Profile of Professor Banks

Amazingly, there are highly educated persons with backgrounds in energy matters who are unable to deal with the realities of the international oil markets. One of these harbingers of bad good news made herself known to me a few years ago.

Where that person was concerned, the outcome from using seismic technology (for locating oil and natural gas) was instantly characterized as a “guess and a gamble”. Furthermore, I was told that even when drilling you can miss a mega-sized oil field by a matter of “feet” (or meters). With all due respect, I interpret this kind of wisdom as no less than contempt for mainstream science and technology, as well as the men and women who sometimes sacrifice life and health for it.

I was informed by the same person that the attempt to assess oil reserves should be characterized as “guesswork” – which to a certain extent it is, though it has many of the characteristics of a genuine science – and so “the stuff written today about peak oil is a bit like the usual nonsense about climate change. It is written by people who know nothing about it”.

Really, Madame. Can we poor ignoramuses take that contention to the bank and draw a decent rate of interest on it? If so, then what is wrong with poor benighted me that I continue to believe that on the average, the rank and file of oil geologists, petroleum engineers and managers now accept the peak oil thesis? And how can they do otherwise, since the output of conventional oil has peaked in oil powerhouses like the U.S., perhaps Russia, and definitely the English and Norwegian North Seas, and the same cannot be avoided in the Middle East for many more decades. (In explaining peaking to students, I suggest that they look at production curves for the 100 largest oil deposits, which tells the entire story.) I have also heard from associates that a large percentage of genuine climatologists attach a high probability to climate change taking place that is influenced to some extent by human behaviour.

Personally, I don’t have the slightest idea as to what the climate outcome is going to be, or whether the people dealing with it are genuine scientists or charlatans, even after being informed about what is happening on the climate and environmental front in many parts of the world, particularly the Arctic, But what I do know is that the skiing at the ski area 10 minutes from where I live is not as predictable as it once was, and in gorgeous Kitzbühel (Austria) – called ‘Kitz’ by ‘hipsters’ and Kitzbühel regulars – helicopters have been chartered to fly in enough snow to keep various ski runs open. As a result, I no longer tune out when I hear or read or dream that some sort of climate change is actually taking place, and I might be better off if smart people were asked by policy makers to figure out how to protect us from its protectable aspects, regardless of the cause. By that I am not talking about skiing, but e.g. where to construct and how to pay for very high and thick concrete walls, and where to locate nuclear power stations so that they will not be interfered with by tsunamis.

I also decided to reject the hypothesis offered by that young lady that 80 percent (or more) was the correct figure for the recovery factor of oil. In other words, 80 percent of the ‘oil in place’ could be classified as reserves (i.e. oil that could be removed at an acceptable cost). Even if this were correct, our oil worries might not be over, because on a global basis only about one barrel of conventional new oil is discovered for every three barrels consumed. I also wouldn’t advise wasting valuable time mulling over the above recovery factor, and wondering when it will be raised by a large amount.

When I gave my first lecture on oil in Australia, the average global recovery factor for conventional oil was about 32%, and on several occasions I have been told that it may have reached 35%. Successful producers have understood for many years that talk about very high recovery factors is mostly nonsense, and thus it often makes economic sense to reinject a portion of the natural gas that may accompany the oil they produce in order to maintain or increase the pressure in oil deposits, and therefore the flow rate of oil being extracted.

Of course, there are always ‘unconventional’ resources (as shale oil in the U.S. is sometimes designated), oil sands (or tar sands) of the variety found in Canada, and ‘heavy oil’ of the kind located in Venezuela. Where the first of these is concerned, at a workshop in Vienna many years ago, an American business executive called me a fool because of the enthusiasm I showed for this resource, saying that in his part of the U.S., there wasn’t enough water to economically obtain large quantities of shale oil. (Actually he was more correct than he knew, because the availability of water for all uses is apparently going to be a major problem in the coming decades.)

At the present time the belief in shale oil is almost sanctified, unshakable, because it is pictured as an antidote against the potential ravages of OPEC – ravages which have not taken place in the past in the manner believed, even though gross inconveniences that have been suffered because the laws of supply and demand have not been understood the way that they should have been understood by the high and mighty and their experts, given the simplicity of these laws. For instance, when the price of oil (in 2008) reached $147/b, and certified experts spoke of it reaching and likely passing $200/b, a light panic was experienced that contributed to the rising price of both physical oil and ‘paper oil’, where the latter has to do with the prices of financial assets like futures and options, and often is confused with the price of the former.

