Saturday, June 20, 2015

Massive hydraulic fracturing proves a point I made more than five years ago

Maybe you remember it. Whether you remember or not—remember this: I was right then, and I’m still right, now. In the post linked above, I attempted to explain how advances in technology change not only how we estimate energy reserves, but also our ability to extract and exploit reserves once believed to be inextractable and unexpolitable. The recent advances in massive hydraulic fracturing technology have led to significant increases in the efficiency of current and expected future extraction methods. These advances have also led to changes in how we estimate reserves in the ground.

The result? The shift in the Production Possibilities Curve that I predicted in May 2010. These advances have also positioned North America as the global leader in proven oil and gas reserves, and a long run drop in oil and gas prices.

Here are some excerpts from the May 2010 post:

What the doom-and-gloom crowd don't tell you about is the economic concept of production possibilities, time and the effect technological change has on production.  This is not an oil only concept.  It applies in every market.

I'm an economist, so I can't have a discussion on economics without a chart.  To the right is what's called the Production Possibilities Curve.  The vertical axis, C, represents capital (plant, equipment, etc).  The horizontal axis, L, represents labor. Any point on one of the curved lines represents a mix of capital and labor that produces the same quantity of a good or service.  It doesn't matter if the good or service is oil, gas, coal, legal services, cars, buildings, widgets, software or blog posts--substituting more labor for capital will not increase production any more than substituting more capital for labor.  Certain industries, like oil production, are very capital intensive.  Oil producers spend hundreds of billions of dollars on capital but don't spend as much on labor.  Conversely, legal services are labor intensive.  What this means is that most industries have mixes of capital and labor that are defined by the nature of the industry itself, rather than the decisions of the producer.  The producer may fiddle a little here and there with the mix, but his or her industry most likely determines the general neighborhood of the mix.

What the producer will not do is produce an amount that falls to the left or below the curve.  The profit motive causes the producer to add more capital and labor until the curve is reached.

What the producer cannot do is produce an amount that falls to the right or above the curve, and the limit is imposed by the state of technology at the time the production commences.  This is important to understand.  The production possibilities chart I have presented here shows two curves--one for period t and one for period t+1.  As a result of the growth of technology between the two time periods, the same mix of capital and labor is capable of producing a greater quantity. Only a change in technology can cause the entire curve to shift out and up (conversely, only external intervention in the market can cause the entire curve to shift in and down, but that's a blog post for another day).  And, technology tends to have a larger impact on capital-intensive industries than labor-intensive industries, because technology tends to affect the productivity of capital more than it does the productivity of labor.  That is, more efficient capital tends to make labor more efficient, but more efficient labor has a much more limited effect on the productivity of capital.

These are basic tenets of microeconomics and are—or should be—taught to every sophomore economics student (we don’t let freshmen take economics).

What is great about such tenets is that empirical data tend to demonstrate how effective they are in describing economic phenomena, and what you are seeing in the explosive growth of energy production and the precipitous decline in energy prices constitutes all the empirical data you need to reach the most reasonable, most logical conclusions.

When I published my 2010 paper, the “peak oil” folks and Paul Ehrlich neo-Malthusians came after me with vitriol. How dare I say that we would never run out of fossil fuels!

 Read that 2010 post. It’s a chapter right out of a Microeconomics 205 lecture.

Five years later, I’ve been proven right.

And I’ll be right in another, 5, 10, 15 years. The data don’t lie. People do.