 All right so Today, I'm going to try to teach you something that you won't believe I Am going to try to teach you or explain to you Why we're never going to run out of fossil fuels Now you have been told over and over again That the world is running out of fossil fuels and someday maybe someday soon We'll all be sitting In the coal in the dark freezing And we won't be able to drive our cars and society will collapse and so today I'm going to try to convince you this is untrue Now I must say there is a tenancy among humans For whatever reason to like these stories of the apocalypse That civilization is going to collapse Because we're going to run out of stuff we need for our society And I'm going to try to introduce you because for most of you I won't convince you To the concept that we're never running out skeptical Why you're skeptical Why do you say this you feel that we're going to run out eventually but you're of course not sure when Right So there's a limited supply. I Don't think so Really like there's a certain amount, but there's there's only so much that's accessible There's only so much that's accessible with modern technology That's good That's good. Who else doesn't believe me? Sure Getting more Okay, hydraulic fracking here in this part of the world, but that's different in different places Eventually, you know, I've been here in this eventually all my life and we never get there We never get closer There's a lot more energy now energy reserves fossil fuel reserves in the world and there were 40 years ago It keeps going up. Why? Why so I Mean, you know, I go to some stupid party. I try to stay away from parties, but sometimes you can't avoid it, right? And Then someone comes up to me and they're trying to make small talk and they say hey, what do you do for a living? So I go to party and I say well, I'm an energy economist And the person says oh, when are we running out of energy? And then I say never and then they get mad at me and that kills the party Okay, I need a new proof. I need a new fake profession. I Don't know Ask me an Irish contractor. I Could be like I could work. Yeah, I could work for NC is You know something like that something like a spy and then when they ask question you go I'm very sorry, but I can't tell you That'd be good That'd be good, you know, I'm like Arnold in true lies. I Tell people my job is to be an energy economist, but in fact, I'm a secret agent Yeah, that's it. That's the ticket Anyhow, I can't teach class next week because I'm going well. I can't tell you See that's just a joke Okay So About every 30 years There have been predictions That we're going to run out of stuff And so, you know the US Geological Service has these estimates of reserves and they say well, you know At current levels of production. We only have 20 years left of something tungsten is my example and So You know makes you think well gee in 20 years. We'll have no tungsten Or anything else and then we'll all get success society will collapse And you know, I think I remember who this is. I think this is David Malthus Thomas Malthus from about 1800 This is a person who some people know Paul Ehrlich He's a very famous biologist at Stanford in the late 60s He wrote a book called the population bomb that said we're all going to overpopulate the world Then he wrote some other things saying we're all going to die. We're all going to be dead by the year 2000 And you know Professor Ehrlich keeps saying this And you know according to him we all should have been dead 15 years ago But he keeps on saying it and by the way just I should say that His son-in-law used to be my boss So I saw that was very nice And it was daughter too. She was very nice, but man. He seems to be a wacko to me, but anyhow Okay, so there's Thomas Malik Malthus. He's from 1800 You know, he said we're going to use up resources from a couple centuries ago. There's Paul Ehrlich He's I guess Paul is about 75 years old now. He's still with us Maybe he's 80 years old So, you know, this has been going on a long time and of course I don't take it seriously But you know don't make for good exam questions. I suppose All right, so Today we've run out of nothing Absolutely nothing Okay, we've had this industrialized society for 130 150 years. It's been using up all these materials fossil fuels the most obvious steel tungsten all these other things and we have run out of nothing even though during this time period All kinds of prominent people said we were going to run out Doesn't this make you suspicious So why is this spinning correct? Well, first of all You need to think about this term known reserves that our friends at the Geological Service use And we also have to think about economic incentives. One of the problems people have In economics, you know in economics, you may have noticed what I'm really trying to do is stretch your minds And now I'm trying to stretch it in a different direction. I'm trying to stretch it across time So people have trouble thinking about economic incentives over time So let's think about a world where We had just a little bit of oil left What would the price of oil be really really high? Right Now let's say you were a greedy company Which of course all are Wouldn't you want to save your oil For when the price is really really high Pardon me Yeah So then we wouldn't run out of oil