The oil futures market was discussed in the previous chapter, along with an elementary treatment of options, but in case the expression ‘futures and options’ causes you a problem, you should realize that you already know more about these topics than most people, and that includes persons with a taste for irrelevant mathematics.

As for Canadian oil sand or tar sand reserves, these are valuable resources, but after remembering some of the research of Professor Douglas Reynolds (of the University of Alaska), I don’t have much faith in them or in ‘heavy oil’ where changing the international oil picture is concerned, at least in the near future. At the same time it might happen that unconventional oils will provide us with all the motor fuel we need to keep our autos moving toward the skiing and partying in the resorts of Middle Sweden, and even further North in the Midnight Sun later in the year, although I have some doubts about the quantity and quality of the motor fuel or the ski slopes that will be available in the last half of this century.

Quite obviously, if there were as much oil in this old world of ours as the young lady above thinks, or thought, then we would never have to worry again about oil prices escalating the way they did in 2008. That price was catastrophic for much of the global economy, although wish-fulfilment for several countries in the Middle East. Perhaps another point of some importance is that that oil price escalation initiated some undesired (or unwholesome) changes in the international economy that still exist.

FINAL STATEMENTS

I never tire of reminding my students how Professor Milton Friedman foolishly predicted the downfall of OPEC in the weekly publication NEWSWEEK, and also predicted the collapse of the oil price to $5/b or lower. He convinced a number of his fans that he knew what he was talking about, but as things stand at the present time, we will be extremely lucky not to confront a sustainable oil price well above $100/b before the end of the present decade, which could mean a reintroduction of the macro-economic and share market discomforts that were so acute only a few years ago. Think about it: a price of $115/b, or perhaps more for an item that cost $25/b a decade ago, and not too long before the Second World War, in California, was selling for less than 10 cents (=$0.10/b), or a tenth of a dollar! Of course, in 2008 that price touched $147/b

I also suspect that it might be wise to correct those persons who insist that things are different from the way they are described in this book because the real value of the dollar has decreased due to inflation and exchange rate changes. For instance, although a declining dollar is annoying for oil exporters in general, their situation is actually not so unfavorable as often alleged. As clarified in my new energy economics textbook (2014), the superb present (and future) physical transformation of the Gulf states alluded to above would have been impossible if the dollar decline was as malicious for oil exporters as often maintained by academic cranks and know-nothings in the business press. The reason is simple: comparing the oil price in l980 with the oil price today – as the pompous Josh in the TV series The West Wing attempted to do – is as scientifically inconsequential as comparing a rap standard to a rendition of ‘Hail to the Chief’ by the U.S. Army Chorale. The base year for calculating the real price of oil is something that I never think about, but given the miraculous economic progress that has taken place in some of the OPEC countries, I am unable to believe that the real price has decreased, or that it is meaningful to devote time and energy to its consideration.

The problem with many observers, to include teachers of energy economics, is that they cannot comprehend the power of oil, which derives from its usefulness. Consider for instance Norway, whose government was not intelligent enough to reduce their output of oil when – about 1999 – the price seemed to be heading for the dumps. They were later able to ride the oil price rise that began early this this century up to a position where, in theory at least, if the ‘oil-fund’ of that country – which is managed by the government, and used to buy financial assets and property in various parts of the world – was sold and the proceeds distributed, every resident of Norway – adults and children – could be awarded a million Norwegian crowns (or at the present rate of exchange, about 150 thousand dollars).

This Oil Fund (= Oljefondet), consists of income received by the government from taxing the profits made from the sale of oil and natural gas that is produced in Norway, or in the water around Norway, and also income from investments in stocks, bonds and property by that fund, which apparently amounts to more than 40 billion dollars a year. This good luck has made Norway one of the richest countries in the world, or by my standards the richest (together with Switzerland), because the wealthy OPEC countries often have to deal with various kinds of international and internal tensions.

Last but not least, a short mention of PEAK OIL seems in order, where an important analysis is provided by one of the leading oil economists in the world, Dr Mamdouh G. Salameh (2007). Peak oil is not about the future, but about the past! It’s about the (generally unspoken) intention – formulated many years ago by the most important countries in OPEC – to reduce the ‘rate’ at which their invaluable oil (and probably also gas) is produced when they got the opportunity. The present high oil price has given them the opportunity. In simpler terms, it’s not about the kind of run-of-the-mill profit maximization you studied in the course in Economics 101 that you may or may not have taken, but formulating a strategy in which attention is being paid to the future as well as the present. The kind of approach alluded to in the last chapter of the superb microeconomics textbook by James Henderson and Richard Quandt (1980). In other words, the OPEC countries prefer smart to other options where oil is concerned.

