Connecting the dots: Iran, Peak Oil, fracking, 9/11, climatic change

Some fifteen years ago Peak Oil theoreticians were very actively predicting that the world oil production would peak in the near future with dire consequences to the world economy. Indeed, in 2008 oil prices hit a very high value and in 2009 the world experienced a depression. This economic depression passed and Northern American companies started producing unconventional oil and Peak Oil was declared a false: there is enough oil in the ground, only it should not be extracted since burning fossil fuels causes a climatic change.

            Another issue is that the USA and Israel seem to be looking for a way to attack Iran. Iran is claimed to support terrorism and secretly develop nuclear weapons. This sounds much like Iraq before the 2003 attack. Iraq was claimed to have weapons of mass destruction and to be connected with the 9/11 terrorists, but both claims were false. Iraq had oil and that appeared as at least a part of the real reason. Iran also has oil. I had to check again the Peak Oil theory and if it really was shown invalid.    

            There is now statistics of world oil production up to 2017. Apart from the oil crisis in 1970s inflation adjusted oil prices were between 20 and 40 dollars per barrel up to the year 2003. Then there was a fast increase of the price up to 2008 when a barrel cost over 100 dollars. The prices stayed high to the end of 2014, after it went to under 50 dollars per barrel and in 2018 climbed to 70 dollars per barrel. Oil production was on a plateau in the early 2000 but since then has increased. However, if one looks at conventional oil the production has been rather stable since 2005. The highest level of conventional oil production was reached in 2014 when oil prices were still high. If oil will be more expensive it is theoretically possible that the conventional oil peak of 2014 could be slightly exceeded, but it is improbable as wells deplete and new conventional oil is found less every year. Since 2005 the increase in world oil production is almost only from unconventional sources, notably shale oil in the USA and oil sands in Canada.

            Unconventional oil is more expensive to extract than conventional oil. American shale oil is light tight oil from porous shale. Light tight oil is ordinary crude oil and does not need special processing, but it has to be extracted with pressured water fracturing shale and chemicals increasing viscosity by a process called fracking. Fracking is not any new technology. It has been used in off shore wells for quite a long time. What makes this oil more costly is that the wells deplete very fast, just in a few years. Several countries have banned fracking because of environmental concerns, notably the danger of chemicals leaking to ground water. About 11% of world oil resources are light tight oil. Canadian oil sands contain bitumen, which is processed in the same way as other heavy oil. Oil sand is extracted from open mines and has environmental concerns. Canada has second or third largest oil resources in oil sands. Venezuela also has large heavy oil resources.

            In addition to light tight oil and heavy oil there is arctic oil, which is expensive to extract doe to the conditions, and synthetic oil from oil shale. The USA has huge reserves of oil shale, but it is so not economical to process it and the environmental cost of mining oil shale is high. Shale oil is light tight oil from porous shale while making synthetic oil from oil shale means turning kerogen to other hydrocarbon by a complicated and expensive process. Estonia is one of the few countries using oil shale. The country creates its electric energy by burning oil shale. Oil shale is as polluting as lowest quality coal and this energy source will be replaced in the future by some cleaner energy.

            The US shale industry started from a small share of oil and gas production around year 2000 and has grown very fast so that shale gas makes today two thirds of USA natural gas production. Shale energy is less prominent in oil, but shale oil and Canadian oil are responsible for the growth of the world oil production since 2005.

            Clearly, there are unconventional oil resources. The world is not running out of unconventional oil resources any time soon, but there seems to be an economic paradox: the US shale industry has every year has a negative free cash flow, that is income from operations minus operational costs. A negative free cash flow means that the industry has sold shale oil and shale gas for cheaper price than what is profitable and paid the difference from their capital. This capital is either from loans or from issuing new shares. Thus, US shale energy was not profitable even when the prices were around 100 dollars per barrel. This contrasts strangely with the announced breakdown price of about 50 dollars per barrel for shale oil.

            Canadian oil sands are economically profitable around 70-80 dollars per barrel, the same is probably true for other producers of heavy oil. With current prices Canadian oil is not profitable. With CO₂ tax the breakeven price for oil shale energy in Estonia is estimated to around 90 dollars per barrel. This may be a reasonable estimate for synthetic oil from oil shale and additionally there is the environmental issue. Arctic oil is on the same range. This means that no unconventional oil should be able to compete economically in the market with the current oil prices.

