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Page added on February 23, 2011

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What ‘Peak Oil’ Really Means for the Energy Sector

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Peak oil is here. Even the International Energy Agency (IEA) has admitted that production of conventional petroleum has peaked, although they forecast continued conventional production at 2011’s reduced levels (down 2 million barrels per day from 2006) many years into the future.

The attainment of even this plateau, however, depends on rapid increases in Saudi production, for which there are no guarantees and indeed very serious doubts. If Saudi production cannot be raised, global production of conventional crude oil will necessarily begin a precipitous decline.

The impact of “peak oil,” however, is often discounted by arguments that it is only the cheap oil that is now limited, and that limitless unconventional supplies are available, just at a higher price. These unconventional sources include: Tar sands, extra-heavy oil, ultra-deep water, and “ultra-thin” formations such as the Bakken Formation, etc.

This argument, however, fundamentally misunderstands the basic premise of peak oil. Peak oil is all about barrels per day; its about flow rates. It has very little to do with reserves in the ground theoretically recoverable at some market price.

The flow rates of much conventional oil production are very high. Giant oil fields with deep reservoirs full of light sweet crude oil under intense geologic pressure such as the Ain Dar section of Saudi Arabia’s Ghawar, Russia’s Samotlor field and the big East Texas fields produced hundreds of thousands of barrels per day from just a few dozen wells. We have all seen pictures of blow-outs spewing thousands of barrels of oil onto the ground. Oil under intense pressure is capable of creating very high flow rates quickly and with little up front investment.

By contrast, the process of scaling up production of unconventional oil is very, very slow and capital intensive. If global conventional oil production peaks and falls at a 2% annual rate (comparable to the decline in North America post-peak), that will result in a loss of 1.5 million barrels per day of oil production. Even if alternative sources of liquid fuels can only be increased 500,000 bpd per year (and that is a really optimistic estimate), all the negative effects of peak oil will be felt despite the availability of “oil” in the tar sands, in the Orinoco in Venezuela, and deep undersea offshore of Brazil, not to mention the ultra-thin sliver of oil spread over 200,000 square miles in the Bakken Formation that will take countless wells to fully produce.

These unconventional sources will be very nearly irrelevant if conventional production is falling 1.5 million barrels per day year after year.

When you start to think about peak oil in terms of flow rates, and not in terms of reserves and theoretically recoverable resources, you begin to realize just how fast global petroleum production could decline post Peak. And you begin to realize just how high the price of oil really could go as a result.

What that means is that energy investments and particularly the oil service sector stocks such as Schlumberger (SLB), Baker Hughes (BHI), Halliburton (HAL), Transocean (RIG) and National Oilwell Varco (NOV) have extraordinary upside potential in the years ahead. (ETF investors can buy the Oil Services HOLDERs (OIH), of which the big oil service stocks make up around 75%.)

The key point is this: If conventional production declines significantly, oil prices could go an awful lot higher than the 2008 peak of $148, especially if the dollar weakens and stays weak. Taking profits in energy investments when oil hits $120 may result in energy investors leaving a lot of money on the table.

Seeking Alpha



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