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Peak Oil or Oil Bubble? – The Peak Oil Argument

This is a guest post from Ed Rempel (CFP and CMA).  For those of you joining us recently, Ed has written a number of controversial articles for MDJ in the past.  Today’s article is about a hot topic in everyone’s life, the price of oil and the peak oil argument. This is part 1 of 2.

“No one goes there anymore – it’s too crowded.” – Yogi Berra

Tired of high gas prices? They have risen sharply because oil prices have shot up from $10/barrel in 1990 to $20/barrel in 2002 to $60/barrel in 2005 and now to $145/barrel in 2008. Is this just a temporary spike or just the beginning of a much larger rise in gas prices?

The most significant investment issue now is this big debate – is the huge rise in oil the beginning of a new reality or is it this decade’s version of the tech bubble? Which investments we would want to hold will be very different depending on which of these is true.

It is impossible to know for sure whether or not this is Peak Oil or an oil bubble, since the oil reserves claimed by many of the largest oil producing countries, especially OPEC countries in the Middle East, are widely considered to be unreliable and politically motivated.

Before you answer – let me say there are quite a few very smart people on both sides of this argument. Here are the arguments for both sides. Which do you believe?

Peak Oil

The theory of Peak oil states that when you have taken out half the oil from an oil deposit, then the rate at which you withdraw it peaks and only declines after that. It was discovered by King Hubbard and accurately predicted in 1956 that the peak of oil production in the US would happen by 1970. Since then, many other countries have hit their peak production.

If we are at Peak Oil, then we will still have oil for about 100 years, but the amount we can produce each year will decline. If demand continues to climb at the same time, then today’s sky-high price of oil – and gas at the pumps – is only in the early stages of a permanent rise.

The peak of oil is probably inevitable, but the big question is when. I read 2 in-depth books on this about 5 years ago (including “Out of Gas: The End of the Age of Oil” by David Goodstein) and the debate among oil experts was whether we were 10 years or 40 years from the peak. The Association for the Study of Peak Oil and Gas (ASPO) predicts it will happen in 2010, while Cambridge Energy Research Associates (CERA) predicts that we are at least several decades away.

Oil price increases in the past have lasted only a few years, followed by a crash. The recent spike in oil prices is unusual, though, because it is the first not caused primarily by a disruption in supply. Unlike the Arab Oil Embargo of 1973-1974, the Iranian Revolution of 1979 and the Gulf War of 1990-1991, the rise in oil prices from 2002 to the present primarily has been driven by growth in world demand, especially from China and India.

Arguments in favour of Peak Oil:

  1. Peak Oil is inevitable, since oil was created millions of years ago and there is a finite quantity. Whatever amount of oil exists is all we have, since making new oil would take millions of years.
  2. World oil production is declining by about 4% per year, since many existing oil fields have reached their peak. If conventional oil production is roughly 85 million barrels per day, then the first 3.4 million barrels of new daily production every year only serves to offset declines in existing fields.
  3. New discoveries are increasingly rare and small. In the 1960s it was not uncommon to find 40 to 50 billion barrels per year of new oil reserves. Now, 10 to 15 billion barrels is considered a more typical exploration year.
  4. New discoveries are from sources that are more much costly or environmentally unpopular, such as the tar sands and off-shore. Barrack Obama has said he may ban oil from the tar sands for environmental reasons and environmentalists claim that off-shore drilling would threaten ocean species.
  5. Oil-producing countries seem unable to increase production. They claim they are trying to increase production, but so far they have been unable to do it.
  6. Emerging markets demand growth is very strong, especially in China. In the last five years, yearly oil consumption in China has grown from 1.88 billion barrels to 2.80 billion, an increase of 920 million barrels a year, or about 37% of the total increase in world consumption over that time frame. China is obviously at a stage of its economic development where its thirst for oil is growing rapidly. India is following, and there is a long list of future emerging markets countries where development (and therefore oil demand) may take off in the coming years.
  7. Oil price subsidies in many countries can help maintain this demand. The Chinese government also has been subsidizing oil prices, thus muting the effect of higher prices on Chinese consumers. Fuel subsidies, in fact, are widespread in emerging market nations. Morgan Stanley estimates that half the world’s population enjoys fuel subsidies, as almost a quarter of the world’s gasoline is sold at less than market prices. The cheapest gasoline is in Venezuela, at five cents per liter. Until very recently, Chinese motorists paid $0.79 per liter.
  8. Governments have not responded either because they are “leaving it to the market” or are unable to do anything. The theory is that market prices will increase oil prices, which will result in alternative energies becoming profitable. However, the development of mass alternative energy sources will likely take years. Oil is a globally traded commodity, so individual country governments may not be able to do anything.
  9. Oil industry analysts are just being conservative about long term prices when they assume $80-90/barrel when valuing oil companies. They have historically been slow to change their underlying assumptions.
  10. Many investment experts believe in Peak Oil. Proponents of Peak Oil include Jeff Rubin (economist from CIBC who is predicting $200/barrel oil by 2012, possibly by 2009) and Eric Sprott (hedge fund manager that believes we are going back to 90% of our population being farmers with horses and plows by 2200).

