Monday, September 14, 2009

Investors Should Ignore Warnings Of Peak Oil

The proponents of the theory of peak oil would have you believe that oil is becoming a scarce resource that can only increase in price. However, the alternate view, as argued by Bill Smead, is that oil is an abundant resource and will eventually fall in price when the current bubble pops. The following article, from The Street, explains why it is a bad idea to buy into the idea of peak oil.

The rally in oil from $32 a barrel in March to $73 in late June had characteristics very similar to the mania that took oil up to $147 a barrel in July 2008.

I've argued before that we've never seen a bubble burst in the investment markets get put back together in anything less than about five to seven years. And here we are at $72 a barrel today with the U.S. economy appearing to be on the mend, and the same army of energy bulls still out there promoting huge upside in the commodity oil and the energy-related stocks.

My professors in college always criticized me for not providing enough evidence in my writing to back my arguments. Fortunately for me, Michael Lynch, the former director for Asian energy and security at the Center for International Studies at the Massachusetts Institute of Technology, provided all the evidence we need in an Aug. 25 op-ed in The New York Times. In his piece, "Peak Oil Is a Waste of Energy," Lynch backs the argument from an energy consultant's fundamental viewpoint.

Peak oil is a Malthusian argument which states that geological scarcity will at some point make it impossible for global petroleum production to avoid falling. To the Malthusians this could spell economic disaster. Lynch wrote:

"Like many Malthusian beliefs, peak oil theory has been promoted by a motivated group of scientists and laymen who base their conclusions on poor analyses of data and misinterpretations of technical material. But because the news media and prominent figures like James Schlesinger, a former secretary of energy, and the oilman T. Boone Pickens have taken peak oil seriously, the public is understandably alarmed.

Lynch explained that most arguments about peak oil are based on anecdotal information, vague references and ignorance of how the oil industry goes about finding fields and extracting petroleum. As an example, he showed how using pumped water in the Ghawar Field in Saudi Arabia scared Malthusians because the field registered 35% water. However, they failed to mention that the average field is estimated at as high as 75% water!

But those are just the latest arguments -- for the most part the peak-oil crowd rests its case on three major claims: that the world is discovering only one barrel for every three or four produced; that political instability in oil-producing countries puts us at an unprecedented risk of having the spigots turned off; and that we have already used half of the 2 trillion barrels of oil that the earth contained.

Lynch debunks the discovery argument quickly. He describes the fact that at the beginning of a discovery the energy industry chooses to make a conservative estimate of what is in the field. It is almost always revised upward, because of new pockets or improved technology. Those raised estimates are never counted as new discoveries. He says that you hear that all the easy oil is gone. Read Daniel Yergin's, "The Prize," which is a history of the oil business from 1855 to today and you'll realize that there never has been any easy oil.

Once you conclude that the geological claims don't stand up, peak oil folks jump right into the political instability arguments. We all remember the two oil embargoes in the 1970s and Jimmy Carter's wool sweater. The major oil producing companies have diversified themselves around the world and have very much moved away from the Middle East dependence. In the U.S., we currently import more oil and gas from Canada than any other country.

Lynch believes that the most misleading claim of the peak oil advocates is that the earth is endowed with 2 trillion barrels of recoverable oil and we've used half of it already. The consensus among geologists is that there are some 10 trillion barrels out there and based on technological improvements that as much as 35% may be recoverable. Here is Lynch's conclusion:

Oil remains abundant, and the price will likely come down closer to the historical level of $30 a barrel as new supplies come forward in the deep waters off West Africa and Latin America, in East Africa, and perhaps in the Bakken oil shale fields of Montana and North Dakota. But that may not keep the Chicken Littles from convincing policymakers in Washington and elsewhere that oil, being finite, must increase in price.

I argue that the constant enthusiasm displayed for the reflation trade and buying energy based on emerging market economic growth rates is a crowded trade. In my experiences, when investors ignore the law of supply and demand it is at their own peril. Lynch argues that supply is abundant and car buyers are reducing their demand with higher mileage cars. More supply and less demand could spell lower prices and would be very positive for the U.S. consumer, the U.S. economy, corporate profits and owners of quality companies.

This post has been republished from The Street, an investment news and analysis site.


Apotheosis said...

I'm not an expert but have read a lot on both sides of the peak oil argument. You and Lynch both neglected to mention the primary peak oil thesis: the increasing depletion rate of existing fields will not keep up with increasing demand.
As Matt Simmons points out, peak oil is not about the resource base, it's about flow rates. There may be plenty of oil left but will there be an economy when it costs $400 a barrel?

David L. said...

This reveals a foundational misunderstanding about "oil" in failing to differentiate between "light" oil which is easily extractable versus bitumen (tar) or coal. There are three to four trillion barrels of bitumen and even more coal. However, these you can't drive your car on these "hydrocarbons".

Extraction and conversion requires about $100,000 for each 1 bbl/day production of bitumen etc. To replace 1000 barrels per second (85 million barrels per day) will require about $8.5 TRILLION.

US oil production peaked in 1970.
Non-OPEC peaked in 2005.
OPEC was able to double the price from $32/bbl in six months by cutting supply. They are clearly now in control of prices. This suggests global production of LIGHT oil is close to peaking. i.e. we have used up about half of global light oil production.

The author has very little understanding of the time or cost or manpower skills require to replace conventional oil depletion with alternative fuels.

Do your homework properly and prepare.

See etc.

ctemp said...

plus there is this whole thing called climate change that oil adds to.

