of how good the mining technology.
EROEI: think about disposable batteries for a minute. What is their cost per kWh? Huge. And I bet their EROEI is negative. But we (willingly) pay over the odds for portable power. I suspect it will be the same with oil - short term, economics will triumph over thermodynamics - but not in the long run!
Applying the principle of charity to statements about higher prices creating more supply, I have always taken that to mean that projects that are only profitable at higher price points will come into production as the price rises, not that oil will magically appear. What J is pointing out is that there will be a significant lag between the price rise and the project due to the history of oil prices as they affect the culture and decision making process of oil companies.
JN: Bravo (or brava) for bringing up the battery example. That's the one that a lot of people in PO discussions don't like, because it shows how powerful economic influences can be.
As for the whole issue of higher prices bringing out more supply--of course it does, within geological limits. If you're an oil company, and you have the rights to a field that will be very expensive to produce (due to remote location or whatever other reason), you won't produce the oil until you can do so at a profit, period. If the market price of oil is below the production cost per unit of oil, and then rises above it (and you have reason to believe it will remain above the production price), then you'll put the field into production. It doesn't get any simpler than that.
And no, I'm not one of those economist boogeymen who say that high enough oil prices will produce all the oil we could ever need or want, etc. This pricing effect is obviously limited by physics, as anyone who's ever eaten the last Oreo in the package should realize.
The EROI issue is better shown by rephrasing the water question:
"But you will never pay 2 glasses of water for it."
But I WOULD pay 2 glasses full of ice for it, if all I have is ice and I don't want to wait for it to melt.
There'll still be a place for extracting oil out of the ground (with a greater amount of energy from coal, let's say) as long as oil still has other immediate advantages such as portability (can't run your car on coal).
Relax, American Chronicles of Beverly Hills origins has it all figured out:
"As you can see, the problem is not a shortage of oil, but it is the price of oil. International politics and speculation would have prices rising in any case, but the war and turmoil in the Middle East is causing most of the excessive price speculation that we see today."
http://www.americanchronicle.com/articles/viewArticle.asp?articleID=1888
The truth that my intelligently designed mind wants is the simple truth that it finds. And seeing is believing (or maybe the other way around).
Ah, we humans are clearly at the top of the evolutionary chain and the fossilized dinosaurs can't touch us from where they lie. So we are safe. Turn off the alarms. Relax. Go back to sleep you beautiful sleeping beauties. Prince Charming is coming. We will live happily ever after. There is no problem. The fundamentals are fundamentally sound. We can rationalize our way out of any situation. We always have. Kunstler is a crazed maniac. Pay no attention to his rants.
I think a lot of people are missing the point about higher prices not bringing more expensive oil online because all the infrastructure needed for that oil is rising as fast or faster than the oil price.
Here is an analogy from the 1970's. Dupont investigated ethanol as a replacement for petroleum during the last oil shock. They invested millions into working out the fermentation process and optimizing all parts of engineering required for high throughput production.
And then they shut the whole thing down. Why? Because they realized late in the game that ALL raw material prices (primarily grain at that time) were absolutely determined by the price of petroleum. As oil rises, all the feed stocks for ethanol rise as well. These feed stocks always make ethanol more expensive than oil no matter how high oil prices go. The energy in ethanol is built on the floor price of oil and there is more inefficency in making the ethanol feedstock than just using the oil as feedstock. So DuPont went out and bought an oil company, Conoco. Which, by the way they sold a year or so ago when oil prices were low, talk about bad timing.
The only way to escape the above catch 22 is to close the loop on raw material production. If renewable resources, like ethanol or biodiesel, are used to produce the feedstocks (and all equipment used) for ethanol and biodiesel than maybe they can be cheaper than oil.
But I think we are a long, long, long way from that point.
vinc -
We sell oil, not energy. Oil is used to mine iron ore. Natural gas is used to refine the ore and turn it into iron. Again to turn that into steel. Again to form the steel into shapes. Oil is used to transport this steel somewhere. Then the steel is made into a final product by someone using natural gas generated electricity. Each employee in this process and trucking operation uses oil to get to work or deliver goods. Now we have to pay for their services and costs and provide them a profit at each step. And then, if the Chinese are using a lot of it, we have increased demand allowing higher profits, and thus higher end costs to us.
