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You are here: Home > Current Topics > Mind your Business > 6 February 2006 |
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Oil is a non-renewable resource. At some point it will run out. Should we be concerned about this fact? Possibly. According to figures from the Energy Information Association (EIA), proven global oil reserves stand at around 1,292.550 billion barrels. The same organisation quotes the average supply of oil at around 84 million per day. Assuming 365 days in a year, that amounts to 30.660 billion barrels a year. On present estimates based on this use, therefore, there are 43 years of reserves left. 
A barrel of oil contains 44 gallons (200 litres) of oil. The world is currently producing 84 million of these a day to satisfy our oil needs - and the figure is not falling. In many cases, it is not even sufficient to meet our needs. What happens to the price when this situation arises? Copyright: Carlo Winkelmann, stock.xchng The increase in the demand for oil from developing nations like China and India has been well documented as a contributory cause of the rise in oil prices in recent years. Gone, it seems, are the days when a barrel of oil cost $25. A price of $60 is not unusual, and it is predicted to go even higher than that. So - are we staring into the face of disaster? Will we be unable to develop alternatives to oil that will help to fulfil our energy needs into the future? Possibly, but predictions of doom have been made before. The Reverend Thomas Malthus in 1798 made dire predictions of the future in his 'Essay on the Principle of Population'. Malthus speculated that the rate of growth of the population was greater than the capacity of nations to feed this population. The result would be mass starvation, famine and death. Whilst Malthus' essay was, in part, an exhortation to man to turn his back on laziness, he did not foresee the tremendous impact that the industrial revolution would have on the ability of man to increase productivity at the rate it has grown. Productivity, however, is dependent to a large extent on the rewards that come from increasing productivity. The chances are that there are plenty of other reserves of oil in the world yet to be discovered; the problem is how accessible these are. For many years now, it has been known that Alberta in Canada has large reserves of oil. The problem has been that this oil is mixed up with sand. Despite this, there is a lot of oil there - reserves second only to Saudi Arabia, running into trillions of barrels. 
Image: Alberta, Canada, is 661,185 sq km in size. The Athabasca Oil Sands have reserves of 1.6 trillion barrels - that's 254km3! (Source of data: Wikipedia).The potential number of barrels recoverable could be as much as 311 billion. Map courtesy of www.theodora.com/maps, used with permission. 
Image: the yellow areas show the sites where the oil sands are located. Courtesy of Athabasca Regional Issues Working Group The problem has been that the cost of extracting the oil from the sand was such that removing it in any great volume was not worthwhile. Developments in technology has improved the viability of exploiting these resources and the rise in oil prices has also helped. Native Cree Indians knew how to extract oil hundreds of years ago: they would put the sand into a pot of boiling water and skim off the bitumen to use for waterproofing. The same technique is still used - steam heating the sand to separate the bitumen from the sand, and then processing that bitumen. For every two tons of sand dug up, around 75% of the bitumen can be removed. The processed sand is then returned to the site. The companies involved in the development are planning to replant the area with trees to restore the natural habitat. According to the Department of Alberta Energy, only 2% of the known resources have been exploited so far. As the investment into the industry and the fact that it is now becoming worthwhile to take this land into production grows, the volume of oil produced is rising. In 2003 oil production rose by 15.7% on the year before; it is expected that output will soon cater for half of Canada's total oil output and around 10% of total North American crude oil production. The very fact that oil prices have risen has made investment into this resource practical. The workings of the market have somehow managed to help solve some immediate problems of meeting our energy needs. Time magazine suggested that the reserves of oil sands "could satisfy the world's demand for petroleum for the next century" - but only if the price is right! |
The theory related to this story concerns the concept of the margin. The margin is an important concept in economic and business analysis. You will come across marginal utility, marginal cost, marginal revenue, marginal product and a host of other marginal terms. But what is the margin?
The margin refers to the difference when one additional or one less unit of something is observed.
One important thing to remember about this concept is the difference between marginal and total values. Let us take a simple example to try to illustrate this.
