The collapse of oil prices and energy security in Europe

17 11 2014

This is a written version of the brief talk I gave at the hearing of the EU parliament on energy security in Brussels on Nov 5, 2014. It is not a transcription, but a shortened version that tries to maintain the substance of what I said. In the picture, you can see the audience and, on the TV screen, yours truly taking the picture.

Ladies and gentlemen, first of all, let me say that it is a pleasure and an honour to be addressing this distinguished audience today. I am here as a faculty member of the University of Florence and as a member of the Club of Rome, but let me state right away that what I will tell you are my own opinions, not necessarily those of the Club of Rome or of my university.

This said, let me note that we have been discussing so far with the gas crisis and the Ukrainian situation, but I have to alert you that there is another ongoing crisis – perhaps much more worrisome – that has to do with crude oil. This crisis is being generated by the rapid fall in oil prices during the past few weeks. I have to tell you that low oil prices are NOT a good thing for the reasons that I will try to explain. In particular, low oil prices make it impossible for many oil producers to produce at a profit and that could generate big problems for the world’s economy, just as it already happened in 2008.

So, let me start with an overview of the long term trends of oil prices. Here it is, with data plotted from the BP site.

These data are corrected for inflation. You see strong oscillations, but also an evident trend of growth. Let’s zoom in, to see the past thirty years or so:

These data are not corrected for inflation, but the correction is not large in this time range. Prices are growing, but they stabilized during the past 4-5 years at somewhere around US 100 $ per barrel. Note the fall during the past month or so. I plotted these data about one week ago, today we are at even lower prices, well under 80 dollars per barrel.

The question is: what generates these trends? Obviously, there are financial factors of all kinds that tend to create fluctuations. But, in the end, what determines prices is the interplay of demand and offer. If prices are too high, people can’t afford to buy; that’s what we call “demand destruction”. If prices are too low, then it is offer that is destroyed. Simply, producers can’t sell their products at a loss; not for a long time, at least. So there is a range of prices which are possible for oil: too high, and customers can’t buy, too low, and companies can’t sell. Indeed, if you look at historical prices, you see that when they went over something like 120 $/barrel (present dollars) the result was a subsequent recession and the collapse of the economy.

Ultimately, it is the cost of production that generates the lower price limit. Here, we get into the core of the problem. As you see from the price chart above, up to about the year 2000, there was no problem for producers to make a profit selling oil at around 20 dollars per barrel. Then something changed that caused the prices to rise up. That something has a name: it is depletion.

Depletion doesn’t mean that we run out of oil. Absolutely not. There is still plenty of oil to extract in the world. Depletion means that we gradually consume our resources and – as you can imagine – we tend to extract and produce first the least expensive resources. So, as depletion gradually goes on, we are left with more expensive resources to extract. And, if extracting costs more, then the market prices must increase: as I said, nobody wants to sell at a loss. And here we have the problem. Below, you can see is a chart that shows the costs of production of oil for various regions of the world. (From an article by Hall and Murphy on The Oil Drum)

Of course, these data are to be taken with caution. But there are other, similar, estimates, including a 2012 report by Goldman and Sachs, where you can read that most recent developments need at least 120 $/barrel to be profitable. Here is a slide from that report.

So, you see that, with the present prices, a good 10% of the oil presently produced is produced at a loss. If prices were to go back to values considered “normal” just 10 years ago, around 40 $/barrel, then we would lose profitability for around half of the world’s production. Production won’t collapse overnight: a good fraction of the cost of production derives from the initial investment in an oil field. So, once the field has been developed, it keeps producing, even though the profits may not repay the investment. But, in the long run, nobody wants to invest in an enterprise at so high risks of loss. Eventually, production must go down: there will still be oil that could be, theoretically, extracted, but that we won’t be able to afford to extract. This is the essence of the concept of depletion.

The standard objection, at this point, is about technology. People say, “yes, but technology will lower costs of extraction and everything will be fine again”. Well, I am afraid that it is not so simple. There are limits to what that technology can do. Let me show you something:

That object you see at the top of the image is a chunk of shale. It is the kind of rock out of which shale oil and shale gas can be extracted. But, as you can imagine, it is not easy. You can’t pump oil out of shales; the oil is there, but it is locked into the rock. To extract it, you must break the rock down into small pieces; fracture it (this is where the term “fracking” comes from). And you see on the right an impression of the kind of equipment it takes. You can be sure that it doesn’t come cheap. And that’s not all: once you start fracking, you have to keep on fracking. The decline rate of a fracking well is very rapid; we are talking about something like a loss of 80% in three years. And that’s expensive, too. Note, by the way, that we are speaking of the cost of production. The market price is another matter and it is perfectly possible for the industry to have to produce at a loss, if they were too enthusiastic about investing in these new resources. It is what’s happening for shale gas in the US; too much enthusiasm on the part of investors has created a problem of overproduction and prices too low to repay the costs of extraction.

