- M. King Hubbert's prediction of a peak in US oil production proved eerily accurate in 1970.
- Peak oil enthusiasts predicted a peak in world oil production between 2004 and 2008.
- In fact, depending upon how it is measured, US oil production is now approaching the 1970 peak and world oil production has been increasing since 2009.
- The reason is that more expensive sources such as shale fracking, tar sands, and tertiary recovery have emerged and are increasing rapidly.
- A new oil market is emerging with higher marginal costs of production and more stable (but high) prices; there are very important investment implications.
M. King Hubbert was a renowned geologist who made an uncanny prediction that US oil production would peak sometime around 1970. He predicted a fairly sharp and steady decline from the peak and for a while that seemed to play out. Alaska production reversed the trend briefly but didn't lead to a new peak and the decline resumed in the 1980s. Hubbert's followers predicted a peak in world oil production in the first decade of the 21st century. Kenneth Deffeyes's excellent book, Hubbert's Peak, (written in 2001) predicted a world oil production peak between 2004 and 2008. His 2008 edition of the book announced that the peak occurred in 2005.
Most peak predictors also warned that once the peak was reached and production declined, there would be a mad scramble for the remaining oil leading to military conflict and severe social disruption. Now that we are safely past the predicted peak, it seems like a good time to reexamine these matters.
US Oil Production - Using Energy Information Agency (EIA) data, it appears that US oil production is on the increase and total production (including natural gas liquids) is on the threshold of exceeding the 1970 peak. The table below provides an "all in" average daily production number in thousands of barrels per day for the old peak year of 1970, and the bottom year (2006) through 2013. This number includes natural gas plant liquids (NGPL). I have also provided crude production and NGPL production separately. Looking at these numbers, we may be about to prove the peak oil production prediction wrong. Even narrowly defined crude oil field production is on the increase and this is inconsistent with Hubbert's prediction of a steady downturn in production after the peak. The year to date 2014 numbers are 8,206 for crude, 2,806 for NGPL and 11,012 for the total. We are creeping back up to the 1970 "peak" for the total although we still have a way to go to get there for crude. At any rate these numbers do not look anything like the curve posited by peak oil advocates which would have required a gradual decline from the 2008 crude oil bottom rather than a rebound of more than 50% off that bottom.
World Oil Production - World oil production is also calculated by EIA and it shows increases since 2009 with new peaks being reached each year. The table below shows average daily world oil production in thousands of barrels per day for each year since 2005 (only crude production is included; NGPL data is excluded); no year prior to 2005 exceeds the 2007 level so that 2013 is a "peak" year which will likely be exceeded in 2014. Again, the prediction of a peak in the first decade of the 21st century seems to have been wrong. We are well above the 2005 level described by some as a "peak." While we can see how Deffeyes could crow in 2008 that his prediction of a world oil production peak in 2005 had been proven correct, had he waited a few years he would have had to eat crow instead.
Conventional versus Unconventional Production - First of all, we have to be careful about definitions here. Many peak oil predictors conditioned their prognostications with a caveat that the peak would apply only to "conventional oil production." This has not been tightly defined but it would probably exclude at least the following; 1. processing of shale rock to recover oil through heating; 2. tar sands; and 3. natural gas liquids. I am sure I will see a lot of comments to this article arguing that the peak oil predictors have been vindicated because, depending upon how conventional oil production is defined, they are actually correct.
The above world oil numbers probably include roughly 2 million barrels a day of tar sands production. The United States crude oil numbers include a large volume of production due to the hydraulic fracturing and horizontal drilling in shale formations. Whether this process is defined as "conventional" is probably open to debate. Hydraulic fracturing was being employed in the 1950s and so is not an exotic technology but I can see an argument being made that this process is not "conventional."
The important point is that peak oil predictors should not be allowed to have it both ways. If their predictions apply only to a narrowly defined category of "conventional" oil production, then the warning that a peak will lead to shortages and a mad grab for oil is questionable because it excludes the possibility (which has become a reality) of large scale "unconventional" oil production. Thus, if peak oil predictions are limited to a narrow definition of conventional production, then they do not necessarily have dire consequences. On the other hand, if peak oil predictions apply to all petroleum production, then it appears that they are simply wrong.
Once again, it appears that economists who cautioned that we should trust in human greed to respond to higher prices with more aggressive and creative production techniques have been proven correct. The recovery of US production is largely due to increased production induced by higher prices and the combination of this production and Canadian tar sands production has been a very important factor in the increase in world oil production.
