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Page added on September 1, 2012
Peak Oil Myth: Debunking The Peak Oil Theory
One of the most important energy theories for investors in energy of any sorts is the notion of “peak oil”, or the idea that at some point, we’re going to hit a certain amount of oil production, and then we’re going to have to naturally start producing less going forward from that middle point.
This makes sense if one doesn’t understand the nature of innovation, the basics of economics, or the business of oil production. But once we analyze those angles, the theory falls apart.
Most importantly, let’s look at what this all means for those investors of us who are looking forward to being long-term investors in energy of all sorts, including oil and natural gas.
The Theory: What Is Peak Oil?
The Financial Times Lexicon explains the definition:
“The debate over ‘peak oil’ – the point at which the world’s oil supplies go into irreversible decline – is a long-running argument that has not yet had much impact on energy policy.”
For the purpose of this article, we’re focusing on the notion of “irreversible decline.” If production happens to begin declining due to a lack of demand because of electric cars or something, that’s not necessarily peak oil.
Peak oil is the notion that we actually begin to run out of oil, and production is less because we can’t find enough to produce. Unfortunately, most new research goes against the notion of peak oil.
Every few years, another author comes out and says that we just reached peak oil and should begin preparing for the onslaught that will be starting to occur — then, of course, it doesn’t occur, mostly for the following 3 reasons.
Problem 1: Innovation Changes Economically Recoverable Oil Supply
When economists begin formulating theories, they often make one of the most critical mistakes possible — something, thankfully, the Austrian school doesn’t do. They begin assuming that economics involves static numbers.
George Soros’s theory of reflexivity is probably one of the most important concepts investors should learn to understand. It’s the notion that people react to people and change their actions, and the other people react to the changes, creating an endless feedback loop.
This feedback loop is why it’s impossible to assume that trends are constant when they are about society. This includes economics, innovation, demand for certain goods and services, and other things.
Peak oil might make sense if we were stuck with a set amount of oil, people were not going to begin shifting away from oil consumption ‘in time’, if innovation didn’t exist, and if economically unrecoverable oil couldn’t become recoverable with higher prices.
Of course, all of the above aren’t true. In fact, this is one reason researchers at Harvard are making the opposite predictions of the oil-peakers.
From Harvard’s Kennedy School website on June 26th:
“Oil production capacity is surging in the United States and several other countries at such a fast pace that global oil output capacity is likely to grow by nearly 20 percent by 2020, which could prompt a plunge or even a collapse in oil prices, according to a new study by a researcher at the Harvard Kennedy School…
Contrary to some predictions that world oil production has peaked or will soon do so, Maugeri projects that output should grow from the current 93 million barrels per day to 110 million barrels per day by 2020, the biggest jump in any decade since the 1980s. What’s more, this increase represents less than 40 percent of the new oil production under development globally: more than 60 percent of the new production will likely reach the market after 2020.”
Far from reaching peak oil and seeing prices increase forever, we’re seeing a very real possibility of the opposite. Innovation exists. Oil supply can increase. Not forever, of course, but certainly long enough for society to transition to another energy source altogether, like electric or something else.
Companies like Exxon (XOM), Chevron (CVX), and BP (BP) are dedicating huge amounts of money to make sure that innovation and exploration get better every year — not static.
Problem 2: Higher Prices Change Economically Recoverable Oil Supply
Innovation makes some oil sources economically recoverable that used to not be recoverable. For example, according to the Economist last year, we were seeing demand outstrip supply. But that doesn’t mean we were seeing peak oil. Even with increased demand, we were seeing a boost in production.
When demand begins to outstrip supply, this has an important impact on the market. It makes some oil that wasn’t economically recoverable suddenly more recoverable because of the higher prices.
Just look at shale oil. As prices begin to increase, as well as technology, more and more oil is suddenly recoverable and can be put on the market. Apparently, supply and demand still work.
Problem 3: Higher Prices Automatically Cut Demand For Oil Products
This is probably the most important concept we need to understand. Higher oil prices make non-oil based fuels more economical. This means electric cars or something else entirely. We’re decades away from even needing electric cars, but if there are long-term trends of oil price growth, then we’ll see people transition to fuels that are cheaper. It’s the way the market works.
This is one reason having higher fuel standards on cars actually is an economically destructive thing, because higher gas bills for consumers can end up pushing billions toward developing new fuels, allowing us to move to more economically friendly fuels decades earlier than with higher fuel standards.
Once again, government action misses the point of “higher prices” in the first place. Governments often miss the fact that ignoring prices with policy is economically destructive.
What This Means For Investors
This means investors shouldn’t be worried about energy companies somehow struggling over the next 30 years, but should look for ways to invest in the new technologies.
Oil companies in general will likely be a great bet over the next couple of decades. Offshore drillers like SeaDrill (SDRL) show promising signs, as do companies that help service them like GulfMark Offshore (GLF). Alternative fuels are also providing, well, alternatives, like Westport Innovations (WPRT), which helps build alternative fuel engines, or Clean Energy Fuels (CLNE).
Of course, getting exposure to the innovative field of oil wouldn’t be complete without a hat tip to Exxon and Chevron, two of the biggest corporations helping push us toward better technology, new oil reserves, and an end to the credibility of “peak oil”.
Overall, the lesson to be learned is that investors will make far more money if they bet on innovation rather than against it. The coming decades will likely show us this is true time and time again.