because people would be saving their oil You see once you start to think about it in terms of trading off the present versus trading off future incomes The idea of running out of something actually becomes a contradiction in terms almost So geophysicists It turns out that geologists by the way Scott Hodges was I think he mentioned this in there Like the most optimistic people in the world It's like oh, yeah, we got a whole bunch of oil here or Natural gas, you know, maybe it's there. Maybe it's one. So Geologists divide the world into a nice table and So on one category is the knowledge of the earth Okay, now the problem with knowing about the earth's crust is what what's the challenge of knowing about the earth's crust Well, that's true, but what's the what's the real inherent problem? It's all the way underground So it's hard to figure out what's there and you know, this Marcelo shale stuff is 8,000 feet Below the ground and 8,000 feet it varies a little bit, but that's about it Okay, it's really far down and you don't know exactly what's there So you've got you know orchestrated reserves inferred hypothetical speculative All these different kinds of things. I'm not gonna ever too sure the difference in the definitions But there's all kinds of information, you know sets out there. We know there's natural gas We think there's natural gas. There might be natural gas. I got an idea. There's natural gas You know and I'll have lower levels of information Okay On the other axis which will show up in a minute is the economic feasibility now Two things go into the economic feasibility What are they? Right, how much it costs to get the stuff out of the ground from 8,000 feet and then how much you can sell it for? So here's a nice table so the Minerals that we can actually get out now are parts that are economic and Identified now this is just today square, you know Does anybody live near oil city? nobody oh Charlene do you live you have a family cabin? Okay, and why is it called oil city? Right there used to be lots of oil wells in oil city, but there aren't now how come Well part of the problem was is that they got into this common pool issue They drew them close together and stole each other's oil and all that And so they got a lot of oil up, but they got out too fast it turns out the other problem is that When Texas East the spindle top play in Texas came in in 1903 Texas oil was like, you know a third of the cost of Pennsylvania oil So the Pennsylvania oil You know went from here to here so You know, what have I seen lately I? Don't know what kind of new geophysics stuff do they have? The are you familiar with this? Well, what new methods do they have in geophysics? No, no, that's engineering. I'm sorry like to figure out what's below the earth Well, I don't really know but they have all kinds of new radar and sonar stuff that You know helps, you know in the early days what they used to do is just set off dynamite and record how the waves moved The sound waves moved around now. They have all kinds of more sophisticated things But one of the big differences is now they have much better idea of whether there's oil or natural gas there another thing that's happened is this hydraulic fracturing Which was kind of derived in a? Trial and error method, but here's how it works Anybody know what this means hydraulic fracturing and get somebody else to explain it. What do you think it means like? Okay, so that's a good part of it. What's another part of it, right? So so what happens is a combination they get a well site and they drill down 8,000 feet and then the pipe Turns horizontal and goes out all the way up to about 10,000 feet So almost two miles and then any well pad they'll have it depends But six or eight of these wells going out in all kinds of different directions kind of looks like a spider web Okay Now this is relatively new. Oh the other part the other thing that's new is basically what they do is they basically Explode water into the rock formation at different parts in the horizontal Horizontal well, so what they do is they push the water underground It's got a lot of water put under high pressure and then it breaks into the formation and Releases the natural gas or oil here natural gas in other places like North Dakota's oil and so Wow all the sudden This gas that was you know over here Got to be over here. Of course there was a countervailing factor Now that we have all this Marcella shale gas what happened to the price of gas? Went down so you know Now the price of gas went down now if you talk to Producing companies which I have to do I'm not gonna have to do it. I kind of like it You know they say they're always looking for the price to go up. I'm not so sure Why would the price go up? Pardon me said again Well, if the man if the price goes up the quantity demand will go down well in general scarcity increased demand Changes in technology, but I mean I could be wrong But because you never know what the EPA is going to do, but I think that the cost of drilling for this stuff will go down I Don't think the demand will increase although You know I keep waiting for people to drive natural gas cars So I don't think the price is going back up. Of course. I don't tell them that Natural gas Why would there I mean this is the question right? Why would there be a larger demand? Mm-hmm, right