Modeling Peak Oil and the Geological Constraints on Oil Production
CentER Discussion Paper Series No. 2014-036
26 Pages Posted: 6 Jun 2014
Date Written: June 4, 2014
We propose a model to reconcile the theory of inter-temporal non-renewable resource depletion with well-known stylized facts concerning the exploitation of exhaustible resources such as oil. Our approach introduces geological constraints into a Hotelling type extraction-exploration model. We show that such constraints, in combination with initially small reserves and strictly convex exploration costs, can coherently explain bell-shaped peaks in natural resource extraction and hence U-shapes in prices. As production increases, marginal profits (marginal revenues less marginal extraction cost) are observed to decline, while as production decreases, marginal profits rise at a positive rate that is not necessarily the rate of discount. A numerical calibration of the model to the world oil market shows that geological constraints have the potential to substantially increase the future oil price. While some (small) non-OPEC producers are found to increase production in response to higher oil prices induced by the geological constraints, most (large) producers’ production declines, leading to a lower peak level for global oil production.
Keywords: Peak oil, Hotelling rule, Exploration, Reserve development, Geological constraints
JEL Classification: Q30, Q47, C61, C7
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