Stay tuned, Ed Rempel will be back for tomorrows post regarding the oil bubble argument.  The peak oil argument looks fairly convincing.  What are your thoughts on the peak oil theory?

If you would like to read more articles like this, you can sign up for my free newsletter service below (we will not spam you).

About the author: Ed Rempel is a Certified Financial Planner (CFP) and Certified Management Accountant (CMA) who built his practice by providing his clients solid, comprehensive financial plans and personal coaching.

Ed has written numerous articles to educate the public and his clients on his unique insights into strategies that actually work, instead of the “conventional wisdom” common in the financial industry.

Ed has trained more than 200 financial advisors and is considered the Smith Manoeuvre expert in the Toronto area. He has received accolades from Frasier Smith in his book “The Smith Manoeuvre” for customizing this strategy for hundreds of clients. His extensive experience in tax and finance has placed him in high demand. Ed’s team collaborates on each of their clients to help them create financial security and freedom.

{ 11 comments… add one }
  • nobleea July 23, 2008, 12:18 pm

    I think that peak oil is a reality, it has to be. The current pricing is probably somewhat of a bubble, but the long term trend is up.

    There are fewer and fewer big finds these days, so increased production will have to come in the form of new technologies or improved artificial lift methods.

    The official name is ‘oil sands’. Tar sands was created by environmentalists to give it an even dirtier image. Obama can try and ban oilsands oil from the states, but a lot of the refineries are designed specifically to handle it. I don’t know where they’re going to get the oil from instead. It’s tough to find a safer and better business partner than Canada when it comes to buying oil.

  • FrugalTrader July 23, 2008, 2:26 pm

    Thanks for the great article Ed, very educational. It’s hard to say if we’re currently going through peak oil or not. To me, it sounds more like fear mongering.

  • ThickenMyWallet July 23, 2008, 2:28 pm

    The question of when will never truly be known given that it is often believed most OPEC countries are over-stating their reserves.

    As a complete aside, oil companies (sorry, now branded energy companies) are making billions quarterly, spend very little on new exploration relative to their profits and pay a very modest dividend. In other words, they are hoarding their money and enriching themselves. Why isn’t there a greater outcry over this?

  • nobleea July 23, 2008, 2:48 pm

    At the last conference I went to, Spears and Associates presented a speech on how the oil industry is changing. While we see and hear all about the large multinationals/integrated energy company making all the money, the growth is actually coming from the nationalized companies and independents.

    When we hear about massive quarterly profits, these are from public companies. I would bet that each one of us, somewhere in our investments, owns a little bit of each one of these companies. They don’t spend a whole lot on exploration anymore because they can’t. The areas were there are large new finds are in areas controlled by countries nationalized oil companies. The large integrateds need a certain size of find for it to be worthwhile and they’re not going to find too many of them anymore. Where does the money go that the large multinationals are hoarding? A lot of it’s got to go to research and innovation to try and improve production methods on what they already have. Some might go to buy out smaller companies in order to gain reserves. Some might be used to buy back shares. Hoarding the cash for themselves doesn’t sound right since they are public companies.

  • Quincy Walters July 23, 2008, 3:57 pm

    For a more academic treatment of the peak oil argument, I suggest you check out The Oil Drum…for example they have a breakdown of the CFTC report on specs today, etc. The Oil Drum. Good stuff in my estimation…not too doomerish, not very hopeful either.

  • easypz July 23, 2008, 5:24 pm

    “Oil sands” is the industry’s term. Describing it as the “official name” implies that the oil industry ought to set the terms of discussion. They mostly do, and have for a long time, but maybe we ought to pause a bit before accepting their values so quickly, given the dire situation those values have led us to.

    Refining the toxic gunk in Northern Alberta – bitumen, aka “tar” – causes 3-4 times the greenhouse gases of getting oil from traditional wells. The sands contribute the largest single addition to Canada’s increase in those emissions. According to The Pembina Institute, the main environmental organization studying the environmental effects of the sands, forests “an area as large as the State of Florida” are at risk. Not to mention local rivers. “Tar” is the accurate term, if not the official one.

