Peak Oil: Undulating Plateau Shaped By Price

Includes: CHK, DVN, EOG, USO
by: JJ Butler

Dr. M King Hubbert famously predicted peak conventional oil. Supporters point to Hubbert's correct predictions as a source of doom prophecy. Detractors misrepresent Hubbert and point to the unconventional shale oil revolution. Both sides ignore economics and price.

The U.S and world conventional oil production predictions of Hubbert were largely correct. U.S. production peaked in 1970 and world conventional production peaked in 2006, a date later than planned because of political, rather than geological, reasons. Last decade when the oil price was marching higher the peak oil enthusiasts could be heard screaming loudly.

Meanwhile, technology advanced. In 1956 Hubbert could not have known large offshore oil fields would be discovered and developed in places such as the North Sea. These fields are drilled by multi-hundred million dollar drill ships from a mile or more above the ocean floor. Yet today's North Sea oil production is in terminal and inexorable decline.

The unconventional U.S. shale boom is underestimated by all but the most strident bulls. Horizontal drilling was first applied to natural gas by pioneers such as Devon (NYSE:DVN) and Chesapeake (NYSE:CHK). Soon the E&P industry advanced the technology enough and applied it to crude oil (NYSEARCA:USO).

Leonardo Maugeri's recent energy project spoke of an unprecedented worldwide upsurge of oil production. The report was a farce with ridiculous decline rate assumptions. The oil and gas treadmill runs ever increasingly fast.

Price seems to be the forgotten important factor. All new oil production requires a high price to be developed economically. Bear calls for $65 oil ignore drilling capex budgets would be slashed at such a level and production fall. Oil bulls calling for ever high prices do not grasp the outstanding cash flows producers would be reinvesting to increase production.

Oil production appears to be on an undulating plateau, the shape of which will be determined by price. With higher prices oil production would gently increase as demand is choked. Lower prices will quickly crush producer cash flows given today's very high cost of marginal production. The catalyst for the shale revolution was a new much higher price deck.

EOG Resources (NYSE:EOG) CEO Mark Papa said it well on a recent conference call:

"Two recent concerns I've heard from oil bears involve horizontal shale oil. One concern is will the U.S. create enough shale oil to affect global supply. EOG's forecast is an increase in the U.S. of 2 million barrels of oil per day by 2015, which, we believe, will not impact a 90 million barrel of oil a day global market...

The second concern relates to possible international horizontal oil shale plays and their potential impact on supply. My answer there is maybe it will happen, but it's not likely for another 10 years at least."

Horizontal drilling outside of North America will not arrive in meaningful scale this decade. Without mineral property rights privately owned, no other nation has the mature and developed oil services industry necessary to replicate the boom. Imagine trying to source sand in Poland to frack in France!

The world has the ability meaningfully grow hydrocarbon production through natural gas and coal production, but not crude oil. Join me as I follow developments in these markets.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

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