Peak Oil Production

Written By Brian Hicks

Posted May 22, 2008

I must admit, the first time I ever heard the words "peak oil crisis" I kind of wanted to chuckle.

"Yeah right," I thought to myself as I smirked, "the world is running out of oil." The sky is falling; the end is near, blah, blah, blah…. I had heard it all before.

So I quickly put peak oil production into the doom and gloom dustbin with the rest of the fake crises that would never happen.

Being a free market type, that was pretty easy. After all, in my mind supply would always meet demand. Oil was no different.

I also had the weird feeling that somehow I had seen all of this before during the last "energy crisis" with its gas lines and locking gas caps.

But the truth was that I was being intellectually lazy on this one, hiding behind my belief that it would somehow all work itself out—just like it had before.

The Oil Production Crisis is Real

That was over four years ago when oil was $40.00 a barrel—-today it’s pushing $130.00.

Peak oil, in other words, has turned out to be real.

I figured that out about two years ago when I began to write about energy issues for our sister publication Energy and Capital. It was akin to an epiphany.

And the truth is, it was a conversion that didn’t take too long once I actually took my brain off the sofa and began to take a serious look at what the peak-oilers were saying.

Chicken-Littles they were not. Their numbers were indisputable if you bothered to look at them—energy was about to become a serious worldwide problem.

But what I also learned was that "peak oil" wasn’t about the end of oil at all. Peakers, after all, admit there is more oil to be found. That’s not their essential gripe—even though most people mistakenly think that it is. That’s why they dismiss them so easily as as cranks and peak freaks.

Instead, they contend that oil is becoming increasingly harder and more expensive to find and develop. Moreover, they are simply stating a fact when they point out that all oil fields eventually reach a "production peak" which is followed by a period of protracted decline.

Now ask yourself for a moment how irrational is that exactly?

The result is a fundamental supply and demand imbalance that can’t be easily remedied. Ignoring it is only an exercise in denial.

Peak oil then is not so much about the end of oil in the short term as much as it is about the end of cheap oil. That is the key.

So when you see forecasts like the one recently released by Goldman Sachs predicting $141 a barrel oil by the end of the year, and $200 a barrel oil in the not too distant future, don’t be so quick to dismiss them as the work of the doom and gloom crowd.

The evidence, meanwhile, says otherwise. Oil fields do peak. And when they do, it quickly turns nations that used to export oil into nations that import oil, draining critical supplies off of the fast growing world markets.

Great Britain and Indonesia are two recent examples. Before they peaked they were so flush with oil that they were both exporters. Today between them they import a total of 2 million barrels a day.

That change took place in less than a decade, as both of them essentially went offline.

Behind them is a list of countries—including Saudi Arabia—that will peak eventually. In fact, the Saudis recently admitted as much, with an announcement that the kingdom would voluntarily limit future oil production, in order to leave oil wealth "for future generations."

That was before they told President Bush to essentially take hike when he showed up on their doorstep asking for increases in production. Some even believe in a darker truth—that the Saudis couldn’t increase production if they wanted to.

Of course, getting the Saudis to simply turn it up has basically been the sum total of our energy policy for over 20 years.

That makes peak oil a big a problem if you live in a country like the United States that imports 72% of its oil. That figure, by the way, is up considerably since 1979 when the U.S. imported 22% of its oil, or even in 1991 when the figure was only 42%.

But let’s forget about all of this speculation about the Saudis for a minute—as important as it is. There is a known problem south of the border called Mexico. Mexican oil production peaked in 2004 and has been in steep decline ever since.

Mexico is About to Go Offline

In fact, its largest field, a giant called Cantarell, is in an annual decline rate of 15%. Cantarell, by the way, is responsible for about 55% of Mexico’s oil production.

But Cantarell is only part of larger and more worrisome decline in Mexican oil.

In a recent televised address, Mexico’s President Felipe Calderon warned, "We must act now, because time, and oil, is running out on us." Analysts estimate at the current rate of consumption Mexico’s oil production could last 9.2 years and exporting will end in less time.

The result is that Mexico will likely go offline in as little as five years, which would have an enormous impact on world oil markets, particularly in the U.S.

After all, Mexico ranks third behind Canada and Saudi Arabia in exports to the United States by supplying 8% of our oil needs. That is 1.2 million barrels a day that we are going to have to find somewhere else in a tight market just to stay even.

But the truth is that just staying even is a loser’s game.

That’s because within the next 7 years, worldwide oil consumption is expected to increase from our current 87 million barrels per day to 103 million barrels per day. That’s a net increase in consumption of 16 million barrels.

That means that we will have to develop the current equivalent of roughly two Saudi Arabia’s for supply to have a snowball’s chance in you-know-where to meet demand.

So where are we today?

Well as T. Boone Pickens is quick to point out worldwide oil production stands at about 85 million barrels a day. Meanwhile, worldwide demand is over 87 million barrels a day.

That leaves an "oil gap" of nearly 2 million barrels a day that can’t be conned—85 won’t cover 87 no matter how hard you try.

The result is a market in which oil goes to the highest bidder for years on end.

Fixing it will require a national effort that is equal to what we did in World War II to defeat Germany and Japan.

Remember that when you head to the polls. Eliminating the gas tax, suing OPEC, and gouging the oil companies is not an energy policy.

Peak oil is real. The only cure is the free markets.

By the way: A little over two weeks ago Mexico announced that it would be unable to fulfill this year’s scheduled oil exports to the U.S. As a result, Mexican imports will decline by about 11% or 184,000 barrels a day.

Your energy-loving analyst,

steve sig

Steve Christ

Chief Investment Analyst

The Wealth Advisory

PS. Energy is a big part of The Wealth Advisory portfolio. Click here to learn more about how to profit from the peak.

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