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Goldilocks Is Dead

March 24, 2015

Five years ago I wrote an article for Reuters titled “Goldilocks and the Three Fuels.” In it, I discussed what I call the Goldilocks price zone for oil, natural gas, and coal, a zone in which prices are “just right”—high enough to reward producers but low enough to entice consumers. Ever since the start of the fossil fuel era, such a zone has existed. Sometimes price boundaries were transgressed on the upside, sometimes the downside, but it was always possible to revert to the zone. 

But now, for oil, the Goldilocks zone has ceased to exist. This will have staggering consequences throughout the economy for the foreseeable future.

During the past dozen years, the Goldilocks zone for oil steadily migrated higher. As conventional crude reservoirs depleted and production rates leveled off, drillers had to spend proportionally more to develop the capacity to pump the next marginal barrel. Oil prices soared from $30 in 2003 to nearly $150 in 2008, collapsed during the economic crisis, then clawed their way back to roughly $100—a price that was maintained through mid-2014. But the economy did not do well with oil prices at elevated levels. Despite massive bailouts, stimulus spending, and low interest rates, the recovery following the 2008 crash was anemic.

However, at $100 a barrel, the oil price was high enough to incentivize fracking. Small, risk-friendly companies leased land and used expensive drilling techniques to free oil from rocks that geologists had previously described as too impermeable to bother with. This entailed a tenuous business model that required not only high oil prices but easy money as well, as low interest rates enabled producers to pile on enormous amounts of debt.

Oil production in the United States rose sharply as a result, and this eventually impacted prices. Since mid-2014, the oil price has declined by half, settling around the historic, inflation-adjusted mean price of $50 a barrel. Consumers are much happier than they were with oil at $100, but producers are wilting. The American petroleum industry has seen over 75,000 layoffs, the balance sheets of fracking companies are bleeding, and drilling rigs are being idled by the score.

For consumers, experience suggests the acceptable oil price zone is $40 to $60 in today’s dollars: higher than that, and goods and services (particularly transportation) become more expensive than current spending patterns can handle. For producers, the acceptable zone is more like $80 to $120: lower than that, and upstream investments make little sense, so production will inevitably stall and decline—eventually making consumers even less happy.

You will have noticed that there is no overlap. An oil price of $70 would not be high enough to give the industry a rebound of confidence sufficient to inspire another massive round of investment. Clearly, consumers would be happier with $70 oil than they were with $100 oil, but if $70 isn’t a high enough price to incentivize production growth, then it’s not really in the Goldilocks zone.

According to the narrative emanating from most mainstream energy economists, oil production rates will soon slow, prices will rebound, and everyone will be happy. That narrative misses the all-important news that Goldilocks is dead. There is no longer a price that everyone can live with. And that’s a recipe for price volatility.

For oil traders, price volatility may offer opportunities for profit. But for everyone else, it is treacherous. Price volatility only hints at the real extent of our peril: we have built an economic system overwhelmingly reliant on a nonrenewable, depleting resource. This is not a sustainable situation. Unless our dependency on oil somehow magically disappears, we are in for a wild ride on an unmapped road. 

A version of this article was published as a Reuters op-ed.

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  • John Doe

    If you wish to make economic arguments as to what is good, or bad, in terms of price, and what consumers like, or dont like, is there any possibility that you might throw in some cost of supply and demand curves? As far as what consumers find acceptable, I would refer you to the hysteria over the FIRST time nominal prices crossed the $40 mark early in just this century, there wasn’t anything Goldilocks about it at the time. Only after the new acceptance of such prices has set in can anyone claim that it somehow a new “normal”, as long as “normal” is defined as “only the past few years”. Certainly real prices in he 70’s were just as bad as they were as of late, and we are seeing the beginning of what some industry folks are worried is the same consequences that they faced post 1986.

  • EVHappy

    “Price volatility only hints at the real extent of our peril: we have built an economic system overwhelmingly reliant on a nonrenewable, depleting resource.”

    I would like to add, “… on an inexpensive, conventional, non-renewable, depleting resource.”

    The un-conventional resources of last resort only give up net energy that is too costly for the masses and our current infrastructure to tolerate. Even basic maintenance is impossible with EROEI ratios this low.