    Sands oil costs a lot to refine, but it works if the price of oil is higher – like it is now. Although we’ve become the largest supplier of oil to the US and good ol’ NAFTA prevents us from cutting off oil to them, thus making the supply very secure indeed, and multinationals are about to sign a sweetheart deal in Iraq which will free up a lot of oil and profits – the Iraq National Oil Company is supposedly in control, yet foreign companies will keep 75 percent of the contracts’ value (so much for the influence of Nationals: we’ll just take what we want, thanks) – yet despite all that, oil prices have kept going up. So I think that there will be cycles, but the trend will be upward, regardless how many new sources of oil are discovered.

    The very existence of the tar sands bonanza, and other “initiatives,” such as the lobbying to drill in the Arctic National Wildlife Refuge, seems to moderate the one-to-one cause/effect notion that high oil prices will spawn free-market innovation in alternative energy. It’s clear from these examples that the market, if let alone, will keep on seeking oil from wherever, no matter the environmental cost, for as long as possible. If prices keep going up, so much the better, not only for profits, but for public relations: that condition makes it easier to convince the public to allow environmental destruction in the name of access to a vital resource – against the otherwise overwhelming tide of opinion that values protecting the environment above the maintenance of an unsustainable way of living.

    I think the most effective way to spawn innovation is to empower the entrepreneurial spirit through progressive legislation and incentives. The people’s will, through government, should be a major player in the marketplace. That’s the combination that really works, not just one or the other polarity. At this stage of the environmental crisis, it’s madness to abandon our direct will to an abstraction like the free market. The free market without the people’s influence means lobbyists in the back rooms of Ottawa and Washington pushing the “official” agenda. Which is the old agenda, the one that got us here in the first place.

    There are so many amazing people and projects around the world devoted to improving energy efficiency/effectiveness and finding sustainable alternatives, creating workable strategies to radically reduce oil consumption in various industries (especially important is construction), increasing cradle-to-cradle manufacturing, developing and marketing biodegradable substitutes for traditional plastics that aren’t made of petroleum, etc., etc. Although they’re not hard to find, they don’t have the clout that the “official” industry does, so they can really benefit from government help in the form of increased tax benefits to support R&D and so on. The “official” industry line is only going to get in the way.

  • nobleea July 23, 2008, 5:39 pm

    “The word tar to describe these natural bitumen deposits is really a misnomer, since, chemically speaking, tar is a man-made substance produced by the destructive distillation of organic material, usually coal. Since then, coal gas has almost completely been replaced by natural gas as a fuel, and coal tar as a material for paving roads has been replaced by the petroleum product asphalt. Naturally occurring bitumen is chemically more similar to asphalt than to tar, and oil sands (or oilsands) is more commonly used in the producing areas than tar sands because synthetic oil is what is manufactured from the bitumen.”

    I’d like to see the Pembina ‘Institute’ and the Fraser ‘Institute’ go at it in the ring. I wonder who would win…

  • easypz July 23, 2008, 5:59 pm

    Oh, the Fraser Institute would win hands down, as it’s arguing for the winning side. A quick look at the environment will show that it’s the one sagging on the ropes.

    I think the appropriateness of using the word “tar” isn’t in its chemical description, but in the value of keeping in mind the context of refining bitumen. It needs a lot of energy to process. “Oil,” in that respect, is misleading, because it implies that the resource is available with minimal fuss.

    At any rate, what I’m trying to get across is sort of reframing the question. We can’t sustain our use of oil even if there was an unlimited supply. It’s going to peak, but not solely because of the status of reserves left in the ground.

  • Tony July 24, 2008, 12:34 am

    The peak oil theory will some day be accepted as widely as human-induced climate change. The problem is that most people do not want to believe it because it means making changes in their lives. And even though this article mentions emerging market subsidies, there is no mention of the ridiculously low price Americans still pay for gasoline compared to the rest of the world. When I was paying $1.40/L here in Canada, CNN was whining about Texans paying $3.60/US gal. That means they’re paying less than $1/L. Boo hoo. And they are the largest energy consumers in the world. 3% of the world’s population accounting for 25% of global energy consumption. Sure China and India are growing fast, but it will be some time before they develop the voracious appetite for oil of the Americans.

  • newbie July 24, 2008, 6:39 pm

    if it is true, I wonder how many little and big ways it will change our lives. Some changes may be more subtle than others. There seems to be a movement away from cadmium colours (some of the favoured colours of modernism produced from petroleum) towards natural earth pigments among artist. There are health benefits to this so not everyone is sad that these beautiful if toxic pigments may not be available in hundred and fifty years. Something for the historians to look back on…

    I don’t relish the thought of shoveling horse manure all the same. (-:

  • Gary March 25, 2012, 3:56 pm

    Well written article…it is interesting to see if those experts are correct with oil hitting $200 a barrel in 2012. I always like to go look at predictions to see if they come true or not.

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