As might be shown by serious teachers with a serious interest in the so-called dismal science, it’s about obtaining or enjoying what is likely a controlling interest in the global supply curve, which to me is reflected in their ability to obtain the oil price they feel they need – the price that will provide an annual income of one trillion U.S. dollars. Basically, for an organization like OPEC just now, it’s less about geology than economics, and they have a much more thorough knowledge of the oil under their control than hackneyed researchers and busybodies at elite American universities who once preached to students and colleagues that OPEC is a lost cause, and deservedly so.

A slight addition to the above presentation is probably useful, and this has to do with how the OPEC countries in the Middle East feel about the increased supply of world oil due to ‘fracking’ – i.e. exploiting on a much larger scale shale oil, as a result of dramatic improvements in the technology for obtaining this oil. On the surface at least they do not seem worried, and sometimes refer to it as a ‘bubble’ ( = a deviation from fundamentals). There is no reason to comment on that judgment at this point in the exposition, however there are many observers who refuse to be impressed by fracking and its alleged potentialities. Moreover, the OPEC countries almost certainly realize that the large oil companies do not intend to do anything foolish that would reduce the price of oil, nor to prevent that price from increasing if buyers increase the rate at which they are taking their requirements. After all, they have many shareholders to satisfy.

The thing to remember here is the situation when an oil company executive made it quite clear that if forced to choose between his firm and his country, his country would come in second place. If he was serious, and his colleagues felt the same way, then they have no choice but to work with OPEC, although probably as silent partners.
MATHEMATICAL APPENDIX: A SIMPLE TOPIC MADE DIFFICULT
In my first energy economics textbook, I derived an equation that related the rate of growth of oil consumption with the rate of growth of reserves, and which displeased certain bystanders because of an approximation that was employed. I will now present a completely formal derivation in which no approximations are necessary, to include the one that I employed in my lectures in Paris and Bangkok, In the discussion directly below, the following notation is used: Q is reserves (a stock), while q is production (a flow). ‘n’ is the rate of growth of consumption, while ‘g’ is the rate of growth of reserves. T and ‘t’ refer to time. (θ will be defined as the reserve-production ratio, or Q/q. The background to this discussion however is the brilliant article by Andrew Flower (1978) and the book by Mamdouh Salameh (2004).

But before turning to the integrals, I would like to present a simple numerical example. Suppose that reserves are 150 units, and output is 15 units per period. The reserve production ratio ( θ = Q/q) is thus 10. Now let us assume that n = 0%, and g = 5% = (0.05), and see what happens to reserves. Q at the beginning of the next period is 150 – 15 + [150 x 0.05] = 142. 5. Both reserves and the reserve production ratio have fallen: the latter is now 142.5/15 = 9.5.

In the same vein, we can start with a value of θ = 40, and so with q = 15 (and thus Q = 600), and the same values for n and g, we get for the beginning of the next period Q = 600 – 15 + [600 x 0.05] = 615, and so as opposed to the earlier example, θ has increased to 615/15 = 41. The next step is to generalize these results using some calculus. We start with the relationship for Q at time t = T, having commenced with a value of Q(0) at time t = 0.

Q(T) = Q(0) – (1)

We should recognize that q(t) = q(0)e^nt and g = 1/Q[dQ/dt]. Now we can write:

Q(T) = Q(0) – (2)

This expression can immediately be differentiated to give dQ(T)/dT = – q(T) + gQ(T). Continuing, with θ(T) = Q(T)/q(T), we can write:

(3)
The penultimate move in this derivation is to substitute dQ/dT in (3), and to use θ = Q/q where it is appropriate:
[ – q(T) + gQ(T)] – θn = – 1 + θ(g – n) (4)
Thus, for dθ/dT > 0 we need θ(g – n) > 1. For the values in the previous example, with n = 0 and g = 5%, for θ to increase we must have θ > 1/0.05 = 20. This is the same outcome as informally obtained in my earlier energy textbook (2000).

For this teacher, the use of calculus is always a big deal, having failed college algebra my first year in engineering school, whereupon I was expelled from Illinois Institute of Technology. But in point of truth, it is only marginally important than the secondary school algebra that I employ to extend Andrew Flower’s important contribution, and which my students are told to learn, because unfortunately many of them have not been taught how to differentiate integrals.

Something else that they have not been taught is to read the business sections of their local newspapers. If however they did on March 4, 2014, they might had been told that because yesterday Russia informed the government of the Ukraine that if they did not comply with Russian instructions by 4 O’Clock the following morning, then by breakfast they might be under attack. That threat caused a general rise in oil prices, to include those thousands of miles away from the Ukraine, which says more about the importance of oil than all the loose talk in circulation about shale resources.

