Hold Off on That Gas Guzzler

by Bill Chameides | January 12th, 2009
posted by Erica Rowell (Editor)

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Just because gas prices are low today doesn’t mean they will be forever.

With oil prices way down maybe your neighbor is thinking now’s a good time for that shiny new gas guzzler. Good idea? I’d say no. What goes down goes up.

When it comes to gasoline, 2008 was the ultimate roller coaster. Prices started at a little less than $3 per gallon, peaked at more than $4 a gallon in early summer, then fell to an average of about $1.60 a gallon. This mirrored the global market’s average price for a barrel of oil (see graph below).

With gasoline prices at a nadir, one might think the age of cheap gasoline and its gas-guzzling, ugly stepsister is back. Think again. Here’s why.

  • Better times ahead: Don’t forget a global economic collapse precipitated the collapse in oil prices. Now I’m no economist, but Econ 101 teaches that rising demand eventually means rising costs. So at some point, the economy should recover and with it the demand for gasoline.
  • The long-term prospect is not good: Oil is finite resource; there’s only so much of the stuff in the ground. Once we’ve pumped it all out, we’ll have to wait about 500 million years for all the carbon we’ve put in the atmosphere to find its way back into the Earth’s interior and transform into fossil fuels. That’s a long time to keep your car in the garage waiting to slake its thirst.

The “peak oil” theory holds that there will become a point at which demand for oil will outstrip conventional supply. Not surprisingly experts disagree widely about when peak oil might occur. Some say right about now. Others, like Shell, say sometime around 2025 or later [pdf].

Into this fray comes the International Energy Agency (IEA) and its annual tome on all subjects energy: The World Energy Outlook. The latest report, released in November, has a significant under-reported departure from previous editions. For the first time ever, IEA states [pdf] that the production of conventional oil will plateau sometime toward the end of 2030. It also says that existing fields are declining at a rate of 6.7% – nearly double that of last year’s reported 3.7%.

Why the departure from the normal rosy outlook? Unlike previous reports that simply used global assumptions not calibrated with field data, this year’s outlook incorporated a detailed analysis of the world’s 800 largest oil fields. The result is a conventional oil outlook bordering on grim.

So maybe your neighbor considering a new gas guzzler is unimpressed by a prediction of peak oil more than 20 years (and many car generations) into the future. Maybe so, but here’s the kicker.

Current price unsupportable: It strikes me that IEA’s key finding is that output from the largest fields is declining at a faster rate than previously thought. That’s bad news for oil prices. The cost to pump oil from the largest conventional fields, such as those in Saudi Arabia and Venezuela, is quite low — well under $10 per barrel. Even at the current price of ~$40 per barrel, that nets a nice profit. But as oil demand increases and the supply from these large fields decreases, two things occur:

  1. the quality of the oil decreases and
  2. it’s harder to get.

So more and more oil must come from smaller or remote offshore fields. These fields are more expensive to develop and pump.  By EIA’s estimate the average cost to produce a barrel of offshore oil in the United States was about $70 in 2006. The price point — the break even price — would be even higher.

As long as prices stay below that price point, pumping oil from marginal fields is not profitable – better to let it stay in the ground and wait for higher prices. And as long as prices stay low, finding and developing new oil fields like those found offshore is not profitable either. But without those timely investments, production may not meet supply in the midterm.

Right now oil stocks are high, so supply can meet demand even at the low price. But as those stocks decline, prices will have to rise to get companies to pump from marginal fields. How much will they rise? Here again there is some disagreement among the experts, but you shouldn’t be surprised to see a doubling over today’s price — likely followed by a rise in gas prices.

Personally I drive a hybrid – as the dean of the Nicholas School of the Environment it’s in my job description. (Just kidding: I would have the car regardless.) And even with my almost 40 mpg I enjoy the low gasoline prices. But I’m not planning on those low prices long term.

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