How Did Hubbert Identify The Indicators Of Scarcity
In 1956 M King Hubbert predicted that oil production would reach a peak level of production and then production would decline as oil became increasingly scarce. How could we tell if oil was becoming scarce and is there evidence that Hubbert was right?
This essay will first attempt to identify the indicators of scarcity and then will analyse the debate surrounding Hubbert’s theory of Peak Oil (1956) and whether scarcity is the sole reason for production levels of oil peaking.
Introduction
M. King Hubbert predicted that oil production in the United States (US) would peak around 1970 and that the world production would peak in 2000. In the words of Jeremy Rifkin: [“Hubbart] argued that oil production starts at zero, rises, peaks when half the estimated ultimately recoverable oil is produced, and then falls, all along a classic bell-shaped curve.” His theories proved to be extremely accurate for US production as it peaked in 1971 (Figure 1), however with regards to world production, it is clear to see (Figure 2) that production has not been consistent with Hubbert’s Peak Theory as it is currently on the rise. This has, consequently, spurred much discussion and examination surrounding the integral factors that affect oil production.
Indicators of …show more content…
Scarcity
Hubbert’s theory proposes that scarcity was the prominent catalyst for oil production peaks but there is much deliberation surrounding the proposed indicators of scarcity.
Work by James L Smith argues that scarcity indicators should be evaluated using a comparative static criterion developed by Brown and Field (1978), by which an indicator of resource scarcity might be assessed. It states that: “A minimum condition (for a good index of scarcity) is that the index go up when underlying determinants shift to increase actual or expected demand for the resource relative to actual or expected supply”. According to this criterion, if, for example, there is an unexpected decrease in scarcity due to a new oil discovery, the indicator of scarcity should fall.
Smith also shows that the traditional economic indicators of resource scarcity (unit cost, resource rent, and price) provide inconsistent signals of real changes in the underlying degree of resource scarcity, and also mentions that they integrate the stochastic influence of long-term trends unrelated to changes in economic scarcity. This is supported by Farzin (1995) who notes, “The search for an appropriate indicator of scarcity is complicated by the fact that, in numerous cases, the three traditional indicators will not move in concert along the equilibrium path.”
Moreover, given the possibility of variation in the exogenous factors that enter these models (e.g.
technological progress and exploration), almost any pattern involving the traditional economic indicators might be encountered as the economy progresses along its equilibrium depletion path. Thus, it is evident that it is not plausible to rely on any set of market indicators to measure the status of exhaustible resources. This conclusion echoes the view of Cleveland and Stern (1999), who suggests, “…In order to develop more effective forecasts of future resource scarcity we need to look beyond the indicators to the production technologies, natural resource bases, and market structures that influence the
indicators.”
Misplaced Emphasis on Hubbert’s Peak Oil
Since Hubbert proposed the idea of Peak Oil in 1956, there has been a growing debate surrounding the validity of his theory. Whilst many economists believe there are elements of the concept that should be utilised as warning signals, there is collective scepticism surrounding Hubbert’s method of treating predictions of oil production as an exogenous process, purely based on geological measures of oil dissociated from economical market incentives. If the peaking phenomenon did not register changes in the underlying economic factors, it could hardly serve as an indicator of changes in the degree of scarcity; “…Peaking is an ambiguous indicator that provides inconsistent signals regarding resource scarcity.” Smith (2012)
Economists such as James L Smith support that idea that a well functioning economy, endowed with a limited amount of an exhaustible resource will limit production through time according to subsequent economic incentives that reflect market fundamentals such as the size of the resource stock, the cost of production, discount rates, the strength of current versus future demand, and the availability of substitutes. Hence, in contrast to Hubbert’s theory, that focuses on the physical state of the resource, the neoclassical view believes that the peaking phenomenon is a result of market forces that regulate the intertemporal allocation of resources based on demand, rather than the physical supply of oil.
Furthermore, in support of the idea of market forces, because oil is a major global commodity that is bought and sold years before it is extracted from the ground, if there was insider knowledge of a peak crisis in the near future many investors would be seeking to seize these arbitrary opportunities which would consequently be reflected by a shooting in the price of oil. But it is evident from the lack of such volatility in oil prices that very few investors are convinced that oil is becoming scarcer, and some even argue the opposite. Cambridge Energy Research Associates "…concludes that the world’s oil-production capacity could increase by as much as 15m barrels per day (bpd) between 2005 and 2010... the biggest surge in history"
As well as the counterargument made by various economists, evidence illustrates Hubbert’s predictions regarding oil production were substantially off. For example, while the model did accurately predict that U.S. oil output would peak in 1971, the prediction was for output to peak at three billion barrels per year, whereas actual production reached 4.1 billion barrels. (Nehring, 2006; Brandt, 2007).
