Sometimes the concepts of energy resources and energy reserves get confused, which leads a lot of people to believe we have more oil available than is actually the case. So then people are left to wonder why — if we have 3 trillion barrels of oil left — oil prices are still hovering near $100 per barrel.  

A resource is the total amount of a commodity that is in place. However, much of that resource will likely be unrecoverable because the technology doesn’t exist yet, or it is too costly to produce.

The huge oil resource in tight formations was known for many years, but only began to be unlocked economically through innovations in hydraulic fracturing and horizontal drilling. Today, $100/bbl oil enables lots of it to be extracted economically from the Williston Basin in North Dakota and the Eagle Ford Shale in Texas, but 20 years ago the technology hadn’t yet been sufficiently developed.

Today we have both the technology and high enough prices that a portion of these vast tight oil resources can now classified as reserves. But if the price is too low, the resource still will not be developed unless the price increases, or technology improves to the point that the cost to produce drops below the sales price.

Consider this analogy. What if I told you the location of several trillion dollars’ worth of gold? It does in fact exist, dissolved in the world’s oceans, and it’s there for the taking. The technology to extract the gold exists.

So why isn’t this gold being produced? Because it exists in such a diluted concentration and is mixed with numerous other compounds and elements. As a result, it is incredibly complicated and energy intensive to extract the gold and purify it. Thus, while gold may sell for $1,400 a troy ounce, it might cost $10,000 a troy ounce to produce it from the oceans. It will remain there, untouched, until gold prices are much higher than they are today, or until someone comes up with a much cheaper way to produce it.

Some of the world’s oil resources are similarly out of reach for the moment. In addition to the large fraction being as of yet technically unrecoverable, there are oil fields that are only economical at $150 or $200 a barrel. Thus, as oil prices increase, some of these fields that are uneconomical today will eventually be tapped.  

This has implications for the concept of “peak oil” because oil reserves and oil production are effected by oil prices. Indeed, the world has likely passed “peak $20 oil.” At that price none of the US tight oil plays will be economical, nor will much of the world’s oil sands production. The output of oil that is economic to produce at $20 has been falling for years.

But that means the price of oil has been rising. And a rising price of oil is a big reason that the world’s proved oil reserves are more than 60 percent greater than they were in 1990. If $20/bbl was the metric for measuring economically recoverable oil, we would have to slash the proved reserves to a fraction of the current value.

For investors in the oil sector, this is an important concept to grasp, because it is one of the key reasons I believe we are in a period of permanently higher oil prices. While one major brokerage or another will still capture headlines with a prediction that oil prices are headed to $50/bbl, I don’t believe such a low price is sustainable simply because there isn’t enough oil that can be economically produced at that price.

That could change; for instance if technology enabled Canadian and Venezuelan oil sands to be economically produced at $20/bbl, it would eventually put tremendous pressure on the global price of oil. But there is nothing like that on the horizon, and every day the developing world demands more oil. Thus, even as oil production in North America continues to expand at a record pace, the world continues to consume that oil and more, which continues to be supportive of higher prices.

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