We make no money on electricity generation. That is another tier of businesses. And you forgot the biggest influence on price - greed. When demand rises, it makes an economic mini-bubble...
I assure you the 300% figure is accurate. I am signing the invoices...
The point of my previous post is that oil companies might still have better financials pumping old wells at low volumn in an oil scarce market than bringing new high priced wells online. As J points out their financials aren't rosy for the hard to get oil so why do it before the old wells stop producing?
NC -
You got it!!
I had forgotten about the Dupont fiasco. You can still see abandoned ethanol plants if you drive south out of Lafayette, in the heart of Cajun oil country. There is a reason they are rusting.
But more importantly, you get it that EVERYTHING we drive, use, do or eat is based on really, really, really CHEAP oil prices. It is the world adjustment to higher, more representative pricing that will choke our economic chicken. But the timing will likely be such that it is viewed as a series of disparate and unconnected events. It is not likely to happen all at once, but happen it must.
This just in from squawking chicken channel: crude "draw-downs" exceed expectorations (sic) --this may negatively impactorate the markets. :-(
Wisdom of the Market Masses:
"Oil prices have to eventually hit their tipping point" [and go down]
quote from is from the bottom line of
http://money.cnn.com/2005/08/17/news/economy/gasoline/index.htm?cnn=yes
Why?
Because what goes up always comes down.
See. It is all "sound" logic. The masses in the lemming herd know what they know.
The coming oil price crash should cool demand then, according to money.cnn.com, right? But that will likely derail the economy too, or at least cause a big retrenchment. Oil supplies will rise, we will be flush with oil again, and then everybody will start growing their economies again. Except those smaller countries who have been hammered into oblivion.
So, after the oil price collapse, we climb back on our hamster wheel and repeat the same process until we finally learn that we are repeating a process.. Is that how it is supposed to work? Because that is what J is also speaking about.
If the demand is destroyed for awhile, then the focus is off o oil. However, this doesn't make any more oil. It just slows depletion. When the world economy heats back up, will we not be driving towards the same cliff again?
Spooky --that is why we at the Lemming Institute are working on ways to make contact with the happy hampsters even as they race forward in their squirrel cages of success, forever chasing after the elusive "progress". In our neck of the digs, it was the famous Adlemm (Adam) Smith who foresaw this behavior in his epic book, "The Wealth of Tunnel Visions". Everyone claws mindlessly to create his own burrow hole of prosperity. Together, we produce a Labyrinth of Prosperity. It is very sound logic. The fundamentals are all fundamentally sound. There are no holes in the theory. To question it, is to be blasphemous.
P.S. Oil prices have plummeted to a sustainable $64/barrel today according to 321energy.com and others. See? What goes up always comes down. (Cough, cough, ... who was that who sneezed "civilization"? ... how dare you sir ... that is the "exception" to the rule ... it is all fundamentally sound.) ;-)
...
Um, if there's a economic crash, I might not plan on a recovery any time soon. During the last oil spike there was still plenty of relatively cheap natural gas, coal, electricity as fallbacks. Now you might norice that coal prices have doubled over the last two years, and natural gas has tripled. Without a lot of new investment the U.S. is looking at local production peaks for both of those fuels. And the basic fact the J has already stated is that if you can't afford to invest in new energy sources right now with low interest rates and large corporate profits you have zero chance when a recession starts.
I'll believe that Tim, when I see a Peak Coal site or a Peak Natural Gas site.
For now, I am going to continue to build my burrow of prosperity, because I know that hard work is always rewarded.... :)
The North American natural gas peak is pretty well documented. See "High Noon", by Julian Farley for example. Matt Simmons has addressed it in some of his speeches (available online from http://www.simmonsco-intl.com). I don't know the coal situation very well - anyone have good references (either online or off?)
Stuart.
Stuart -
Sarcasm was intended - should have made it drip more I guess...
Back on EROI: gasoline has approx 33kWh per US gallon. At $2.50 that's about 8 cents/kWh. Disposable batteries are $50 -$100/kWh! (suggesting the EROI is very negative)
Spooky --obviously you have been at the lemming holes because you are starting to talk lemm-talk. I agree with Tim. Burrowing costs are relatively low now. When Alan Greenspin starts spinning our burrowing costs higher we will not be able to dig as far and as fast as we once could. However, it is hard hard work to find Angels and VC's who will invest in your vision of prosperity. They are skittish about everything and want detailed business plans assuring them of untold rewards. They all want to win The Lottery.