So, producing this kind of resources, the so called “new oil” is a complex and expensive task. Surely technology can help reduce costs, but think about that: how exactly can it reduce the energy that it takes to break a rock into fine dust? Are you going to hammer on it with a smartphone? Are you going to share a photo of it on Facebook? Are you going to run it through a 3D printer? The problem is that to break and mill a piece of rock takes energy and this energy has to come from somewhere.

Eventually, the fundamental point is that you have a balance between the energy invested and the energy returned. It takes energy to extract oil, we can say that it takes energy to produce energy. The ratio of the two energies is the “Net Energy Return” of the whole system, also known as EROI or EROEI (energy return of energy invested). Of course, you want this return to be as high as possible, but when you deal with non renewable resources, such as oil, the net energy return declines with time because of depletion. Let me show you some data.

As you see, the net energy return for crude oil (top left) declined from about 100 to around 10 over some 100 years (the value of 100 may be somewhat overestimated, but the trend remains the same). And with lower net energies, you get less and less useful energy from an oil well; as you can see in the image at the lower right. The situation is especially bad for the so called “new oil”, shale oil, biofuels, tar sands, and others. It is expected: these kinds of oil (or anyway combustible liquids) are the most expensive ones and they are being extracted today because we are running out of the cheap kinds. No wonder that prices must increase if production has to continue at the levels we are used to. Then, when the market realizes that prices are too high to be affordable, there is the opposite effect; prices go down to tell producers to stop producing a resource which is too expensive to sell.

So, we have a problem. It is a problem that appears in the form of sudden price jumps; up and down, but which is leading us gradually to a situation in which we won’t be able to produce as much oil as we are used to. The same is true for gas and I think that the present crisis in Europe, which is seen today mainly as a political one, ultimately has its origin in the gradual depletion of gas resources. We still have plenty of gas to produce, but it is becoming an expensive resource.  It is the same for coal, even though so far there we don’t see shortages; for coal, troubles come more from emissions and climate change; and that’s an even more serious problem than depletion. Coal may (perhaps) be considered abundant (or, at least, more abundant than other fossil resources) but it is not a solution to any problem.

In the end, we have problems that cannot be “solved” by trying to continue producing non renewable resources which in the long run are going to become too expensive. It is a physical problem, and cannot be solved by political or financial methods. The only possibility is to switch to resources which don’t suffer of depletion. That is, to renewable resources.

At this point, we should discuss what is the energy return of renewables and compare it to that of fossil fuels. This is a complex story and there is a lot of work being done on that. There are many uncertainties in the estimates, but I think it can be said that the “new renewables“, that is mainly photovoltaics and wind, have energy returns for the production of electrical energy which is comparable to that of the production of the same kind of energy from oil and gas. Maybe renewables still can’t match the return of fossil fuels but, while the energy return of fossil energy keeps declining, the return of renewables is increasing because of economies of scale and technological improvements. So, we are going to reach a crossing point at some moment (maybe we have already reached it) and, even in terms of market prices, the cost of renewable electric power is today already comparable to that of electric power obtained with fossil fuels.

The problem is that our society was built around the availability of cheap fossil fuels. We can’t simply switch to renewables such as photovoltaics, which can’t produce, for instance, liquid fuels for transportation. So, we need a new infrastructure to accommodate the new technologies, and that will be awfully expensive to create. We’ll have to try to do our best, but we cannot expect the energy transition – the “energiewende” – to be painless. On the other hand, if we don’t prepare for it, it will be worse.

So, to return to the subject of this hearing, we were discussing energy security for Europe. I hope I provided some data for you that show how security is ultimately related to supply and that we are having big problems with the supply of fossil energy right now. The problem can only increase in the future because of the gradual depletion of fossil resources. So, we need to think in terms of supplies which are not affected by this problem. As a consequence, it is vital for Europe’s energy security to invest in renewable energy. We shouldn’t expect miracles from renewables, but they will be immensely helpful in the difficult times ahead.

Let me summarize the points I made in this talk:

Thank you very much for your attention and if you want to know more, you can look at my website “Resource Crisis”. www.cassandralegacy.blogspot.com


Ugo Bardi teaches at the University of Florence, Italy. He is a member of the Club of Rome and the author of “Extracted, how the quest for mineral wealth is plundering the planet” (Chelsea Green 2014)

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13 responses

17 11 2014
John Weber

It takes energy to produce energy and it takes energy to produce the materials, plants, and machines that produce the materials, plants and machines that make the solar and wind capturing devices.