The New World Oil Market - The emergence of new forms of oil production is important for other reasons as well. Conventional oil production generally involved extensive discovery and exploration work and then relatively low marginal production or "lifting" costs. In a sense, it was more like a treasure hunt than a mining operation. Once the field was discovered, production costs were low and production would continue even if the price of oil declined dramatically. On the other hand, it was not so easy to produce more oil in response to a higher price because a new field had to be found and developed and that took time or was simply impossible. I realize that these generalizations ignore important nuances - more production could be generated from existing fields in response to higher prices and more exploratory drilling would also be induced by price incentives. But - in comparison to many other commodities - oil production - at least in the short term - was relatively price inelastic. As a result, if some production came off line due to weather or war, the price could skyrocket before the market would clear. This higher price would then slowly induce more production, which would tend to build up a surplus, which, in turn, could drive the price way down when the offline production returned to the market because wells would continue to produce and still be profitable at much lower prices so that supply would not contract in response to a lower price.
Whenever the price shot up and supply got tight, we would have a strong public policy response in favor of alternate fuels, conservation and greater efficiency. All sorts of technologies would be showered with subsidies and supported by studies showing that they made economic sense at the current oil price. However, when the oil price declined, these technologies did not look as attractive. Investors observed the cycle and got gun shy in terms to betting on technologies whose success depended upon a high oil price.
The market is becoming very different. It is likely that most new sources of oil production involve relatively high marginal costs. Shale fracking is expensive and tar sands production is very expensive. A decline in the oil price will lead to a reduction in production from these sources relatively quickly. As more expensive oil production plays a bigger and bigger role in the market, the amount of production that will be driven off line by a price decline will increase. In economists' terms, the supply of oil will become more price elastic - especially on the down side. As a result, prices will tend to stabilize with a floor set by the price incentive necessary to sustain this more expensive production. This price level is probably somewhere in the $65 - $80 range today. It is unlikely that we will ever see $30 a barrel oil again unless there is a major global economic depression.
Investment Implications - The oil industry will also begin to depend more and more on advances in extraction technology and less and less on the discovery of new fields. In that sense, it will change from being analogous to treasure hunting and will become more analogous to agriculture. Within the industry, companies at the cutting edge of extraction technology are likely to be attractive investment opportunities.
Perhaps more importantly, companies pursuing technologies involving substitution of other fuels for oil, conversion of other products into liquid fuels, or technology for the more efficient end use of liquid fuels should benefit. They no longer will have to worry about the specter of a rapid and steep decline in the price of oil and its negative impact on the incentive to adopt the technology they are trying to deploy.
In this regard, companies with strategies to displace petroleum in the transportation sector should do well. I have long recommended Methanex (NASDAQ:MEOH) (most recently, here) which has a strong position in the methanol market; I consider it a long-term strategic hold. Clean Energy Fuels (NASDAQ:CLNE) leads the way in the effort to utilize natural gas in the transportation market; it has been covered frequently on this website and by me most recently here. Westport Innovations (NASDAQ:WPRT) is also active in this area. While there is a question of whether the trend will catch on fast enough to reward current shareholders, in the long run natural gas will almost inevitably make its way into the transportation sector. I have also recently written about Aemetis (NASDAQ:AMTX) here; AMTX is a company, which is using innovative technology in the ethanol and biodiesel sectors and I continue to recommend even though it has moved up considerably.
Conclusion - It is likely that the era of cheap oil has ended. The good news is that we will likely be able to cushion the blow and arrange a transition due to more sophisticated drilling and recovery technology as well as unconventional sources of petroleum. This will, however, be expensive and will require a relatively high oil price. The high oil price will, in turn, create a powerful incentive for the deployment of fuel substitution technology and a transition to the ultimate result of reduced petroleum consumption. We will not wake up one morning and be unable to buy oil at any price. Instead, the price will gradually go up and lead energy consumption in new directions.
In the United States, we actually appear to have already experienced an important "oil peak." Oddly enough, this peak was a peak in oil consumption. Oil consumption appears to have peaked in 2007 due to the displacement of oil in the heating and electric power plant sectors as well as improved vehicle efficiency in the transportation sector. The adjustment to more expensive oil is well underway and this process is likely to create a number of very attractive investment opportunities.