On Oil's Sesquicentennial, The Dream Becomes a Nightmare

Includes: DUG, OIL
by: John Petersen

On August 27th, we'll celebrate the 150th anniversary of Colonel Edwin Drake's completion of the world's first successful oil well near Titusville, Pennsylvania. That discovery and the many that followed planted the seeds of an industrial, economic and cultural revolution that transformed America from an agrarian backwater into a global superpower. For the next 114 years, oil was cheap, plentiful and the solid bedrock of the American Dream. Since the early '70s, however, the dream has gradually become a nightmare as domestic and global oil production began an irreversible decline.

My first graph comes from the Energy Information Administration and shows the annual U.S. production of crude oil over the last 150 years.

Click to enlarge

My second graph comes from Wikipedia and shows both nominal and constant dollar oil prices over the last 150 years (click on the graph for an expanded view).

The most interesting feature of the two long-term graphs is the general shape of the constant dollar oil price curve. If you smooth out the price shocks of the '70s and '80s, the graph shows a pronounced albeit elongated U-shape. While there are many theories about where oil prices will stabilize when the global economy begins to recover, it seems safe to assume that the price won't be $20 or even $40 per barrel.

My third graph takes historical oil price data I downloaded from the Energy Information Administration, adds a price channel overlay on the ten-year trend and shows why I believe oil prices will stabilize around $80 per barrel later this year and continue to move upward in the price channel over time.

Barring unexpected major new discoveries, there's only one way for oil prices to go over the long term.

It doesn't take much reflection to see that oil production, consumption and pricing have become major problems that can only get worse as six billion people in emerging economies strive to attain the lifestyle that 600 million Americans and Europeans have enjoyed for decades. The harsh but undeniable reality is that oil cannot sustain global economic growth for the next 20 years, much less the next 150. This reality is the driving force behind a concerted global effort to identify and harness alternative energy resources that can offer relevant scale solutions to a looming global shortage. Unfortunately, many alternative technologies are even less sustainable than oil because they depend on a smaller natural resource base.

There are only four unlimited energy sources known to man. The first is the internal heat of the earth itself. The second is the movement of the hydrosphere. The third is the movement of the atmosphere. The fourth is the sun. Where the Ancient Greeks taught that earth, water, air and fire were the classical elements, the new science of alternative energy teaches that earth, water, wind and sun are the true classics. When it comes to harnessing that energy, however, the only thing that matters in the long run is the mineral wealth of the earth's crust and oceans.

Many alternative energy technologies including windmills, PV solar cells, fuel cells, advanced batteries, and advanced electric motors depend on exotic metals that were pretty scarce to begin with. Like oil, each of these exotic metals will have a U-shaped price curve and while they're relatively cheap and relatively available for the time being, each will eventually hit an inflection point where they'll no longer be cheap or available. According to experts like Jack Lifton, many critical natural resources will reach their price inflection points within a few years, rather than decades or centuries. So far, the only alternative energy technologies I've identified that do not face daunting mineral scarcity risks are concentrated solar power, or CSP, and geothermal power.

Historically, investors have not had to worry about how natural resource constraints might impair their portfolio companies because the required raw materials have always been available for a price. As we enter the Age of Cleantech, the sixth industrial revolution, those rules will be re-written in ways that many will find shocking. I've previously described how raw materials shortages will impact the battery and hybrid electric vehicle markets. Over the next few weeks I hope to expand my focus to consider the principal raw materials that are critical to the development of a truly sustainable alternative energy infrastructure. Unlike this article, future installments will identify companies that enjoy specific natural resource advantages or suffer from specific natural resource risks, and hopefully help investors identify the likely winners and losers.

Given the long-standing animus between environmentalists who see themselves as protectors of the planet and miners who see themselves as simple providers of essential raw materials, I'm not optimistic that humanity will be able to solve its energy problems without catastrophic conflict and horrific environmental consequences. If we are to have any chance at all, the environmentalists must come to grips with the fact that a clean energy future depends on the robust and responsible development and use of all the earth's resources.

Disclosure: No positions