Solar and wind capturing devices are not alternative energy sources. For the physical devices – for wind, photovoltaices, solar hot water, hot air panels – the sun and wind are there, are green, are sustained. The devices that are used to capture the sun and wind’s energy are an extension of the fossil fuel supply system.

There is a massive infrastructure of mining, processing, manufacturing, fabricating, installation, transportation and the associated environmental assaults. There would be no sun or wind capturing devices with out this infrastructure. This infrastructure is not green, sustainable, or renewable. The making of these devices inadvertently but directly supports fracking, tar sands and deep ocean drilling because of the need for this infrastructure.

I have just looked at the materials to make the base of one 2.5 megawatt wind energy capturing device. http://sunweber.blogspot.com/2014/11/prove-this-wrong.html

17 11 2014
robertheinlein

This is a great article as it sums things up very nicely: “Maybe renewables still can’t match the return of fossil fuels but, while the energy return of fossil energy keeps declining, the return of renewables is increasing because of economies of scale and technological improvements. So, we are going to reach a crossing point at some moment (maybe we have already reached it) and, even in terms of market prices, the cost of renewable electric power is today already comparable to that of electric power obtained with fossil fuels.”

The market will take care of our needs by making fossil fuels more expensive than solar and wind, leading to a society-wide de-carbonization movement based upon supply-and-demand, not forced change.

But, I fear that politicians in Australia have already “jumped the shark” in their rush to protect carbon interests. No green investor in their right mind would put any capital into Australia at the moment. It’s going to take many years before Australia will receive the benefits of the new investment cash to transition over from the fossil-fuel model to the renewables model.
—Bob

18 11 2014
johnfrieslaar

What is the answer? Should we be moving fast towards a hydrogen economy?

18 11 2014
mikestasse

There will NEVER be a Hydrogen economy…. this is what Susan Krumdieck wrote here as a comment:

Now for story of Hydrogen from electrolysis of water as a way to store renewable energy.

There should be a story tax. Anybody who wants to tell a story about something should have to pay a tax equal to the cost of actually doing it. If you had that money, then you should actually do it and then provide DATA, and not tell stories.

Get yourself a wind turbine. (go shopping and get a price, then use a free software like SAM from NREL to calculate how much power you could produce in your area)
Get yourself a solar panel (go shopping….)
Get yourself an electrolyzer. (go shopping! just go get one, or at least try real hard, try a chemistry equipment supplier)
Get yourself a hydrogen compressor and storage tank. The compressor needs to be lubricant-free. AirSquared make one – go buy it. The tank is pretty standard you can get it from AirProducts. You’ll need a regulator too and some valves and controls and monitoring system.
Get yourself a fuel cell. That’s right. Remember that Amory Lovins said we were going to have a hydrogen economy more than 15 years ago. Remember that there have been billions spent on research around the world. Now – go to the market and actually PURCHASE a bloody fuel cell.
Get your safety shed and certification for having a tank of hydrogen, and the electrical inverter and controllers needed to hook up the fuel cell to your appliances and lights.

Now – go get yourself a bank of lead-acid batteries with the same capacity as your fuel cell.

Finally – Ask yourself why you would want to add 3 more wind turbines in order to use the same amount of electricity in your appliances, so that you could use that hydrogen system instead of the battery one. And look at your bill.

The next person you hear bring up hydrogen, tell them to just go buy a hydrogen system or shut up about it.

Now going back to your question “What is the answer?” The answer is to live more simply so we may simply live. This entire industrial / hi-tech civilisation is a mere blimp in the history of humanity, all made on the back of a one off fossil fuel endowment we blew mostly on greed and triviality. At least, we will be able to mine our garbage tips for future resources, and recycle much of the now above ground highly refined metals….. but we need to reduce our population by 80 to 90 percent first.

18 11 2014
mikestasse
20 11 2014
johnfrieslaar

Guys thanks for the feedback.

Considering the information, what is the positives? The answers seem to be very pessimistic, are there any optimistic alternatives?

20 11 2014
mikestasse

John, I see no negatives in using way less energy. In fact, only positives. Do we really all need to have smart phones and cars to drive to the supermarket? That sort of lifestyle is actually killing us……. I won’t miss it. Just adapt to a more physically active life and get to know your neighborhood.

20 11 2014
johnfrieslaar

OK, my bad … Let me rephrase … What are the alternatives for an energy future that is equal to current demand and able to support increased demand, what will be the best source of energy, and which is the best bet? or is it a multiple of various technologies?

All considering that we do not want it to kill us and that the triple bottom line needs to be considered at this stage (Social, Economic and Environmental).