:-)
stepback -
I'm taking a page from the Enron manual to offset the greed of the VC's and Angels. I am employing obfuscation and technospeak combined with solid enginering references from government sources. This will further insulate me via ignorance of my own terminology when questions arise concerning any topics in my business plan. I will merely send my engineers to talk to their accountants and my accountants to converse with their engineers.
I cannot fail!!
Yep, you need low interest rates and lots of oil to fuel economic recovery, don't you?
I can't see either on the horizon until there's another large scale terrorist attack...then the Fed will go back to emergency footing like they did after 9/11...which then pushes the dollar back in the crapper...which then...which then...etc., etc.
Hey Spooky, don't forget that you need at least two paradigm shifts you can talk about.
PG -
As I just said in another thread - Bush has never let the facts get in the way of his agendas. If we need another "terrorist threat" or other "incident" to keep things going his way, I am sure he will be able to deliver.
Now I have to go work some shifty paradigms into my business plan!!
Spooky and Tim,
Are there any websites you can recommend for how to manage potential investors --seriously-- ? (I have not yet learned "paradigm shift" speak yet, but sorely need to. It is the sound that resonates in the mind of the Greedy Hand Who Holds the Investment Cash. Need to learn how to make those sounds. So far, I know mostly how to make engineer-sounds. Doesn't work with them who know no science but hold the cash. Thanks.)
J, I understand what you're saying. I understand there's this "treadmill" effect where as oil prices go up, the oil industry's inputs become more expensive, and this takes away much of the extra profit. But you're going much too far when you say that higher oil prices don't change extraction economics.
Sure, steel prices are driven partly by energy prices. But steel prices are driven by lots of other things, too. For example, there's demand for steel by other comsumers, who compete with the oil industry for steel--if demand for cars rises, oil companies have to pay more for steel, and vice versa. There's the cost of labor, and health care. None of these are proportional to oil prices--sure, there's some dependence, but it's not a huge dependence. A machine shop will charge $50/hour for a machinist's time. They're not charging that much because the machinist uses $50/hour of energy--he doesn't use anywhere close to that. Most of that money is for the machinist's skill. And yeah, if oil goes way up, the steel company will ultimately need to pay machinsts more because of inflation, but a doubling of oil prices will certainly not lead to a doubling of wages, all else equal. As for demand, that's probably a negative feedback--high oil prices mean high steel prices which means other steel consumers reduce their consumption.
Now maybe you just meant that high prices don't change extraction economics as much as many people think, which I don't have a problem with. I apologize if this seems overly nitpicky but this kind of complete denial of the market's ability to self-correct really bothers me. Are markets often overrated? Sure. But they're not useless. Any solution to Peak Oil is going to involve markets.
vinc:
The trouble with "markets" is not in the flow of liquid assets. The trouble is in the flow of false and deceptive information. All too often, there is one party in the deal that stands to profit from being less than honest. Visited your used car dealer lately?
stepback, that's true, but I don't see how it's relevant to the specific point I'm making.
If the markets were "transparent" then information about peak oil and actual reserves (to the best extent such reserve numbers are known) would be available to everyone. But they are not. That is what Matt Simmons complains about. Producers have an incentive to, and do hide the true information from the public and then the public cannot make well informed choices in how they spend their money. The market is not the "solution" to Peak Oil but rather a means and motivation for hiding the existence of the PO problem from the general public.
JN,
good argument about EROEI and batteries. But there's two different implications.
1 (as you point out): Oil companies will not go out of business. Even when oil becomes a net negative energy ("-E) producer, it will still be useful to extract as a raw material. It will be a very valuable precursor for lots of plastics and industrial chemicals. Fuel users may find that paying for expensive oil is cheaper than the capital costs of switching to alternate energy sources.
Bizarre Comparative Advantage hypothetical: in 50 years (ex-Saudi) Arabia will still have large reserves of -E oil, but could also be a world leader in solar production with solar farms across the Empty Quarter. For the Arabians, the easiest way to store and export their energy to distant markets might be to use the electricity to extract and refine oil, and then ship the oil.
