Peak Oil - Becoming a Reality | Investing

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Oil continues to climb even in it’s so called “shoulder season.” A number of years ago we started writing about “Peak Oil” and the work of Marion King Hubbert. Back then when we first wrote about “Peak Oil,” oil was priced at under $35.

M. King Hubbert was a Shell Oil geologist in the 1950’s who noted that oil discoveries graphed over time tended to follow a bell shape curve. He supposed that the rate of oil production would follow a similar curve, now known as the Hubbert Curve. In 1956 Hubbert predicted that production from the US lower 48 states would peak between 1965 and 1970. Despite efforts from his employer to pressure him into not making his projections public, Hubbert did so anyway. However, at the time most people in the industry dismissed Hubberts’s predictions. As it happens, the US lower 48 oil production did peak in 1970/1.

Looking at the global situation today, namely a global credit crunch, a recession in the world’s most oil dependant country, in addition to a housing crisis that is likely to see over 1 million foreclosures this year alone, here we are looking at oil prices that are sitting at the $120 level. The current oil prices are almost double what they were a year ago and up over $35 this year.

Certainly factors such as the dramatic decline of the US dollar, geo-political risks throughout the Middle East and speculation are major contributors to the high price of oil, but we cannot believe that the Peak Oil theory is not playing a major role here. Peak Oil theory is focused on the rate of decline in the producing conventional oilfields. In looking at some recent future predictions for oil production in the major oil producing regions, we see that these projections have been way off the mark.

Russia has been hailed as the new Saudi, with its massive oil reserves. But just a few weeks ago, we read that the International Energy Agency (IEA) reported that Russian oil production in the first quarter of the year fell 1% compared to the first quarter of last year – the first reported decline in 10 years. This change of pattern from what has been expected is quite challenging for the oil market, given that the anticipation was an increase in production of 3% per year.

From the Financial Times: "Russian oil production has peaked and may never return to
current levels, one of the country’s top energy executives has warned, fueling concerns that the world’s biggest oil producers cannot keep up with rampant Asian demand Leonid Fedun, the vice-president of Lukoil, Russia’s largest independent oil company, believed last year’s Russian oil production of about 10m barrels a day was the highest he would see "in his lifetime.”

It needs to be understood that over 80% of the world’s current oil production comes from fields that were discovered prior to 1970. One of the keys that we predicted many years ago is that what most investors do not grasp is the reality that these oil producing countries will ultimately hoard these oil supplies for their own use. In fact, in a recent speech Saudi Arabia’s King Abdullah, suggested that he wants to preserve the nation’s oil wealth for future generations, saying “Let them (oil reserves) remain in the ground for our children and grandchildren who need them.”

Given the US example, where after the oil peak in 1970, the production in the US has dropped off 40% to today’s levels, the world capacity estimates for the next 7 years of 100 million barrels, per day, could be more like 65 – 70 million barrels per day. A potential dramatic decline in oil production and an ever growing demand for energy – is not a good combination.

So what’s the solution? Many feel that unconventional production of oil will step in to fill the gap. But if the Canadian Oil Sands projects are any indication, there are many problems there as well. Not only are the costs going through the roof, resulting in a more expensive product, but the environmental costs are also high, due to the massive amounts of methane being produced. In addition, the Canadian Oil Sands projects consume huge amounts of natural gas.

While the supply side is looking quite precarious, the demand side continues to grow. Last year, we saw for the first time, the emerging markets of China, India, Russia and the Middle East exceed consumption by the US. These countries are seeing massive economic growth and with that growth and prosperity comes the demand for new and better things – things that consume energy. Last year in China alone, the demand for automobiles grew by 21%. The facts are that energy demand is young and growing, while energy supply is old and shrinking.

We continue to believe that nuclear power is going to big a huge contributor to the solution of Peak Oil. It is amazing to us that in the US, the country with the highest per capita consumption of energy; there is no appetite for nuclear energy. But if not nuclear – what is America’s solution? There isn’t one. It is as if everyone believes that this problem will just somehow go away. Three years ago we talked about seeing $10 a gallon gasoline prices. Back then people thought we were crazy, today that doesn’t seem so far off.

Other than nuclear, the only other possible solution that we see as being viable is tidal energy. Our oceans are a source of powerful energy. Our experience with the ocean’s energy has up to now only been of the destructive kind – such as tidal waves or tsunamis - but in the future the oceans could provide us with the energy that we need. The world is 70% covered by water. Ocean currents, waves and tides could be valuable sources of energy. While the US spends billions on outer space, why are we not spending this money on ocean research in the quest to find new sources of much needed energy?

There are problems with all energy options. With nuclear the problem is what to do with the spent fuel. With ocean energy there needs to be much research into the impact of fish and plant life. But this research needs to be done – otherwise it will be lights out.

In the meantime, oil sits around $120, although we should see a decline below $100 in the next month or so. Uranium stocks look very cheap here, but may not move much until this current commodities correction turns back up.

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