to find a new use right so maybe I'm sorry the person behind you Right, so now there's a lot of controversy about Shipping liquefied natural gas to Europe so liquefied natural gas being of course a gas is very hard to ship overseas So what you have to do is liquefy it in a liquefaction plant Then put it in a boat and ship it overseas and not only is that very expensive But to do that you have to get permission from the US government basically And so there's a whole bunch of people who've applied for permission and now a couple of plants have been approved But there's a fear feeling that if you approve all these plants and the price of natural gas will go up Although trying to figure out equilibrium is something I've been trying to do. It's not too clear to me what's going on But anyhow I'm not sure at least in the next couple of years that the price of natural gas here in Pennsylvania would go up But I'm not going to tell that to some of my industry friends Okay, so You know there's room for expansion Right, I mean our geologist friends can find new ways of finding the oil or natural gas our engineering friends can find new ways of getting it out and then Economically the price can go up if there's a scarcity Now of course, I don't think there's a scarcity here because the price is relatively low now there is a scarcity in Japan and Korea because they don't have any natural gas Local natural gas and it all has to come by ship Now the Korean South Koreans are very eager to build a natural gas pipeline from Russia Anybody know why this hasn't happened beside you Andy Pardon me would have to go through North Korea and The North Koreans aren't very friendly a friend of mine in South Korea had this idea He actually tried to get it done. He was where you'd have a pipeline that had no stops on it It would go south through North Korea into South Korea and then curl back up to North Korea And so that way the North Koreans couldn't cut it off without hurting themselves Which is ideas go was kind of clever but nowadays this North Koreans are so I can't words like use like crazy and demented because I'm a professor also a spy But you know So so let's think about something Gonna model just we had this two-period model because that's all the math we can handle And we're gonna talk about something called rent Which is price minus cost Okay, so you find a hundred thousand barrels of oil under your backyard Which if you I mean natural gas if you live in Lycoming County or the northern part of the state is actually Not that unreasonable Okay But I have to go back in the United States you own What's beneath your land in theory to the center of the earth so no one can extract that oil or natural gas Without your permission or some complicated legal things. I don't want to talk about almost everywhere else The government owns this land Which system is better? I'm sorry say it again Okay Well, it's true that I don't have the money to extract the oil But my friends at Exxon are happy to buy it that right from me Well, I don't know the government, you know the government can Lease out this can drill for this land or lease it out and get money and then use it to reduce taxes or pay for the next aircraft carrier or something right Not sure that's any different. What would be better government ownership or Private ownership well, it's true, but wouldn't you want to have the government in charge have the ownership then? Why not? Oh Interesting so what you're arguing is that the government might force this upon me Right Okay Okay, so the argument is that if the government was in charge Hey, they wouldn't care about pollution. They're just interested in the money in the short-sighted effect Just trying to put some some frame on this and so this is the only way this is a good way to protect ourselves from the government Is that a good argument? Okay, am I making a good argument I'm trying to phrase your argument interesting interesting Wait a second. This is this is like, you know Politician mostly Republican politicians just says the free market is the God we bow to Why is the free market better here in your argument? Well, but wait, isn't the government an agglomeration of the people I Mean of course if I happen to have the natural gas under my land, then I'm happier But it's really kind of random who gets this I want to ask Sarah This is bowing to another God Competition Why I want to know why No, why does it create more wealth? Now I think you're getting closer I think part of it is actually in Iraq The Iraqi government has hired a bunch of Russian companies to extract the oil and The reason is is because the Russians are actually better at doing relatively simple extraction and Not using technology advanced technology Okay, so part of it is the government isn't too clever about what it does. You don't like that are you? Okay, I Sarah snorted in it kind of hurt my feelings Actually people are coming close The argument for private ownership is basically if you think about the coast theorem You want to put the property rights in the hands of the people who have the lower transactions cost Well transactions cost for the government is really hard working things through the bureaucracy So the idea is if you put in the hand of landowners Hey, they just want money and So they'll get it out there a lot faster