12 Comments on "Peak Oil Myth: Debunking The Peak Oil Theory"
Wheeldog on Sat, 1st Sep 2012 9:57 pm
Is it just me or is this article using circular logic? Based on my understanding of peak oil it is a point at which producing and refining oil becomes so expensive that consumers are increasingly priced out of the market. The EROI (energy return on investment) declines to the point that production stalls and then goes into long-term decline. Yes, oil and “pre oil” (kerogen) is being extracted from tar sands, tight shale and ultra deep water sources. However, these are increasingly expensive to produce and refine. Perhaps a better measurement of gross oil production is to report “net oil” after subtracting all the energy (total real cost) expended in its production and conversion into useable products. From that perspective we probably experienced a peak between 2005 and 2010, and we have been on an undulating plateau since.
BillT on Sat, 1st Sep 2012 11:25 pm
Wheeldog, you are 100% correct!
Newfie on Sun, 2nd Sep 2012 1:32 am
Never ending growth is a fairy tale.
David on Sun, 2nd Sep 2012 1:45 am
Peak oil is the point at which the maximum rate of production has been reached. The price follows the amount of energy required for extraction. When the same amount of energy is required to produce an equivalent amount of energy extracted, then it no longer makes sense economically to extract additional oil. What the writer is saying is that technology will save the day since it has done so in the past. And yes, I agree that new technologies can squeeze more out of what is left but it does not change the dynamics of energy in vs energy out. So yes, we will be able to continue extracting oil for probably the next hundred years. It just won’t be the oil we can afford. And one additional factor that was conspicuously missing from this optimistic forecast was the demand side of the equation. Demand is flat in the U.S. and has been so for the last 3-4 years, which coincidentally was about the time that world production began to flatten. So demand is flat here but prices still continue to rise. We might be tempted to point the finger at China and yes, they are already above 8 million barrels a day but surprisingly it is the Mideast where demand is growing even faster. The price at the pump in Saudia Arabia is less than 10 cents a gallon so you can imagine how much they use. A tremendous amount of oil is used to desalinate seawater over there.
Bottom line is that there is growing evidence that the world has hit peak oil. Oil companies would not even consider shale oil and tar sands if geologists could provide any evidence that there still is low hanging fruit out there. Another signal that oil inventories are getting tighter and tighter is the roller coaster nature of oil prices since the early 2000’s.
keith on Sun, 2nd Sep 2012 2:56 am
So King Hubbert was right on target. It was just all the a-holes who confused the issue for the last forty years and still do, so they can make money. Money which in reality is energy debits.
DC on Sun, 2nd Sep 2012 10:26 am
This guy seems un-aware that all the ‘new tech’ he gushes about aren’t new, and are all-ready being used, in some cases for decades now. There is not a lot more tech they can thrown down holes in the ground, just tweaking all-ready existing methods. But dont tell this guy that, hes convinced not only is all the stuff the oil cartel is using now is ‘new’, but more is on the way.
I would ask..like what? Dropping surplus nukes down empty wells in hopes of forcing the stuff they cant reach now to the surface?-And yes, that very idea was actually proposed for the alberta tar-sands at one point….
This moron can give hat-tips all he like to Exxon and Chevron, doesn’t change the fact they are among the most corrupt entities, ever.
mike on Sun, 2nd Sep 2012 10:54 am
where do they find these people. They are either just paid to say this shit or really or completely and utterly incapable of grasping what is a very simple concept. Is petrol more expensive now than it was 50 years ago? yes? by his standards oil and petrol should be getting cheaper and cheaper every year as the ever amazing “human innovation” makes the world a better place. It’s like these people never even fill up a car tank.
SilentRunning on Sun, 2nd Sep 2012 3:25 pm
Amen! Amen! The Economics God will triumph over Geology and Physics and provide us with unlimited amounts of oil forever and ever!!
Economics is the One True God, and Free Markets are our Savior!! All we need do is pray to the Gods of Economics, surrender our reason and rationality and ALL WILL BE WELL.
Damn those heretics who dare suggest that there are physical limits to the planet! That is heretical nonsense!!!
DMyers on Sun, 2nd Sep 2012 4:00 pm
Once again, we see the same spin. The article is similar to all the others we have decimated in recent weeks.
Interesting to note the number of such articles and what that says about the relevant market of readers. A lot of people like this good news. Not hard to believe what one really wants to believe. The What This Means to Investors section, above, gives a strong indication of market rallying intent.
Certain elements of the media take it upon themselves to crank up the popular mood in order to stimulate spending (an old idea but still in use).
Good comments.
If and when the people in this country face gasoline lines, the peak oil explanation may become widely accepted very quickly. This speculation flies in the face of popular Maugerianism, which assures strong supply in the mid-term. No such guarantee is credible when you consider the significant margin of vulnerability in the world oil production/transportation system; vulnerability to war, weather, finance, electricity disruption, etc.. Gasoline lines may not, but could, happen any day. A solidifying event like that would lead to a peak oil revival.
Kenjamkov on Mon, 3rd Sep 2012 3:53 am
I think I would like to be prepared for when oil is $500 a barrel than not be prepared.
Simple logic:
If I am wrong and I prepared, it will be easier for me to adapt to the current situation.
If I am right and unprepared, then it will be very difficult to adapt to the current situation.
(I know I’m right though.)
Arthur on Mon, 3rd Sep 2012 8:48 am
@DMyers, Netanyahoo is working overtime to prepare for such a ‘solidifying event’.
Just out of curiosity, how do that, ‘decimating articles’?
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