Wednesday, October 7, 2009

Reserves and Resources

In trying to estimate the size of the problem that will face the world as the available reserves of fossil fuel begin to decline, one has to make some assumptions about the size of the volumes that are available. It is a debate that can lead to people talking past one another if they make different assumptions about the size of those reserves. This holds true in discussions that dot the web sites of those that write about energy, whether writing about oil, natural gas, coal or uranium.

This current post was motivated by a couple of different stimuli, firstly there was an article on Seeking Alpha about the natural gas reserves of the USA and then I was asked a question about the coal reserve assumptions for Alaska.

The natural gas article illustrates, in some ways, the problem of discussing the remaining gas that the United States has available, and whether we have a problem in future supply. With a consumption of around 23 tcf per year, it questions whether the remaining gas reserve is 337 tcf or 1,747 tcf. It was followed, interestingly, by a second article on natural gas that points out the folly (as it turns out) of being in the natural gas market this past year, as an example of the “no free lunch” argument.
Natural gas is probably the best demonstration of the ‘no free lunch’ law in commodity indexing, as evidenced by the S&P GSCI Natural Gas Index which commenced at 100 in January of 1994, ended September at 2.63. Over the same period, the natural gas future has increased about 125%. While 2008 served as a strong reminder ‘to know what you own,’ 2009 has reminded investors ‘to know how to be properly exposed to commodities.’”

This ties into estimating the size of the reserve, because, in raising money to develop reserves, you have to be confident that the money that you invest will give you a financial return on that investment. If the price of natural gas has tumbled to $3 or less (per kcf) then you may not make that return, and may even lose money. You will therefore look more cautiously at what are potential sources and be more selective on where you drill. Some of the more questionable areas will no longer be sites that justify the investment. And thus these areas move from being in the reserve account into that of being a resource that is available, but not justifiable as being exploitable AT THE PRESENT TIME.

Yes I know I was shouting, I did because it is that qualifying clause that gets overlooked time and again when discussions arise over what the fossil fuel base is for the world. The condition as to whether the volume has enough worth to justify being developed changes with conditions. Coal in the UK had a considerable future before the oil and gas reserves of the North Sea were developed. At that time the reserve was proven at over 45 billion tons and the coal was being mined at around 200 million tons a year - but times change, and the cheapness of the liquid fuels, relative to the cost of mining, meant that a lot of the coal, although still there, is currently too expensive to produce – relative to the alternative. It is thus no longer counted as being part of the reserve.

Now this gets into the climate change debate a little, since one of the arguments that are raised is that the users of coal do not pay the full price, since the price they do pay does not include some of the social and environmental costs associated with burning the product. Since the customer ultimately pays for the product, this seems in part to be an argument to justify raising the price of coal based energy to the point that other sources become cost effective. The problem is that in some locations it is hard to find current technologies, even at cost equality, that can provide a replacement for coal as oil and natural gas supplies run down.

Which gets us back to the question as to how much of a reserve of oil and gas we have, and how long will it last before we have to face the reality of a return to coal.

And this is where the price of the product controls, transiently, the volume of fuel available. In the short term natural gas prices are down and it becomes harder to justify continuing to drill new wells, if they aren’t going to make money. But as more folk stop drilling, then with the very transient life of the existing wells, the supply will shorten, and after the stored volumes begin to be used up, then prices will rise to the point that an effective market can be reestablished. How long will that take?

Probably until sometime next year is my current guess, though it depends in part on how hard a winter Europe and North America experience this year. (And since that is weather and not climate I’ll hold off on making that prediction today).

In the longer term there are so many power plants that now rely on natural gas that demand will sustain a higher price, and lead to an increase in the drilling rate, until price:supply and demand reach a more stable platform. At that time the reserve volumes that are currently moving into the resource category will start to move back and the projections for a longer “age of Natural Gas” will start to assume a little more reality.

However I would like to throw a small caveat into that debate, at the beginning of the year the SEC changed the rules for counting the validity of an oil or gas resource, loosing the requirement that the fuel be “proved” to be there. The ramifications of that decision are likely to have some impact on this debate.


  1. A friend, who knows I read about energy sources, has lent me the Sep/Oct. issue of Foreign Affairs. It has (pp 36-52) an article by Edward Morse called Low and behold – making the most of cheap oil. Morse is Managing Director of Louis Capital Markets and was Deputy Assistant Secretary of State for International Energy Policy in 1979-81.

    The first part of the article has a review of the American and global supply and demand situation for oil and gas. He works toward a conclusion that the annual growth in global demand for oil will be 1.0-1.3% for the next few years, a demand that can be met by spare capacity, mostly in Saudi Arabia. Prices, he thinks, will remain in a range under $80.

    We might quibble with this part of Morse’s essay, notably his failure to discuss the now higher-than-historic depletion rates for both oil and gas, and with an estimate of growth that’s lower than the 1.5-1.8% consensus view (and today’s revision by the IEA, which says it will be 1.7% for 2010). However, he builds recommendations for American policy on top of the discussion of supply and demand. The recommendations seem on more solid ground to me, perhaps because this is a topic removed from my normal reading.

    He concludes that the Obama administration should take a more active stance in managing sources of supply, summing up as follows:

    ”The opportunities presented by lower oil prices should not detract from the important goals of reducing greenhouse gas emissions, enhancing the United States’ energy security, and building a new generation of energy-efficient nonhydrocarbon fuel sources. But they should not be overlooked; it would be dangerous to ignore oil and “old energy”. However laudable it might be to pursue clean energy, energy efficiency, and alternatives to oil and coal, oil will continue to be a critical factor in the world’s economic stability and security. Defanging those that use oil as a weapon, prolonging moderate prices, and anticipating supply disruptions require an activist and global approach to energy, not a parochial and national one. It is time for Obama to publicly recognize that bringing energy independence to the United States is an impossible task and that pursuing more modest goals is a better way to ensure the country’s energy security.”

    It’s an interesting article and I hope you can access a copy.

  2. Hmm! Thanks, I'll try and chase it up - though I suspect I disagree with his growth model, about which more in my next post (models that is).