Moreover, Hubbert’s theory that oil production is solely affected by the scarcity of the natural resource is not consistent with the evidence that technological advancements are allowing the discovery of perfectly substitutable resources that are replacing oil. Therefore, it would seem that oil is becoming scarcer, but in truth, it may be because there is a cheaper alternative. For example, Eggert, Lagos, and Tilton (2009) identified at least five trillion barrels, equivalent of 160 years of current oil consumption, of unconventional petroleum resources in the forms like heavy oil, oil sands, and oil shale. Thus, whilst oil production may experience sporadic peaks, there is no pure geological reason that oil production is likely to plateau in the foreseeable future.
Support for Hubbert’s Theory
Despite this criticism, the general public and numerous scientists from disparate fields remain clearly focused on the prospect of an impending and inevitable decline in oil production and embrace the notion that “peaking” manifests a scarcity that necessarily limits future economic growth.
Supporting this concept is a 2008 Journal of Energy Security that analysed the energy return on the drilling effort in the United States. It concluded that there was very limited potential for a sufficient increase in oil production. This was because of a tight quantitative relationship of diminishing returns with increasing drilling effort. In other words, as drilling efforts increased, the marginal energy (hotelling rent) obtained per active drill rig was decreasing. The study concluded that even an enormous increase of drilling effort was unlikely to significantly increase oil production in a mature petroleum region such as the United States. This consequently supports the Hubbert’s Peak Theory and suggests that majority of the large oil fields have reached maturity and since large fields are highly unlikely to be discovered, an unrealistically high rate of small-field discoveries would be necessary to meet ever-increasing demands for oil.
Empirical Evidence
Although Hubbert’s prediction is simple, it is considered invalid due to the neglect of the fundamental economic factors, as mentioned above. Empirical tests of Hubbert’s procedure, performed by Brandt (2007) and Nehring (2006), focusing on the global petroleum basins, failed badly in predicting the peak, which reinforces economists ' theoretical objections to Hubbert’s Theory.
Harris (1977) also demonstrated that a simple OLS regression fit to Hubbert 's data produces an estimate of ultimate recoverable reserves (URR) that falls short of the volume of already known discoveries, which implies that the volume of future discoveries must be negative, which is obviously false, due to the evident rise in current world oil production (figure 2).
Cavallo (2004) also examined Hubbert 's data and found that his bell-curve does not reliably distinguish between alternative values of ultimate recoverable reserves; the regression R-squared of Hubbert Curves with URR ranging between 150 and 600 billion barrels only varies in the third decimal point, implying that there is a large variance in the estimations of Hubbert’s Data.
Conclusion
In summary, it is evident that there is only a tenuous connection between the timing of a peak in oil production and the economical measure of resource scarcity. Assuming efficient markets, where it reacts instantaneously to expected changes in scarcity, it can be only be concluded that a change in scarcity will only advance or delay the peak, not affect its maxima. Thus, the measure of scarcity provides little signal for the level of peaking in oil production.
It is also apparent, in this current day and age, that there is very little evidence supporting Hubbert’s theory and oil production is yet to reach an absolute maximum peak.
1497 words
Bibliography
Fund, I.M., 2011. World Economic Outlook, April 2011, Renouf Pub Co Ltd.
Hanley, N., White, B. & Shogren, J., 2001. Introduction to Environmental Economics, Oxford University Press, USA.
Krautkraemer, J., 1998. Nonrenewable Resource Scarcity.
Livernois, J., 2009. On the Empirical Significance of the Hotelling Rule. Review of Environmental Economics and Policy, 3(1).
Shogren, J., 2013. Encyclopedia of energy, natural resource, and environmental economics, Elsevier Science.
Smith, J., 2012. On the Portents of Peak Oil (and Other Indicators of Resource Scarcity). SSRN Electronic Journal.
Smith, J., 2009. World Oil: Market or Mayhem? Journal of Economic Perspectives, 23(3).