You are looking forward to a night out with friends. You get to the bar and order your first drink. Give it a rank out of 10 in terms of the pleasure it is going to give you. (This represents, in economic terms the degree of utility or satisfaction gained from consumption). Chances are it is going to be quite high - let's say 10/10. The total utility after the first drink is 10 and the addition to total utility - the satisfaction gained from that first drink - is also 10.
You finish the first drink and decide to have a second. This next drink is your marginal drink - one additional drink. How much utility does this extra drink give you? Possibly quite a lot but probably not quite as much as the first, if you are totally honest. Let's say 9/10. The total utility gained now stands at 10+9 = 19 but the marginal utility - the satisfaction gained from that one extra unit - is 9.
What about the third drink? Again, this extra drink gives you some satisfaction but probably less than the second, and almost certainly less than the first. The utility gained might be scored at 7/10 for this third drink. The total utility is now 10+9+7 = 26, but the marginal utility is 7.
The process could continue - and we are not advocating binge drinking here in the pursuit of economic experimentation! It is possible that you might get to eight drinks - the eighth drink might yield only 1/10 and you might be getting to the stage where you are starting to feel a bit unwell. Someone offers you a ninth drink. You know that if you take this ninth drink, you will be sick - it is perfectly possible, therefore, that the utility gained will be negative in such circumstances.
Think about it - is it really worthwhile having that extra drink? Exactly what is the marginal utility gained from it? Copyright: Kat Callard, from stock.xchng.
All the while you are taking these drinks, of course, you have to pay for them. The relationship between what you have to give up in relation to the utility gained is changing. If we assume that all the drinks are the same price (let's say £2.50 for the sake of argument), the relationship between the utility gained and the price you have to pay for the first drink is quite high. Each successive drink, however, sees a reduction in the value relationship. You are paying £2.50 to get 10 units of utility from the first drink but still have to pay the same amount to get only 1 unit of utility from the eighth. If you did take the ninth, then you would effectively be paying £2.50 for the privilege of throwing up!
The concept of the margin, therefore, is important in decision making. In the case of the oil sands in Canada, the decision is whether to exploit this resource that is literally lying around. The decision will depend on the marginal cost of extracting the oil and the marginal revenue gained from the sale. In agriculture, mining and similar industries, there are always marginal resources.
Some land might be very good for producing certain crops - rich in nutrients and easy to access and work. This land is likely to be used first for any cultivation because the relationship between the cost of producing the crop and the return gained from selling it will be highest. However, land that is not so good will be taken into cultivation if certain conditions allow.
These conditions could be a rise in the price of the crop concerned or a means of either reducing the cost of producing the crop (perhaps through a greater understanding of how to maximise crop yield). Alternatively, it could be through some technological development that raises productivity (output per acre) or yield (for example, through breeding, selection and genetic modification).
The capital cost of exploiting this resource is very high and at the margin is only worth investment if the return from one extra barrel of oil is greater than the cost of extracting it. Copyright: Daniel West, stock.xchng
The cost of exploiting the oil sands is relatively high. The separation of the oil from the sand is capital intensive, and then there have to be refineries that will process the oil into its constituent parts. Added to this is the cost of reclaiming the land and replanting it.
Oil prices are determined by an international market. The demand for oil has been rising in recent years. There is, at the moment, plenty of oil available but the ability of the world to extract oil and to process it is where the problem lies. At present, we simply do not have the processing capacity to refine oil to keep up with the rising demand, which is why the price has risen so dramatically. (There are other reasons, of course - concern over Middle East politics, the war in Iraq and so on).
As the price rises, marginal oil reserves - those that exist but are relatively expensive to exploit - become viable. In simple terms, if a barrel of oil from the oil sands area costs $30 to produce, then if the price rises above $30 it makes it economically worthwhile to extract for production, whereas at $25, the decision would be less obvious.
It is certainly the case that non-renewable resources remain exactly that - non-renewable - but as technology develops and as resources become more scarce in relation to demand, the market will lead companies to look to exploit resources that may have been considered impossible to extract or which were simply too costly to produce. It is all down to decisions at the margin.