2. HOWEVER - the world economy doesn't run on oil, it runs on energy. Extraction of -E oil will not generate energy. So all that energy (both for the -E oil industry and for the rest of us) has to come from somewhere else, and it's not gonna be cheap.
vinc -
I am posting this for J.
"Read my last part of the piece. Oil prices ARE NOT HIGH ENOUGH yet to offset the increase in material costs and make smaller stuff attractive. This is basically demand destruction in the oil patch, which we have dealt with for decades by reducing drilling until the supply markets quiet down. To do so now would cripple the economy, and reduce corporate profits when they are at all time highs. It isn't being contemplated at these prices. Instead, we are just reworking economics every time a prospect comes up. More are failing than passing at this price range. When we hit $100+/bbl, then some of these things become economical. But if supplies are still tight, and those prices rise again, then more orphan prospects will be generated.
Steel demand is the problem - it has outstripped supply in the tubular markets for years, and today there is NO spare capacity or standing inventory. We are ordering what we need at whatever they will allow us to buy it for, at long lead times. We are designing wells around casing that has the best price, which is really difficult at times.
Rig demand is isue #2, which I already outlined. What is not outlined is the personnel shortages and materials shortages we are dealing with by re-engineering.
What you do not know about the oil patch is that people are not flocking to work here due to the history of erratic employment and wages/benefits. We are in a massive personnel crunch. Consultants that cost $500/day in 2003 are now $1000/day or more. We have to plan when to start wells based on casing arrival dates or even rig availability. What cost us $1MM in 2003 is nearly $3MM today. We are missing dates on our drilling schedules due to no rigs or re-engineering for smaller, older rigs instead.
You can throw economic theory at me all day long, but when I am signing invoices and working the numbers every day, I would ask that you at least believe the numbers I am giving people here. I have no reason at all to lie. And in a booming market, you need to revise and adjust everything predicated on yearly figures. We go month to month now due top the pricing issues on both the oil end and the drilling end.
I guess to sum it up - we are in a drilling boom right now. Standard economic theory is inapplicable. Please suspend your disbelief - I am not doing this for attention, but simply sharing what I am seeing and dealing with daily."
END
If you build them, the oil will come?
Is that the basic theory? More drilling means more oil? What if you drill a lot of dry holes? Time will tell.
J, I'm certainly not calling you a liar. I never said I don't believe the facts you've laid out. I do. What I disputed was your interpretation. You say over and over again that high energy prices are *causing* the high steel (and other input) prices. I agree that energy prices contribute to the costs, but there has to be much more to it (ie strong demand for steel from China and a strong world economy) for reasons that I think I've made pretty clear. And, because of this, even though the 300% oil price increase was followed by a 300% steel price increase, we shouldn't necessarily expect further energy price increases to cause proportional steel price increases, as you imply.
Reading back, I think what J was trying to get across is exactly what you said, vinc - energy prices contribute to the cost of steel. What J (I think) is trying to say is that without the current demand for oil, drilling demand for steel wouldn't have risen. But when you factor in the exceedingly high demand and couple that with the large number of energy inputs of higher price and "opportunity pricing" (eg - gouging), you get this wildly high steel price. And that hits his drilling cost head-on, like a semi-truck.
vinc, J - can we split the difference? Higher oil prices mean higher energy input costs for steel and drilling equipment. Price rises for a give quantity supplied, and the supply curve moves up. That reduces the quantity demanded. But higher prices also increase potential returns to drilling, potentially offsetting the rise in equipment prices, thus restoring profitability to previously planned drilling operations: same quantity demanded and supplied as initially, but at a higher price. The demand curve shifts upward.
But if in fact there's a *shortage* of equipment and steel, that must reflect an absolute increase in quantity demanded - a further upward shift in the demand curve. It necessarily follows that rising oil prices have made some previously unprofitable activity now profitable in spite of rising equipment costs, although perhaps not as much as would have become profitable had oil prices risen and drilling-equipment prices NOT risen.
If there is opportunistic pricing (e.g., rises in pricing beyond the rise in the cost of inputs, due to the structural barriers to entry and the time-lag for increased equipment production) , that reflects that many more projects are potentially profitable now than last year, and firms are bidding up the prce of rigs and equipment. Once supply issues regarding rigs and tubes are resolved through increased production, we should expect an additional surge in drilling.