    People need to understand that two barrels of oil next to each other does not mean they are the same, from an energy perspective. One of those barrels may allow our current system to run smoothly while the other, because of the massive amount of energy needed to get that barrel, makes it impossible for our system to function adequately.

  • EVHappy

    The difference is that historical 2% annual growth of global net energy production stopped in 2005. When inexpensive net energy is available in ever growing amounts, economies can seem very healthy, even if they are very inefficient. When net energy production growth turns negative, almost all current economic models fail, because most are based on Ponzi-like rules. If you cannot pay off the interests, the system fails quickly, just like if you cannot find more suckers to cover the bottom of the pyramid scheme.

    It is all about the net energy production and the cost of that energy. Unfortunately, these concepts are difficult for most people to understand and accept.

  • John Doe

    Net energy is a useless metric in an economic system that understands and values each BTU differently. So it doesn’t matter if I waste gigajoules of sunlight to run the gensets on a walker rig, or diesel, what matters is that the wells will make enough $$ after completion to pay for that power generation. To match against this we have efficiency, the US using more than 50% less crude oil per person since the last global peak oil in 1979. Certainly the oil and gas industry is as much at the mercy of capital investment as any other, and in no case would that direction of capital be considered a Ponzi scheme. Wall Street might certainly be a ponzi scheme, but you can’t just say that about the basic idea of capital flow.

    Net energy and cost of energy are not the same thing. One is irrelevant, the other is not. Unfortunately, the value of one of these concepts is difficult for most people to accept, but fortunately the other can be explained to anyone writing out a check to heat their home or fuel their car.

  • John Doe

    Once upon a time, nearly every oil field on the planet was “unconventional” in the sense that a new technology would need to be invented to make it “conventional”. Such language only indicates that the user is unaware of the history of the industry turning the “unconventional” into the “conventional” within a generation, on multiple occasions. It also reveals a lack of understanding about the sequence of oil and gas development in the US, where shale gas was being developed FIRST, in 1825, and Devonian shales were being developed all across OH and WV in the late 1800’s. Last resort? They were a FIRST resort, and we are just coming back around with some of those new technologies to wring yet more hydrocarbon energy from the same rocks, overlooked for the past half century while the majors were out white elephant hunting.

    People need to understand that two barrels of light sweet crude oil, 42 API, one drilled from an offshore platform and another onshore are probably IDENTICAL in terms of the energy they contain, and it is only people making up differences without a distinction that even allows the EROEI argument to exist. Never, not ONCE, in the history of the oil and gas industries, has ANYONE, EVER, made the decision to explore, drill, develop, transport or refine oil based on the net energy of that process.

    Not once. Not ever. There are probably 15,000+ fields in the IHS EDIN database, feel free to use any one to prove me wrong. There are more than 4,000,000 wells drilled in the United States over the past 150+ years, feel free to find just ONE to prove me wrong. Just a scrap of PAPER where someone is calculating up all the BTU’s they plan on using to drill, and how many BTU’s they plan on getting out, and deciding to not go ahead with the project because there were too many of one, than the other.

    Shareholders do not fire the CEO for his net energy balance, they fire him for not making money, regardless of whether he uses gigajoules of sunlight to power the gensets on a rig, or diesel. Go find an AFE, and see if you can find the BTU estimate for drilling the well. Go look up a companies SEC filing, and see how many BTUs they expect to spend and acquire next quarter. Go check out a companies proven reserves, and see how many BTUs they expect to acquire as compared to those they’ve invested.

  • EVHappy

    “Net energy is a useless metric in an economic system” – John Doe

    Further debate on energy topics with you would be pointless.

  • EVHappy

    You have to understand the concept of EROEI to understand what I am talking about.

    Let us simplify things:

    Two economies each have 100 apples a day to work with in terms of total energy production. In economy A, the apples are located directly near the community and require only 1 apple’s worth of energy to collect and distribute the 100 apples. In this case, there are 99 net apples left to do the useful work of the community. The EROEI for this energy source is a healthy 100:1, very much like the super giant oil fields produced during a time the global economy was building out a very energy intensive infrastructure.