So you can take or leave it as you want Okay now You have a hundred thousand barrels of oil in your backyard It can be produced either today or next year at a cost of $30 per barrel The cost today is a hundred dollars, which means the rent is seventy dollars what time I have The rent is seventy dollars. Okay, so rent is price minus cost Assume that the price next year will be a hundred and four dollars and the interest rate is five percent Should you extract the oil this year or next year? This year. What do you say that Lily? Next year, it wouldn't be you'd be spending more money or interest Hmm, I think you might be seeing too much in my question, but Why do you say next year? Okay, so well, we don't have inflation by the way Okay, that makes life complicated and that's part of macroeconomics, which you know, I hate So how much money will you get this year if you extract it per barrel you get what? 70 and How much oil will you get next year? 74 assuming your cost stayed the same Okay What would you rather have? Oh, I'm sorry go ahead first Well, you don't have any cost right? It's all profit here. So so what would you rather have? $70 today or $74 a year from now Why? Well that presumably is embedded in the interest rate, but that's a good point a Dollar today is worth more than a dollar tomorrow But what's worth more? $70 today or $74 next year the same Why do you say that? Right, well, we don't have inflation. We don't have inflation. No, no, no bad bad bad How interesting question We're going to assume now that you are what we call liquid So you're not constrained today versus next year, but that's a very real question Really? So my guess is you view yourself as what we call liquidity constrained Well, you'd be happy to borrow money from the future to pay your bills today Right 7350 So if you get $70 today you could put it in the bank at 5% interest and have 7350 next year So it's a choice between having 7350 next year or 74 dollars next year Which would you choose if you invest? I'm sorry somebody said that but I don't know Oh, go ahead Well, if you don't invest, right? This against again to this assumption of liquidity constraints, which I'm not doing a good job of explaining but Assume you could borrow money at 5% To pay for your expenses today or you could put in the bank at 5% Which is really a stretch, right? So I'm going to argue that the way to think about at least this problem is to think about What you would have next year? Okay So You'd rather you know, so you'd get with a hundred thousand barrels You'd get seven point three five million next year versus seven point four million if you hold off for a year You could go to an Exxon which is in your minds is a gigantic oil producer, but in my mind it is an investment bank They have lots of money which they use to purchase properties like in your backyard Okay, and you know, you'd say hey, I need money now to pay off my college loans And all kinds of other things because I'm a college student and you know, I don't have any free cash Hey, maybe someday I will With this big degree in ebf so You'll go sell it to them for some price now Exxon Knows they'll get seven point four million next year So they'll depreciate this by five percent and they'd be willing to pay seven point oh four eight million and You'd be willing to take at least seven million dollars for this. So now there's a negotiation between the two okay But if you believe in this world of limited transaction cost Which I have asserted though not that strongly a hope that is lower when you own the rights than when the government owns the rights Then this property will get this property built not this year, but next year and So the idea is that when producing a property you're forever thinking about profits this year versus profits in the future By the way, who's this guy? Jed Clampett and how do you know mr. Clampett an old television show the Beverly hillbillies Very popular in the late 1960s I'm sure you can find it today on I don't know where the heck you find this stuff Nick at night seven or something Okay now assume the extractions cost For grading your oil out instead of thirty dollars is ten dollars So you could get a barrel out today and make nine dollars Or you get a barrel out you make ninety dollars, excuse me Or you can take a barrel out next year and make ninety four dollars Now What would you rather have? Ninety dollars today or 94 dollars a year from now Why do you say that? Well, I got to ask the question again. Would you rather have ninety dollars today or ninety four dollars a year from now? Well, it's just a question Why Four more what do you think same interest rate five percent Why do you say ninety today you get ninety four dollars and fifty cents So if you put the ninety dollars in the bank and wait a year, you'll have ninety four dollars and fifty cents Okay, so in general The lower cost sources of oil are extracted first because the rent Rises faster in time on the high cost oil Then on the low cost oil Now why do I refer to Jed clamp that oil as low cost oil? So as the song goes You know the song What will you could sing it? Listen here's a story about him. We can do it after class so as the song goes mr. Clamp it was out there with the rifle and shooting at a squirrel for food and He missed the squirrel and the bullet went into the