Peak Oil: A Reality or a Lie?

|
Includes: APA, CVX, DBO, IYE, OIL, USL, USO, XLE, XOM
by: Marc Courtenay

After the epic crash last year, the price of oil is stabilizing and it could rise exponentially over the following years. Over the past year, global consumption has stayed weak and may stay that way for awhile.

However once the economy recovers, crude oil should resume its secular bull-market trend and many pundits think it might shock some folks as to how high prices may go.

This bodes well for companies like Apache Energy (NYSE:APA), ExxonMobil (NYSE:XOM) and one of my favorites among the integrated oil companies, Chevron (NYSE:CVX).

I'm hoping to pick up shares of APA and CVX after the next "Black Swan Event" that may push their share prices down to more attractive levels. For those who want more diversity one might consider an ETF like Energy Select Sector SPDR (NYSE:XLE).

My friend and colleague Puru Saxena, writing from Hong Kong, shared the following with me and gave me his permission to share it with you. It's a longer piece than I usually post but it is a unique perspective on the topic of "Peak Oil".

Draw your own conclusions, but consider it with an open-minded approach because if it is mostly accurate it could be a monumental influence on our investment results in the years to come. The following is pretty much how I received it:

Despite the ‘demand destruction’ hype, it is interesting to note that during this severe global recession, worldwide oil usage has dropped by a minuscule 2.7%. So, what will happen when the world comes out of this recession? Who will rise up to the challenge and meet our insatiable thirst for energy? These are critical questions not many are willing to ask.

According to the US Department of Energy, liquid fuel demand in the developed nations peaked in August 2005 at 41.89 million barrels per day. Since then, it has plunged by 3.6 million barrels per day to 38.27 million barrels per day. However, you may want to note that despite these tough economic conditions, consumption has been extremely resilient in the emerging world. For instance, demand in the developing countries peaked in October 2008 at 46.33 million barrels per day and it is down by only 0.36 million barrels per day! I don’t know about you but I am amazed that the worst global recession in decades has barely managed to shrink energy demand in the developing world. Whilst this is wonderful news for the energy investor, it is a terrible sign for society.

At present, our world is using up roughly 84 million barrels of liquid fuels per day and for the moment at least, there is sufficient supply to meet demand. However, when economic activity picks up, it won’t take much for demand to zip right past supply. Remember, it is much easier to increase usage, but it takes a long time to ramp up production. So, unless this is a permanent global recession (which I doubt), it is inevitable that the price of oil will go up significantly over the medium to long-term.

On the supply side of the equation, let me be clear. If I was asked to pick the biggest threat to a sustainable economic recovery, ‘Peak Oil’ would top that list. Remember, ‘Peak Oil’ doesn’t mean that we are running out of oil reserves, crude will be around for decades. However, ‘Peak Oil’ does imply that we are dangerously close to peak global oil production. ‘Peak Oil’ also means that rather than experiencing a burst in oil supplies as many expect, from here onwards, we will witness sharp declines in global flow rates. In a nutshell, the era of cheap energy is over and the price of crude oil will rocket higher over the coming decade.

On the supply side of the equation, let me be clear. If I was asked to pick the biggest threat to a sustainable economic recovery, ‘Peak Oil’ would top that list. Remember, ‘Peak Oil’ doesn’t mean that we are running out of oil reserves, crude will be around for decades. However, ‘Peak Oil’ does imply that we are dangerously close to peak global oil production. ‘Peak Oil’ also means that rather than experiencing a burst in oil supplies as many expect, from here onwards, we will witness sharp declines in global flow rates. In a nutshell, the era of cheap energy is over and the price of crude oil will rocket higher over the coming decade.

Now, many skeptics will argue that if ‘Peak Oil’ was real, the price of oil wouldn’t have dropped to roughly US$30 per barrel in last autumn’s stunning crash. Valid point; but let us not forget that the spectacular plunge occurred at a time when global economic activity virtually came to a standstill. Let us also keep in mind that last autumn’s crash in asset prices was caused by a total freeze in credit and the associated asset liquidation. Whilst I agree that the final action in crude oil’s parabolic blow-off last July smacked of speculation, I can assure you that speculation alone couldn’t have created a multi-year boom whereby the price of crude oil went up by almost 1500%! As you can see from Figure 1 above, supply clearly fell short of demand between 2005 and 2008 and this is why we had a magnificent bull-market in crude oil.

Make no mistake, global demand for liquid fuels will rise again and if my homework is correct, supply won’t be able to keep up. If you ignore the noise and review hard data, you will observe that the vast majority of the world’s most prolific oil provinces are now past peak production and in a state of permanent depletion. According to the BP Statistical Review of World Energy, out of the 54 oil producing nations and regions in the world, only 14 are still increasing production. Alarmingly, 30 oil producing nations and regions are definitely past their peak output and the remaining 10 appear to have modestly declining production rates. Put another way, when weighted by production, ‘Peak Oil’ is already a grim reality in 61% of the oil producing world!

Still not convinced about ‘Peak Oil’? Then review Figure 2 which charts the expected combined flow rates for crude oil, lease condensates and Canadian Oil Sands. As you can see from the grey shaded area, production is about to decline by roughly 5 million barrels per day by 2012.

Has crude oil production peaked?

https://static.seekingalpha.com/uploads/2009/8/27/saupload_ccst20090515_thumb1.png

Source: The Oil Drum

Ironically, the above graph also plots the optimistic (almost laughable) forecast made by the International Energy Agency (NASDAQ:IEA) in its “World Energy Outlook 2008”. Interestingly, in last year’s “World Energy Outlook”, the IEA stated that in order to fulfill its optimistic projections, the world had to install 64 million barrels per day of new supply by 2030 or the equivalent of six times the Saudi Arabian output! Furthermore, the IEA declared that the energy industry had to invest hundreds of billions of dollars every year to achieve this favourable outcome.

Now, I can understand that the IEA is a government funded agency so it has to paint a rosy picture, but it is ominous that the energy watchdog failed to mention where this surplus oil would come from!

Well, I guess you get the idea. Global crude oil production has probably peaked, new discoveries have dried up and there is a shortage of capital for investment purposes. Apart from these factors, if you believe the energy optimists, all is well in the energy industry and the price of oil is about to drop to zero!

After years of extensive research, I have no doubt in my mind that unless global demand stays weak forever, we will see supply shortages in the not too distant future. And before that occurs, the price of crude oil will stage an explosive rally. Accordingly, I suggest that all my readers allocate a large proportion of their investment portfolio to upstream energy companies and to businesses in the energy services sector.

Finally, in the energy complex, the price of natural gas is still scraping along its recent crash low and this is a fantastic long-term investment opportunity. As we approach winter in the Northern Hemisphere and heating demand picks up, we are likely to see a big rally in the price of natural gas. So, investors may want to allocate capital to this unbelievably inexpensive commodity.

I don't endorse him or his views, but I find him thought-provoking. A great exercise would be for each of us to test his thesis and come to our own conclusions.

DISCLOSURE: I don't own any of the stocks or funds mentioned in this article.