No, Peak Oil Is Not Going To Happen

Includes: CVX, XOM
by: Shaun Connell

A well known economist, William Jevons, wrote a book that upset some of the biggest energy investors and producers in the world. He pointed out that the basic source of our economy's energy was finite, and, therefore, eventually we would run out. This would lead to economic turmoil and we would all suffer.

In his book, he asked the sobering question:

"Are we wise in allowing the commerce of this country to rise beyond the point at which we can long maintain it?"

Scary right?

Only one awkward problem: that book was written in 1865 and was about coal. It was called "The Coal Question". Doomsday energy claims aren't new. They'll probably never stop being popular.

"We're running out of [resource]" theories have been around for well over a century, and they're incredibly romantic, exciting, and dead wrong.

Peak Oil Makes As Much Sense As Peak Coal

Whenever people begin talking about how a resource is finite and we're going to run out, using buzzwords like "sustainability", there's almost always a very basic part of economics being missed. In the case of peak oil/coal/gas, the economic principles are in how the market reacts to higher prices.

A couple of days ago, I wrote about the peak oil theory, arguing that we wouldn't experience an irreversible decline in oil production because of supply constraints, but would see increases in unconventional production, would transition to other alternatives, and eventually see demand decline before we literally start running out of oil to produce.

Peak oil, or at least the vague argument that "we're running out of oil", isn't a new argument, and has been around for well over a century. As explained before, there are three basic reasons it doesn't make sense:

  1. Innovation Changes Economically Recoverable Oil Supply

  2. Higher Prices Change Economically Recoverable Oil Supply

  3. Higher Prices Automatically Cut Demand For Oil Products

Why didn't coal peak? Well, production did, but only because demand began to fall in the 1920s as oil became more popular. This drop in production wasn't because of the economics of "we're running out and can't afford to consume energy". There was no coal crunch.

Several decades later, coal production began increasing again, and it's still higher than it was back in the 1920s. So much for peak coal.

What Peak Oil Isn't

In the article I wrote earlier, a lot of commenters responded with arguments about future higher oil prices, mostly with a misunderstanding of what peak oil is.

Peak oil isn't the notion that production will peak for any reason -- it's the notion that production will peak and irreversibly decline due to supply constraints. This is very different than peak demand -- fundamentally different.

Oil will eventually be a niche commodity, when electric cars and alternative fuels make most production unnecessary. Even eventually, technologies like thermal depolymerization can help create more production as needed in several decades if demand is needed for chemical products and other oil based consumption not related to engines and such.

Because of this, any claims that peak oil must happen because "prices will increase" are missing the point. Of course prices will increase -- that's what helps spur on innovation and new oil sources. It spurs on alternatives. It rations oil -- it doesn't mean production will decline. Those are fundamentally different concepts.

The Awkward History Of Being Wrong

Peak oil theorists have been wrong for over a century. I would make a long list of all the wrong predictions, but I'll just save time and say "any predictions that it would happen by now were wrong". And most did.

Even Hubbert's theory, which was popular in the 70s, said we'd see oil production peak and then decline due to supply constraints in 1995. That just didn't happen.

Why didn't it happen? Because cars have become more efficient, unconventional oil production is growing, and conventional oil production is easier with better technology. And now we're starting to see the seeds of alternative fuels take root, like with natural gas and even the occasional fully electric car.

It's not like oil companies just stick a straw in the ground, sell the oil, and burn the profits in a pit in the backyard. The profits go to research, infrastructure, and further exploration.

This isn't going to change for decades -- and by then, natural gas alternatives and electric cars will be a huge part of energy consumption, fundamentally killing the peak oil theory forever.

Of course, we know what happens then. The peak-oil economists are going to start writing books about natural gas and another industry will be born selling books predicting peak natural gas and the end of the world as we know it.

I'm not buying it. The evidence isn't there, the theory doesn't make sense, and the field of economics is essentially based on explaining why it won't happen. Peak oil theory is just another myth.

The impact to investing is the same as explained before. Off-shore oil drillers, oil service companies, and even regular supermajors like Chevron (NYSE:CVX) and Exxon (NYSE:XOM) are great bets going forward, because they're the ones positioned to profit the most as society learns to retool and innovate to keep up our long-term economic demands.

Disclosure: I am long CVX, XOM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.