Goldilocks and the three fuels

By Richard Heinberg
February 18, 2010


– Richard Heinberg is the author of eight books, including “Peak Everything”, “Blackout: Coal, Climate and the Last Energy Crisis” and “The Party’s Over”. He is also a senior fellow with the Post Carbon Institute. The views expressed are his own. –

Recent shale gas projects, including those involving the massive Marcellus Shale in several northeastern states, have been yielding significant quantities of fuel. Reserves of the stuff are enormous. But drilling costs and per-well decline rates are high, so producers can make a profit only if gas prices are near historic highs.

Where are oil prices headed in 2010? Forecasts for the year are all over the map, from more than $100 a barrel to under $50.

The difference hinges mostly on assumptions about whether the economy will recover or relapse. Yet it may be that price volatility has become an inherent feature of the oil market—and fossil fuel markets in general—for reasons that can perhaps best be explained with the help of a little history and an old children’s story.

Once upon a time (about a dozen years past), oil sold for $12 a barrel and a lot of people thought it would get even cheaper because the market was glutted.

But instead the price rose: many big oilfields were aging and yielding less, and it was getting harder to find new ones—especially in places easy and cheap to drill.

So the glut eroded and petroleum prices rose. Seeing a perfect opportunity (a necessary commodity with stagnating supply and growing demand), speculators drove the price up even further.

As prices lofted, oil companies and private investors also saw opportunity and started funding expensive projects to explore for oil in remote and inconvenient places, or to make synthetic liquid fuels out of lower-grade carbon materials like bitumen, coal, or kerogen.

But then in 2008, as the price of a barrel of oil reached its all-time high of $147, the economy crashed. Airlines and trucking companies downsized, motorists stayed home, and demand for oil plummeted. So did the price, bottoming out at $32 at the end of 2008.

But with prices so low, investments in hard-to-find oil and hard-to-make substitutes began to look tenuous, so tens of billions of dollars’ worth of projects got canceled. Yet the industry had been counting on those projects to maintain a steady stream of liquid fuels a few years out, so worries about a future supply crunch began to make headlines.

By mid-2009 the oil price had settled within a Goldilocks range—not too high (so as to kill the economy and, with it, fuel demand), and not too low (so as to scare away investment in future energy projects and thus reduce supply). That just-right price band appeared to be between $60 and $80 a barrel.

How long prices can stay in the Goldilocks range is anybody’s guess, but production declines in the world’s old super-giant oilfields continue to accelerate and exploration costs continue to mount, which means that the lower boundary of that just-right range will inevitably continue to migrate upward.

Meanwhile the world economy remains frail, so that even $80 oil could strain the recovery.

When discussing the increasing perils of the current oil supply-demand-price balancing act, some commentators opine that the world supply of oil has peaked; others say it is demand that has peaked. It is a distinction without a difference.

There are similarities with U.S. natural gas. Current shale gas projects are tapping into an abundant supply of fuel, and there is plenty more where that came from. But the costs of getting it out combined with the per-well decline rates are high, so gas prices need to be very high to turn a profit.

Nearly everyone believes that U.S. coal supplies are virtually endless, but the Goldilocks syndrome is coming into play there, too. Coal prices just about doubled in the two years leading up to the economic crash of 2008, and high-quality coals from the eastern region of the country are depleting fast.

We will never run out of coal, oil, or natural gas—in the absolute sense. The Industrial Revolution started in British coalfields, and there is still an enormous amount of coal in Britain; but the coal that’s left there is prohibitively expensive to mine, so that nation’s coal industry is virtually gone.

Goldilocks grew dissatisfied with her options, got up, and left. The same has been gradually transpiring in the U.S. oil patch over the past four decades, and the same will happen wherever useful non-renewable resources are found.

Economic theory says the market will always find a substitute for whatever resource is depleting to the point of scarcity. When it comes to fuels, the substitutes are alternatives to coal, oil, and gas—primarily, renewables like wind and solar. Investing in them should be a no-brainer.

But, during the Goldilocks interval, increasing price volatility for oil, gas, and coal can make all energy investments dicey. That means that, as a society, our main strategy for navigating the energy transition will almost certainly have to be conservation.

The lesson of the parable: If you’re an investor, beware—oil prices are going to be increasingly hard to predict over the longer term.

And if you make energy policy, don’t get any more hooked on non-renewable resources than you already are. If you do, you’ll eventually be spending much of your time chasing fickle Goldilocks—and in the end, she’s a bear.

Image shows a gas drilling site on the Marcellus Shale is seen in Hickory, Pennsylvania February 24, 2009.  REUTERS/ Jason Cohn

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