Watkins, G.C., 2006. Oil scarcity: What have the past three decades revealed? Energy Policy, 34(5).
This essay will first attempt to identify the indicators of scarcity and then will analyse the debate surrounding Hubbert’s theory of Peak Oil (1956) and whether scarcity is the sole reason for production levels of oil peaking.
Introduction
M. King Hubbert predicted that oil production in the United States (US) would peak around 1970 and that the world production would peak in 2000. In the words of Jeremy Rifkin: [“Hubbart] argued that oil production starts at zero, rises, peaks when half the estimated ultimately recoverable oil is produced, and then falls, all along a classic bell-shaped curve.” His theories proved to be extremely accurate for US production as it peaked in 1971 (Figure 1), however with regards to world production, it is clear to see (Figure 2) that production has not been consistent with Hubbert’s Peak Theory as it is currently on the rise. This has, consequently, spurred much discussion and examination surrounding the integral factors that affect oil production.
Indicators of …show more content…
Scarcity
Hubbert’s theory proposes that scarcity was the prominent catalyst for oil production peaks but there is much deliberation surrounding the proposed indicators of scarcity.
Work by James L Smith argues that scarcity indicators should be evaluated using a comparative static criterion developed by Brown and Field (1978), by which an indicator of resource scarcity might be assessed. It states that: “A minimum condition (for a good index of scarcity) is that the index go up when underlying determinants shift to increase actual or expected demand for the resource relative to actual or expected supply”. According to this criterion, if, for example, there is an unexpected decrease in scarcity due to a new oil discovery, the indicator of scarcity should fall.
Smith also shows that the traditional economic indicators of resource scarcity (unit cost, resource rent, and price) provide inconsistent signals of real changes in the underlying degree of resource scarcity, and also mentions that they integrate the stochastic influence of long-term trends unrelated to changes in economic scarcity. This is supported by Farzin (1995) who notes, “The search for an appropriate indicator of scarcity is complicated by the fact that, in numerous cases, the three traditional indicators will not move in concert along the equilibrium path.”
Moreover, given the possibility of variation in the exogenous factors that enter these models (e.g.
technological progress and exploration), almost any pattern involving the traditional economic indicators might be encountered as the economy progresses along its equilibrium depletion path. Thus, it is evident that it is not plausible to rely on any set of market indicators to measure the status of exhaustible resources. This conclusion echoes the view of Cleveland and Stern (1999), who suggests, “…In order to develop more effective forecasts of future resource scarcity we need to look beyond the indicators to the production technologies, natural resource bases, and market structures that influence the
indicators.”
Misplaced Emphasis on Hubbert’s Peak Oil
Since Hubbert proposed the idea of Peak Oil in 1956, there has been a growing debate surrounding the validity of his theory. Whilst many economists believe there are elements of the concept that should be utilised as warning signals, there is collective scepticism surrounding Hubbert’s method of treating predictions of oil production as an exogenous process, purely based on geological measures of oil dissociated from economical market incentives. If the peaking phenomenon did not register changes in the underlying economic factors, it could hardly serve as an indicator of changes in the degree of scarcity; “…Peaking is an ambiguous indicator that provides inconsistent signals regarding resource scarcity.” Smith (2012)
Economists such as James L Smith support that idea that a well functioning economy, endowed with a limited amount of an exhaustible resource will limit production through time according to subsequent economic incentives that reflect market fundamentals such as the size of the resource stock, the cost of production, discount rates, the strength of current versus future demand, and the availability of substitutes. Hence, in contrast to Hubbert’s theory, that focuses on the physical state of the resource, the neoclassical view believes that the peaking phenomenon is a result of market forces that regulate the intertemporal allocation of resources based on demand, rather than the physical supply of oil.
Furthermore, in support of the idea of market forces, because oil is a major global commodity that is bought and sold years before it is extracted from the ground, if there was insider knowledge of a peak crisis in the near future many investors would be seeking to seize these arbitrary opportunities which would consequently be reflected by a shooting in the price of oil. But it is evident from the lack of such volatility in oil prices that very few investors are convinced that oil is becoming scarcer, and some even argue the opposite. Cambridge Energy Research Associates "…concludes that the world’s oil-production capacity could increase by as much as 15m barrels per day (bpd) between 2005 and 2010... the biggest surge in history"
As well as the counterargument made by various economists, evidence illustrates Hubbert’s predictions regarding oil production were substantially off. For example, while the model did accurately predict that U.S. oil output would peak in 1971, the prediction was for output to peak at three billion barrels per year, whereas actual production reached 4.1 billion barrels. (Nehring, 2006; Brandt, 2007).