land into the ground and oil spurred it out and then mr. Clamp it and his mother-in-law and His daughter and his nephew the family connections in the clutching climates were kind of unclear They took their money and moved to a mansion with a cement pond in Beverly Hills, California Okay, so the idea here is that You want to drill for the low cost oil first So there's no more oil left like they had in Texas in 1903 this huge gusher from spindle top That doesn't mean we're running out of oil and of course if you really have nothing to do You can go rent the Beverly Hill billies Although You know we could and then you could you could argue whether what was a better show Beverly Hill billies or Green Acres and Yeah, I would a success you not spend a lot of time doing that Okay So here's a problem. I like to ask on an exam So write it down You own a well with a hundred barrels of oil in it today the price is a hundred dollars Next year will be a hundred and two Your cost of extracting the oil is X For what levels of X? Will you extract? The oil today versus next year now what time do I have how would I do this problem by the way? Well, I would put my profits as a function of X today Which would be a hundred minus X And then I put it in future terms, so I'd multiplied out by 1.03 And I'd asked that to be less to be greater than excuse me the profits next year, which is a hundred and two minus X and then I'd solve for X So let's see what we have here Okay So if you produce today You make a hundred minus X per barrel Then you put in the bank at 3% You have a hundred and three minus one point oh three X next year This makes sense. I'm hoping it makes sense Okay, if you produce tomorrow you get a hundred and two minus X So the question is is producing today with a profit of a hundred and three minus one point a three X Pay off more than producing next year, which is a hundred and two minus X And when you solve that out You get that X is less than 33 and a third. I Hope That's one that's point on three. Yeah, so for low production cost You produce today For high production cost You wait till next year. All right. Does that make sense? Let's see what the next slide says so You know people have a lot of time thinking about this Thinking about over time But if you look at more agricultural products, you know So wheat is harvested in the fall But we don't run out of wheat in the market over the summertime That basically people hold wheat off the market Because I would expect the price of wheat is in general higher in the summer than in the winter Perhaps a clearer example is forest So they're private foresters all across this state. They grow trees You plant a tree You don't cut it down depending on the species for 20 to 50 years and So some of you if you like your ebf majors you can go take forestry economics, which some people like and and Talk about this which basically comes down to how long do you keep the trees off the market? Now if you didn't do this then no one would grow trees And we wouldn't have paper or other stuff Okay, and so for depletable resources sometimes the product can be held off the market for a long time Okay People then bring up ethical concerns. I mean if we use the energy now aren't we harming our ancestors? Shouldn't we care about future generations? Shouldn't we have a more whoo that word? What word am I talking about? sustainable Shouldn't we have a more sustainable economy? Sustainable is like the worst word in the galaxy We have to put it in all our reports like you know how we're gonna make a sustainable department Hey, we're the department getting started getting stuff out of the ground. What do you want out of us? But we're sustainable too Should we reduce our energy consumption now? So that people 50 years from now won't have high energy prices. What do you think? Interesting but just just because I'm running out of time. I will ask I will say no Shouldn't we care about future generations? Shouldn't we get rid of our addiction to energy to fossil fuels? I don't know who wants to bite on this, huh? All right What would you think if people if you read that people in 1910 had the same argument? Well, we shouldn't consume oil now because we have to worry about people in 2014 How would that strike you in reading back upon it? Pardon me Well, do you think they should have consumed less so we should be richer today? Do you think they should have consumed less so which could be richer today? Why not? Well, why is it dumb? Well, they're greedy, too Well, we're a lot wealthier than people in 1910 so the idea that we should we should wait now You know, I expect people in the future be wealthier than we are Now I have one more point to make so I'm gonna take you a couple minutes late. I know you're growing anxious Is the price of oil or natural gas going to go up or down in the future? Up, why do you say up? Sure, it goes up and down over time price of natural gas is plummeted Why do you say that? But what else happens? new technology Okay Theory doesn't tell us by the way that the price will go up in time Theory tells us that the rent The price minus the cost will go up over time But the cost keeps of getting stuff keeps declining Thanks to people. Oh, no, I got one more point to make. Oh, I'm done Next time we'll talk about the economics of owning your own oil property