            There are other indications that shale energy is not profitable at the present price level. One example is Poland. In 2011 US Energy Information Administration estimated that Poland has over 5 trillion cubic meters of shale gas. In 2012 Polish National Geological Institute estimated that only about one tenth can be recovered. It is still a lot, but as it turns out, energy companies have withdrawn. Polish shale energy is not economical with current lower prices.

            Oil prices are set by the market, so why are they too low?

            The market price of a commodity is the cost of marginal production to satisfy the demand. Conventional oil is rather cheap to extract. A reasonable profitable price for conventional oil is about 30 dollars per barrel (indeed, Saudi Arabia can pump conventional oil for 10 dollars a barrel).  As conventional oil does not satisfy the world demand, the market price goes up to the level where either the consumer demand decreases (e.g. because they change to some cheaper energy) or more suppliers come to the market, which should imply that they can produce oil economically for that price. In the case of oil these suppliers are the unconventional oil producers, which cannot make a profit if the market price is less than 80 dollars per barrel. Thus, the market price mechanism sets the oil market price to 80 dollars per barrel and conventional oil producers make huge profits.  

            This is a well known problem in the market price: if there is any shortage of any commodity, the prices go up to the marginal price level though the commodity could be sold profitably for a much lower price. Actually 80 dollars per barrel is not the lowest profitable price. For instance, if unconventional oil makes about 10% of the total (as today), the lowest profitable market price for oil is 0.1*80+0.9*30= 35 dollars per barrel, but the market mechanism does not give this low price as it would mean that the producers of conventional oil would subsidize unconventional oil producers.

            Yet, this may be the reason why the price of oil has been on the range 45-70 dollars per barrel from 2015 to 2018. It is a price that is unprofitable for unconventional oil producers, but despite this fact US shale industry has expanded. It is true that after 2014 many US shale energy firms closed, but the ones that stayed still have a negative free cash flow and this fact requires an explanation. One can see that the surviving shale energy companies are connected with giants of conventional oil. If so, unconventional oil may indeed be subsidized by conventional oil in order to set the market price to an optimal level for the whole oil industry. Saudi Arabia has historically set the price of oil by swinging its production. This time the price setter may be some large oil companies. The price of oil is set to a level that does not cause a recession and as this level is lower than the profitable level for unconventional oil producers, they have to be subsidized in some way.

            The other explanation for the expanding and yet unprofitable shale energy is that is is a kind of a Ponzi scheme. This would mean that American shale industry has increased production despite negative free cash flow because if they do not increase production they cannot motivate issuing new loans or shares. A growing company can motivate why it needs more capital though it does not yet pay dividends. If the shale energy firms would not expand their production it would be too obvious that loans or investors money is used to subsidize uneconomical production.

            If US shale energy is a Ponzi scheme, then shale industry will crash: it is not possible to continue unprofitable production for a long time, while if unconventional oil production is subsidized by conventional oil production, then since conventional oil production decreases the price of oil will increase in a rather fast future, within years or decades. In both cases the Peak Oil prediction of the impending high oil prices is very relevant.

            What can be done to avoid the problem?

            The European Union is moving to renewable energy sources instead of shale energy.

Global warming is given as the main reason to reduce fossil fuels. People are told that there is lots of oil and gas in the ground and it can be economically extracted, but doing so causes increased carbon dioxide emissions and a climatic catastrophe, therefore use of fossil fuels must be reduced e.g. by taxing them. What the people are not told is that the climatic catastrophe comes gradually in some 500 years when the main glaziers melt, while the high oil prices come in years or decades, and it will create an economic depression. 

            The USA thinks differently. The USA and Israel seem to be looking for a way to attack Iran. Iran has oil resources. The USA attacked Iraq, which at that time could not sell its oil. After the 2003 attack on Iraq Americans increased Iraqi oil production. This Iraqi oil slowed down the rise of oil prices, but in 2008 oil prices hit the highest value so far. This high price of oil contributed to the crash of the world economy in 2009. After the crash oil price plummeted but increased rather soon to around 100 dollars per barrel. After 2014 oil prices sank largely because of shale oil production, but this shale energy was never profitable. Is it time for another injection of conventional oil?

            I hope I am wrong about the USA and Israel, but as I just watched a movie of the Pentagon Papers, so it is true that the American government does not always tell the whole truth. I do not think Israel does it either. There was no immediate threat of attack in 1967, for instance. It is at least good if the reason for war mongering against Iran is because of oil and not for some crazy religious cabbalistic motive. Oil is just greed.