    Economy B still has 100 apples on the table to work with but the apples were collected from a distant farm where someone has to walk a considerable distance to get these apples, return and then distribute them. In fact, this team of people (maybe they even need a horse) had to consume 50 apples for the calories needed to complete this task. What is the result? This community has much less to work with, in terms of energy available for economic activity, than economy A.

    Same total energy production, much different result. I hope this very simple example makes things easier to understand.

    It is, has been and always will be about the resources and the net energy available to exploit these resources. After that, the topics like sustainability, environmental damage, resource overshoot, etc. come into play.

  • John Doe

    I am completely familiar with EROEI, including how Charles Hall (1981, Science) used it to predict the end of drilling in the United States by the year 2000. I would prefer to use methods approved by the Society of Petroleum Engineers and such that work to estimate value of oil fields and such, rather than those that have already been proven incorrect by reality.

    I have issued a means by which you can prove EROEI to be a relevant concept, millions of examples with which to refute my statement on the irrelevance of EROEI. Repeating your belief in its value does not change the fact that it has none now, has been irrelevant over 150+ years of industry activity, and no one is planning on changing SEC rules on proven or probable reserves within the context of BTUs invested or produced, domestic or international, any time in the foreseeable future.

  • John Doe

    Thank you for showing that you cannot refute the idea of its irrelevancy, even given a century and a half of oil field history, tens of thousands of oil fields, hundreds of thousands of oil projects, and millions of wells, within which you need to find only a SINGLE example to prove me wrong. You cannot. Therefore your desire to retreat from defending your idea is expected and reasonable.

  • EVHappy

    You think the concept of EROEI is only connected to the petroleum industry and that is was proven wrong because some guy who did some calculations in 1981 may have made some mistakes? lol. Thank you for that laugh.

    The concept of EROEI holds regardless of the time or form of energy. Dealing with sun power, wind power, nuclear, biological, etc. you have to have a practical return on invested energy to have significant work done towards supporting organized systems.

    You are just scratching the surface of what energy means. It is everything as no activity can happen without it.

    Reality is, fossil fuels are a non-renewable energy resource that took hundreds of millions of years to form. It becomes more costly, energy wise, to extract because we go for the low hanging fruit first. Eventually we will hit the point where it takes more energy to extract, refine and transport than it returns (negative EROEI). Sure, it will still be useful in some applications, like powering military weapons and producing desired products, but the masses will not be able to enjoy those very costly goods.

  • EVHappy

    Step back from oil and look at the whole energy picture (I give examples in my other posts to you) and you will see that net energy is all that matters. So, you say net energy is irrelevant and I say it is everything. An outside observer would conclude that our point of views are as far apart as could possibly be. The Pope and an Atheist have more in common than we do.

  • John Doe

    The concept of EROEI is NOT only connected to the petroleum industry, but it certainly has been misused in regards to that industry. Ethanol manufacturing is one of those areas where EROEI seems to employ some enthusiasts, maybe it has value there, I am not an ethanol manufacturer so I cannot comment with authority. But I can comment with authority related to the oil and gas industry in regards to the irrelevance of EROEI.

    I am quite familiar with petroleum geology, everyone knows that fossil fuels are non-renewable within the time span of a human and if you knew more, you would understand that “going for” low hanging fruit isn’t a proper description, oil and gas companies go for ANY fruit they can reach, it just happens to be easier to find large discrete accumulations than smaller ones. The “energy” required to drill into either, within a particular technology, is approximately the same, the results are not. Feel free to go drill a well, plan on getting the “low hanging fruit” and see if you get ANYTHING, low hanging, high hanging, or any kind.

    For the record, EROEI can never be negative because it is a ratio of energy return on energy invested. The numerator can never be negative because you cannot create negative energy, and the denominator can only be positive because your energy investment can only be positive. Therefore, at WORST you can only have an EROEI of 0, but never negative.

  • ashermiller

    Thanks for the strawman argument, John Doe.

  • John Doe

    I have discovered that when the helicopter view is directly contradicted by the physics, history, and real world practice of a thing, that the helicopter view itself is usually flawed, and not the other 3.

  • EVHappy

    “oil and gas companies go for ANY fruit they can reach” – John Doe

    Not the ones that stay in business.

