Peak Oil: Just a Myth?

This is an important question for energy investors. And I am one who started asking it after reading the essay “There Will Be Oil” from last weekend’s Wall Street Journal.

Daniel Yergin, the author, is a noted expert in the field, having written several books on oil and consulted on its dynamics at some of the highest levels of government and business.

Yergin challenges “peak oil,” the conventional wisdom of this century that we have seen or are soon near the day when total global oil supplies, including all known reserves, will only shrink.

Why should we listen to him? After all, Yergin is more historian than energy analyst or engineer, more interested in the geopolitics of “black gold” than its geophysics. He is probably best known for his book The Prize: The Epic Quest for Oil, Money, and Power, a number-one bestseller that won the Pulitzer Prize for General Non-Fiction in 1992.

But I remember reading enough of that book years ago to be left with the strong impression that oil, money, and power were inextricably linked and that issues of supply and demand, and thus price, are not always what they seem.

So while I am a believer in the idea of “peak oil,” I would also defer to his expertise on the matter. He doesn’t go so far as to say it in the article, but it suddenly occurred to me what a vested interest producers and other energy business folks could have in promoting the myth.

What’s Wrong With Peak Oil?

Before sorting through the evidence and the history for or against peak oil, Yergin first has a little fun in his piece. He offers some generalized unascribed quotes to characterize the mood among peak oil believers…

They warn that “an unprecedented crisis is just over the horizon.” The result, it is said, will be “chaos,” to say nothing of “war, starvation, economic recession, possibly even the extinction of homo sapiens.”

He then has some fun with their apparent wolf crying, making them sound like that “end of the world” rapture guy who may have to keep moving up his date if it doesn’t prove true soon.

So what does Yergin believe is the truth? Here he sums it up in a few sentences…

But there is another way to visualize the future availability of oil: as a “plateau.”In this view, the world has decades of further growth in production before flattening out into a plateau — perhaps sometime around midcentury — at which time a more gradual decline will begin. And that decline may well come not from a scarcity of resources but from greater efficiency, which will slacken global demand.

Yergin then spends a good amount of the essay telling the tale of a geologist named Hubbert who immortalized the idea of peak oil. The story is worth reading if for no other reason than understanding the arguments and language of “peak oilers” who may try to influence you.

What About Emerging Markets Driving Demand?

This is no doubt a big debate with many smart people on both sides. Since I have been a believer in what Yergin thinks is a myth, I now have my homework cut out for me.

I took the simplicity of the idea and ran with it. And combined with a planet of 7 billion with over half living in the “developing” world, the idea meant that oil demand supply should only fall while demand and price should rise.

But the debate is much more complex than that, especially when you throw in new technological developments and their ability to extract new sources. Yergin again…

The idea of “proved reserves” of oil isn’t just a physical concept, accounting for a fixed amount in the “storehouse.” It’s also an economic concept: how much can be recovered at prevailing prices. And it’s a technological concept, because advances in technology take resources that were not physically accessible and turn them into recoverable reserves.

In 2003, the Bakken formation in North Dakota was producing a mere 10,000 barrels a day. Today, it is over 400,000 barrels, and North Dakota has become the fourth-largest oil-producing state in the country. Such “tight” oil could add as much as two million barrels a day to U.S. oil production after 2020 — something that would not have been in any forecast five years ago.

The shale developments in the US that I have written so much about, like the Bakken and the Eagle Ford in Texas, may face a unique inflection point soon with falling oil prices. On the one hand, if crude slips below $70 per barrel, it could stall lots of more difficult (and expensive) “fracking” E&P projects.

On the other hand, this missing supply could sustain prices as global dynamics drive Brent crude $20 higher than WTI. Maybe the companies involved only have to acquire the shale reserves and sit on them, especially if the environmental challenges currently mount. This is a question for industry experts and another time.

Today, I just wanted to begin the dialog about peak oil — whether it’s real, when it really should be a factor, and how much it drives crude prices and energy company profits now. I’ve got my homework cut out for me.

Oil As Canary in the Mines of Risk

The more immediate concern for many of us as equity investors and traders is whether or not oil prices are signaling recession. I have used the $80 mark for WTI as sort of a line in the sand. But it could be lower. Still a break of $80 is likely the start of a trend toward $65 and we’ll know before then how bad a recession we might get.

What’s interesting now is to watch the related industries still maintaining such earnings strength. I talked earlier in the week about oilfield services with an Industry Rank of 23 out of 265, with top ranked companies such as Schlumberger (SLB – Analyst Report), Halliburton (HAL – Analyst Report), and Baker Hughes (BHI – Analyst Report). See Guns and Bullets for the Oil Wars for more detail on smaller companies.

The refiners are also hot, with an Industry Rank of 12 out of 265, topped with Zacks #1 Rank companies such as Valero (VLO – Analyst Report) and CVR Energy (CVI – Snapshot Report). There is an argument by some analysts that refiners will continue to benefit from the big WTI vs. Brent spread.

I’ll dive deeper into the idea of peak oil next week. Until then, here’s the Yergin article.

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