I also see no downside in a more local lifestyle, but I guess that may be hard to achieve globally at the current moment and the cultural change may take some time.

Just trying to explore if there is any middle ground between the current full on GDP monster and going back to being a caveman … 🙂

20 11 2014
mikestasse

The whole point of these discussions John is that there are NO alternatives…. there will be no increased demand. Population is due to start going down within ten to fifteen years, and demand (not just for energy) will go down with it.

In the end, we’ll go back to food as energy, which will be converted to muscle power from us and animals…. just like we did for thousands of years!

21 11 2014
johnfrieslaar

While I accept most of the issues raised on this site, such as Growth Limits, Energy concerns etc. I’m not sure that the end is nigh just yet … There are people seeking to find a way forward, I would really like to see if anyone has views of alternatives …

The following may be a worthy read … http://spectrum.ieee.org/energy/renewables/what-it-would-really-take-to-reverse-climate-change/?utm_source=techalert&utm_medium=email&utm_campaign=112014

21 11 2014
mikestasse

Hi John…… make no mistake, I know where you’re coming from, been there done that..! That article you pointed us to has one serious flaw as far as I am concerned…. it talks about energy in terms of MONEY, not Joules.

Statements like “What’s needed, we concluded, are reliable zero-carbon energy sources so cheap that the operators of power plants and industrial facilities alike have an economic rationale for switching over soon—say, within the next 40 years” mad my eyes glaze over…..

We don’t have forty years for starters. And the problem with alternative energies is not the money (we can print loads of that), it’s the SURPLUS ENERGY….

Another problem, “Let’s face it, businesses won’t make sacrifices and pay more for clean energy based on altruism alone.” You see, it IS time for altruism…! Profits are not part of a sustainable society.

This article even cuts its own legs off with “Even if every renewable energy technology advanced as quickly as imagined and they were all applied globally, atmospheric CO2 levels wouldn’t just remain above 350 ppm; they would continue to rise exponentially due to continued fossil fuel use. So our best-case scenario, which was based on our most optimistic forecasts for renewable energy, would still result in severe climate change, with all its dire consequences: shifting climatic zones, freshwater shortages, eroding coasts, and ocean acidification, among others.”

You can seek a way forward all you like, but unless you can come up with new energy systems that have an ERoEI of at least 50:1 and don’t require fossil fuels for their manufacture…. we are screwed!

We just need to live more simply so we may simply live……

22 11 2014
johnfrieslaar

Mike

Thanks for the considered reply.

Don’t get me wrong, I agree with your observations (mostly), I agree we need to find a way beyond the money syndrome, we need to be in a place that puts people ahead of profits, and recognise that the economic system (if required at all) is in fact a subsystem of the social system, which is a sub-system of the environment. We are looking at the system the wrong way round.

I am however a little concerned with what I see in the media/press lately, it seems to only see life as being on two ends of a horizontal continuum, one driven by GDP and greed, the other driven by the realisation that we’re stuffed if we continue down that track.

It seems to me that there is massive apathy in the world, which is not allowing people to come up with solutions that explore the various shades of grey or the grey scales of the continuum, or even realise that it can be enhanced by a vertical continuum (or others), that looks at reaching and agreeing positive ways forward. We’re not thinking systemically, when most articles only come to a single end point situation.

Not sure why, but the media/press, which was always about keeping people informed seems to have gone down a sensationalism route as the only way to tell a story. Yes the article I posted is flawed, but it’s more about the spirit, rather than the fact, and this is why I asked the question about “what else”, because I believe that as humans, we should not just give up and wait to die, because at the moment both ends of the current continuum only lead to great pains imho. I personally would love to understand the “what else”

As to your concluding statement about living more simply, yes this is a way forward, however it cannot just be about stick if we are to get the masses to agree, it has to also have some carrot, this is what I am trying to understand, is there any carrot that is feasible and sustainable, or is it several carrots that need to adapt over time, and how long should each be used before they need to be ditched for an alternative. At the end of the day this is going to have to be a culture change, on a global basis, and any cultural change is going to need people to agree if they are to play their part.

There has to be a way forward that benefits ALL that we have not yet considered, the Unknown, Unknowns.

23 11 2014
mikestasse

John, in my own personal experience, living more simply is a huge improvement over my past life expectations…. people today are stressed to the eyeballs and sick from the crap they eat.

The media is largely – no, make that entirely! – to blame by using advertising to sell us a pack of lies. You are being too kind to the media IMO…

The hard part, I find, is convincing people that the carrot is not a McMansion with 2 SUVs in the garage and an iPad in every bedroom plus a 60 inch wide screen TV in the lounge….

Nobody seems to be able to see the carrots…. most people don’t even know how they grow!!

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