This chapter will be concluded with a very long list of references, and eventually I will add questions and exercises for all except the last chapter. I get the impression that many students of energy economics have not read what they should have read, and even worse, they have wasted their time with literature that should have been ignored. It is possible that some of the following references should have been eliminated, but frankly I do not know where to begin. I can however point out a few of my favourites. The article by Andrew Flower (1978) in Scientific America comes first, and forms the basis for the mathematics dealing with oil in my textbooks, articles, and lectures. The results in that article also correspond to those in the mathematics above. The books by Donald E. Carr, David Bodanis and Earl Cook come next, and then the book by Bertrand Barre and Pierre-Rene Bauquis on nuclear. The best microeconomics textbook is Henderson and Quant (1980). Articles such as those written by David Teece on natural gas, Mamdouh Salameh on peak oil, Fred Pearce on the German nuclear retreat, and also the work of Jeffrey Michel, an MIT graduate and prominent energy economist living in Hamburg are essential, especially for students who want and deserve reading materials that are free of irrelevant mathematics. It might also be a good idea to check out M. King Hubbert on GOOGLE!

Not long ago I took part in a net debate arranged by CrossTalk, which is a current affairs debate program associated with Russian Television (RT), and hosted by the American journalist Peter Lavelle. Many of the debaters are important politicians and academics from Europe and North America, and appearing with me were the economists Kurt Cobb and Sohbet Karbuz. Cobb is the author of ‘Prelude’ a peak oil novel, whose important blog is Resource Insights, and Sohbet Karbuz is Director of Hydrocarbons at the Observatoire Meditteranéen de l’Energie (Paris), and a foremost researcher into the mysteries of oil pricing.

With a bit of luck, serious readers of this book will eventually be ready to cross (verbal) swords with experts like Messrs Cobb and Karbuz, as well as other genuine experts, and with luck demonstrate to onlookers and themselves that they are getting somewhere in this matter of energy economics. By serious readers I mean people who read this book or books like it until they are convinced that they understand some of it perfectly, and all of it better than people who are forced or force themselves into contact with the wrong kind of energy literature.

Before finishing this chapter, I want to refer again to the site 321 Energy. If you desire up-to-date information on energy resources – oil, natural gas, nuclear, coal, solar and wind energy – it is a mistake to overlook that site. The persons publishing there are often the cream of energy journalists, and as far as I am concerned the site is Number One in the energy information business. You should also be aware that if you want to debate energy matters, Energy Pulse will provide you with a suitable outlet.

REFERENCES

Allen, R.G.D. (1960) Mathematical Economics. London: MacMillan & Co Ltd.

Banks, Ferdinand E. (2014). Energy and Economic Theory. London, New York

and Singapore: World Scientific. (Forthcoming)

_____. (2008).’The sum of many hopes and fears about the energy resources

of the Middle East’. Lecture given at the Ecole Normale Superieure

(Paris), May 20.

_____. (2007). The Political Economy of World Energy: An Introductory

Textbook. Singapore and New York: World Scientific’

_____. (2000). Energy Economics: A Modern Introduction. Dordrecht and

Boston: Kluwer Academic.

_____. (2000). ‘The Kyoto negotiations on climate change: An economic

perspective’ Energy Sources (July).

Carr, Donald E. (1976). Energy and the Earth Machine. London: ABACUS.

Cohen, Dave (2007a). ‘Living on the Edge’. ASPO (September l9).

_____ . (2007b). ‘A Non-OPEC progress report’. ASPO (September 12).

Cook, Earl (1976). Man, Energy, Society. San Francisco: W.H. Freeman.

Crooks, Ed (2014). ‘US Oil Refiners face fierce battle to prolong halcyon days’.

Financial Times (Monday, August 18).

______ and Jack Farchy (2014). ‘Russia curbs put Exxon’s Arctic goals on ice’.

Financial Times (October 1).

Flower, Andrew (1978). ‘World oil production’. Scientific American (March).

Greenspan, Alan (2007). The Age of Turbulence. London: Penguin Books.

Henderson, James M. and Richard Quandt (1980). Microeconomic Theory: A

Mathematical Approach. New York: McGraw-Hill. (Third Edition).
Hotelling, Harold (1931). ‘The economics of exhaustible resources’. Journal of

Political Economy (April).

King, Carey (2011). ‘Energy and Economics’. Earth (December).

Kohler, Stephen (2012). ‘Einfach Wahnsinn’. Interview in Spiegal (Online).

Levi, Michael (2012). ‘Think again: The American energy boom’. Foreign

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