Heavy Oil Reserves: Economics Still Works

There was a terrific article in the Wall Street Journal the other day describing Chevron's work on the recovery of heavy oil in Saudi Arabia.

What I found reassuring about the piece is that it reinforces my faith in human behavior and economics, which studies that behavior in the area of value exchange.

Basically, as light-oil reserves are drawn down, and crude oil prices rise, the incentive to recover deposits of heavy oil has risen. Chevron is working to recover the substantial Saudi reserves of this molasses-like material. According to the piece, including heavy oil reserves to the Saudi offical reserves would add "tens of billions of barrels" to their current 260 billion barrel estimate.

Buried in the article was a passing reference to the "peak oil" theory. According to the WSJ piece, adding recoverable heavy-oil reserves to the world's oil supply would put a major dent in the theory that we are on the brink of pumping ever-declining amounts of crude each year. This would appear to be no small thing. With India and China bidding up the price of existing supplies of crude in the past year, the prospect of declining crude supply would be a potentially civilization-altering phenomenon.

It's nice to see economic theory still describes how humans react to shortages. As crude prices have more than tripled since 2002, alternatives such as gassified coal, liquified natural gas, tar sands, and, now, heavy-oil are coming onstream to compete with the higher-priced light crude supplies.

Even at $3/gallon, gasoline is cheaper on a real basis now, in the US, than it was at the height of the Arab oil embargo of the mid-1970s. It remains to be seen if these admittedly-higher gasoline, and related, energy prices cause a global recession, but it is by no means at all certain. Recent estimates by economists put the chances at perhaps as high as 36%, up from 17% six months ago. When I read that, I thought it made sense. With higher energy prices and mideast violence, there is a natural concern that energy security issues will contribute to higher prices, and, thus, economic slowdown.

However, as recently as yesterday, Fed Chairman Bernanke reiterated Greenspan's comments of last year, that the US economy has displayed amazing resilience in the face of higher energy costs.

With the price signals of higher energy costs, new supplies are predictably coming onstream. Julian Simons would be so pleased to see his beliefs once again sustained. When these various alternative energy sources provide supply to the market, we should expect to have a near-term ceiling on energy prices and more supply for some time to come.

Crisis identified. Crisis resolved. Free-market style.

Like other resource supply issues of the past, such as silk (nylon, et al), rubber (synthetic rubber in WWII), and steel (minimills), energy, too, will fall to human ingenuity and the desire of people to make a buck solving economic problems.