Earth Care said...

Peak Oil is not a theory; Peak Oil is the reality of past and future oil production. It's not a theory that the U.S. peaked in 1970. It's not a theory that Mexico's biggest oil field Cantarell peaked among many other super giant oil fields. These are facts,and the fact is, at some point all the oil fields in the world will reach peak production and then begin their relentless decline. So please stop giving people false hope. It's about time we all faced reality.

Half Empty said...

As Apotheosis says, Peak Oil is all about flow rates, not how much oil is out there. Lynch is not simply arguing against a small bunch of cranky doomers; he's also contradicting the heads or former heads of Shell and Total, the International Energy Agency, and a huge body of carefully-assembled evidence and study by many oil industry experts such as Matt Simmons, not to mention task forces being set up by many OECD countries to develop policies to mitigate the effects of Peak Oil.

Anyone betting the farm on the basis of a single, fact-lite newspaper article by someone who has been repeatedly proved wrong in the past deserves to have their head handed back to them on a plate.

so left i'm right said...

The executives at Enron said "all is good." Then what happened. Lehman Brothers, AIG, Goldman Sacks etc all laughed and blew off the critics telling us "all is good." Then what happened.

Need I go on?

Anyone who thinks "Peak Oil" is a "theory" skipped high school geography and obviously was too hung over to make geography 101 in collage.

al fin said...

The oil producing infrastructures of Russia, Venezuela, Mexico, Iran, etc are falling apart due to lack of investment. The fat cats couldn't be bothered to keep up with the technology, so no wonder production is flagging.

Matt Simmons makes a lot of money off peak oil, so it must be true.

Seriously, folks, peak oil is nothing without its "scare value." If you can't describe peak oil as a huge catastrophe, then who cares?

If gas to liquids, coal to liquids, bitumen to liquids, kerogen to liquids, heavy oil to liquids, biomass to liquids, and all the other new sources for liquid fuels can take the burden off of the oil dictatorships, well and good.

Peak oil becomes a religion with its devoted followers who get their feelings hurt whenever their pet cause is insulted.

Cry me a river.

Apotheosis said...

There are lots of expensive, energy-intensive technological options for converting things like coal to liquid fuel but I worry about the climate change consequences (not to mention local environmental nastiness) of ramping up those methods. Not to mention the timing. Techno-polyannas are just as guilty of confirmation bias as Doomer-cassandras. For example, I fantasize of a Mr. Fusion powered paradise where all vehicles are I think this will come about in the next 50 years? No.

al fin said...

Right, I understand. If you believe in carbon climate doom, then believing in peak oil doom is just an extra benefit, I suppose. The two doom beliefs reinforce each other in a weird sort of way.

Profitable industries minimise expenses through substitution. Peak oil orthodoxers claim there is no substitute for petroleum.

If they wager their life savings on that belief, they will find out differently in an unfortunate way.

But if peak oil believers sit around in a circular jerkular and do nothing but talk, what is the benefit of their "hard earned knowledge?" The temptation to gamble on a sure thing must be very intense.

ruckrover said...

easy oil = early 20th century drill down a 100 metres and hit a gusher in Texas or Saudi Arabia.

current new oil = find a huge deposit off coast of Brazil, the biggest in decades and have some proclaim there's no peak oil. but then realise you have to drill through 3 kilometres of ocean, 2 kilometres of rock and 2 kilometres of corrosive salt and extract oil at super temperatures and super pipe bursting pressures

Peak Oil is Peak Production of Oil, not really peak of all the oil in the ground. Peak Oil is behind us.

Anonymous said...

If Mr. Lynch's arguments were true, we would have no dependence on foreign oil.

America's domestic oil production peaked in 1970. Thus far, no technological fix, or increase in exploration and investment has increased our domestic production to the point where we would not need foreign oil.

I'd be curious as to what advances Mr. Lynch sees in our future regarding oil location, acquisition or production. The NYT article is somewhat lacking in specifics. I know that here in Houston, few oilfield exploration company personnel are what I would term "optimistic" about an ever growing supply of inexpensive light sweet crude, quite the contrary. Apparently things look different in NYC. Perhaps Mr. Lynch might wish to visit the corporate offices of Shell and Schlumberger here in Houston. The difference in perspective before and after would be quite interesting.

jagged ben said...

The assertion that Lynch offered any "evidence" in his NYT piece is laughable. What he offered is bald assertions that don't stand up to scrutiny, and which almost no one in the industry except him believes. For example, he claims that it's a "consensus among geologists is that there are some 10 trillion barrels [of "recoverable" oil] out there." Only someone who had never read anything on the subject would be taken in by such tripe. (Unfortunately that probably includes most Times readers.) It's hard to know what Lynch bases such nonsense on (because he offers no source to back it up!), but he might be basing this silliness a USGS study from a few years ago that assigned a 5 percent probably to the 10 trillion number. That's right, a 5 percent probability.

One can only speculate about Lynch's motives, but for the Times to use his piece as an introduction to peak oil for the average reader was probably the most irresponsible thing the paper has done since hiring Judith Miller to convince America that Iraq was concealing WMDs.

Anonymous said...

I find the closing comment, that oil demand is falling, to be very poorly thought out. In developing economies like China and India, demand is sky-rocketing as an emerging middle class want the benefits of a middle class lifestyle, one of which is two cars in every family. With the middle classes of these countries exploding, global demand is certainly going to increase faster than car companies make more hybrid cars.