    “The ‘energy’ required to drill into either, within a particular technology, is approximately the same”

    So, drilling into an in-land super giant oil field a few hundred feet takes around the same amount of energy as drilling many miles down on a very deep water floating rig? No, that is impossible.

    “EROEI can never be negative because it is a ratio of energy return on energy invested”

    I am referring to the amount of net energy. For example, if you need one barrel of energy to get one barrel back that is a ratio of 1:1 and you get a zero net energy result. If you need one barrel of energy to get one gallon back you get a negative net energy result, making the investment even harder to justify.

    It is useful to use the term negative because the 1:1 result is a critical crossing point. It means that you do all that work for nothing, but it does not put you into an energy hole. So, technically, you cannot have a negative ratio, you can, however, have a net negative energy flow, which is the most significant point of the concept. So, If we write out the what I posted, “negative energy return on energy invested” it means, for example, I invested 1 barrel of oil to get .5 barrels back, resulting in a net energy flow of -0.5 barrels. I did not write, “negative EROEI ratio”, It we want to spit hairs.

  • John Doe

    What strawman? EROEI angles can be disproven from a myriad of angles using nothing more than the difference in economic value among BTUs. This is a fact, nothing more. Just as it is a fact that if this really was an important metric…someone…somewhere…across a span of more than a century….would have used it to make a SINGLE decision in the field we are discussing, the development of oil and gas resources. But it isn’t, and that is a fact, not a strawman.

    If I can engineer a system that uses 1 billion BTUs of sunlight costing me $0.01, to generate 1 BTU of gasoline that I can sell for $0.02, I have a hideous negative net energy and a wonderfully economic result that everyone and their grandmother would want in on the bottom floor of, if given the opportunity.

  • ashermiller

    It’s a strawman because the value of net energy is not solely contingent upon whether or not fossil fuel companies use it as a determining factor. Obviously, their decisions are based on a different set of metrics.

  • John Doe

    Solely contingent? It isn’t a consideration at all. It isn’t talked about in the board rooms. It isn’t a single presentation slide in the reservoir engineering department meetings when deciding to fund CO2 EOR. It isn’t even by the production engineer when he installs tubing in a flowing well, and in 30+ years of oil industry experience I haven’t seen a single exploration geologist present a histogram of expected BTU results, and expected BTUs produced as the reason why you should drill a prospect.

    Are you suggesting you HAVE seen this happen at some point in time, somewhere in the oil field? If so I would love to hear how it went.

    So no, it isn’t even a strawman within the oil and gas industry. As best I can tell, having watched this concept get fleshed out over at TOD (when applied to the oil and gas industry) it appears to be an exercise limited to academics, and designed primarily to dodge the issue of oil field economics, or resource economics.

  • ashermiller

    Again, you’re missing the point. The point is not whether fossil fuel companies use EROEI analysis in their decision making. The point is that net energy is a critically important factor in our overall energy trajectory and, by extension, the direction of modern society. We already know that companies operate under a different set of considerations than the well-being of society or the biosphere as a whole.

  • John Doe

    Okay. Net energy is critically important. Let us start there. Here is my basic oil field example. I use a single drilling drill embodying 1 billion BTUs to find 100 quadrillion BTUs of oil. 50 years later a single drilling rig embodying 1 billion BTUs finds only 1 quadrillion BTUs of oil.

    The process of why this happens from a geologic standpoint has been studied for decades, and is generally referred to as discovery process modeling. Larger fields are generally found first, and identical amounts of energy for discovering these fields means that a natural decay function is created from this known and well studied fact alone.

    You can read this book if you have an interest in how this process works.

    http://www.amazon.com/Undiscovered-Petroleum-Mineral-Resources-Controversy/dp/0306455242/ref=sr_1_14?s=books&ie=UTF8&qid=1428430780&sr=1-14

    It should be noted that both the EIA and BOEM use this type of modeling to predict oil field sizes going into the future, and therefore the big EIA model (NEMS) incorporates this effect of net declining energy (within the oil and gas business) within the context of general energy use and overall economic activity.

    I maintain that the concept is irrelevant (as an oily guy who knows it means nothing to my NPV calculations for project economics), but I suppose from your perspective it is a good thing that this effect has been properly accounted for, and better yet, within an economic context that policy makers are more comfortable with?