Moreover, Hubbert’s theory that oil production is solely affected by the scarcity of the natural resource is not consistent with the evidence that technological advancements are allowing the discovery of perfectly substitutable resources that are replacing oil. Therefore, it would seem that oil is becoming scarcer, but in truth, it may be because there is a cheaper alternative. For example, Eggert, Lagos, and Tilton (2009) identified at least five trillion barrels, equivalent of 160 years of current oil consumption, of unconventional petroleum resources in the forms like heavy oil, oil sands, and oil shale. Thus, whilst oil production may experience sporadic peaks, there is no pure geological reason that oil production is likely to plateau in the foreseeable future.
Support for Hubbert’s Theory
Despite this criticism, the general public and numerous scientists from disparate fields remain clearly focused on the prospect of an impending and inevitable decline in oil production and embrace the notion that “peaking” manifests a scarcity that necessarily limits future economic growth.
Supporting this concept is a 2008 Journal of Energy Security that analysed the energy return on the drilling effort in the United States. It concluded that there was very limited potential for a sufficient increase in oil production. This was because of a tight quantitative relationship of diminishing returns with increasing drilling effort. In other words, as drilling efforts increased, the marginal energy (hotelling rent) obtained per active drill rig was decreasing. The study concluded that even an enormous increase of drilling effort was unlikely to significantly increase oil production in a mature petroleum region such as the United States. This consequently supports the Hubbert’s Peak Theory and suggests that majority of the large oil fields have reached maturity and since large fields are highly unlikely to be discovered, an unrealistically high rate of small-field discoveries would be necessary to meet ever-increasing demands for oil.
Empirical Evidence
Although Hubbert’s prediction is simple, it is considered invalid due to the neglect of the fundamental economic factors, as mentioned above. Empirical tests of Hubbert’s procedure, performed by Brandt (2007) and Nehring (2006), focusing on the global petroleum basins, failed badly in predicting the peak, which reinforces economists ' theoretical objections to Hubbert’s Theory.
Harris (1977) also demonstrated that a simple OLS regression fit to Hubbert 's data produces an estimate of ultimate recoverable reserves (URR) that falls short of the volume of already known discoveries, which implies that the volume of future discoveries must be negative, which is obviously false, due to the evident rise in current world oil production (figure 2).
Cavallo (2004) also examined Hubbert 's data and found that his bell-curve does not reliably distinguish between alternative values of ultimate recoverable reserves; the regression R-squared of Hubbert Curves with URR ranging between 150 and 600 billion barrels only varies in the third decimal point, implying that there is a large variance in the estimations of Hubbert’s Data.
Conclusion
In summary, it is evident that there is only a tenuous connection between the timing of a peak in oil production and the economical measure of resource scarcity. Assuming efficient markets, where it reacts instantaneously to expected changes in scarcity, it can be only be concluded that a change in scarcity will only advance or delay the peak, not affect its maxima. Thus, the measure of scarcity provides little signal for the level of peaking in oil production.
It is also apparent, in this current day and age, that there is very little evidence supporting Hubbert’s theory and oil production is yet to reach an absolute maximum peak.
1497 words
Bibliography
Fund, I.M., 2011. World Economic Outlook, April 2011, Renouf Pub Co Ltd.
Hanley, N., White, B. & Shogren, J., 2001. Introduction to Environmental Economics, Oxford University Press, USA.
Krautkraemer, J., 1998. Nonrenewable Resource Scarcity.
Livernois, J., 2009. On the Empirical Significance of the Hotelling Rule. Review of Environmental Economics and Policy, 3(1).
Shogren, J., 2013. Encyclopedia of energy, natural resource, and environmental economics, Elsevier Science.
Smith, J., 2012. On the Portents of Peak Oil (and Other Indicators of Resource Scarcity). SSRN Electronic Journal.
Smith, J., 2009. World Oil: Market or Mayhem? Journal of Economic Perspectives, 23(3).
Watkins, G.C., 2006. Oil scarcity: What have the past three decades revealed? Energy Policy, 34(5).