Peak oil: Problems and possibilities

Oil. It's a nonrenewable resource, but only in the last decade or so has the "non" part really begun to hit home. As oil prices continue their seemingly endless trek skyward, the whispers about peak oil have turned into a roar. Peak oil is the hypothetical date when the combined daily output of global oil producers has reached its maximum and then begins to decline. Essentially, this is the point where supply starts to move downward, while demand continues to climb. You don't need to be an economics major to figure out what the effect on prices will be.

The nonrenewable status of fossil fuels isn't up for debate we've run out of dinosaurs but the timing and consequences of peak oil are controversial. Some believe that we are already on the down slope, while others believe this is nothing but fear mongering. In this article, we'll examine the debate and explore some of the consequences that are likely to arise when the well runs dry.

Are We There Yet?

The peak oil theory was first put forth by American geoscientist Marion King Hubbert in 1956. He said production tends to follow a bell-shaped curve, often called "Hubbert's peak" or "Hubbert's curve", and predicted that oil production in the United States would peak in 1970. Despite criticism at the time, his prediction was eventually proved correct (Figure 1).

Hubbert then expanded his theory to cover worldwide oil production. Hubbert predicted a global peak around the year 2000. This is where things get muddy. Often, the only way to be certain of a long-term trend is in retrospect. Some experts believe we have already reached a peak or that one is imminent, while others predict a peak in 2020 or later. A report commissioned by the U.S. Department of Energy titled "Peaking of World Oil Production: Impacts, Mitigation, and Risk " (2005), also called the Hirsch Report, summarizes some of the major predictions that have been published by energy and economics experts:

As you can see from the chart above, an exact date for a peak is difficult to predict even for those involved in the industry. Many experts say we have already crested the peak or that it will come before 2010, while others forecast that it will occur a decade or more later. The difficulty in pinning down an exact date is due to geological complexities, measurement problems, pricing variations, demand elasticity and political influences. What is clear, however, is that we don't have another hundred years of seemingly limitless supply. (For related reading, seeUnderstanding Supply-Side EconomicsandEconomics Basics: Demand and Supply.)

Supply & Demand

World oil demand is forecast to grow 50 per centby 2025, according to the U.S. Department of Energy's, "International Energy Outlook 2004". This is a scary statistic given that a peak in supply is predicted by most experts long before this.

In the Hirsch Report, Robert Hirsch says mitigation of the problem requires a lot of lead time. He predicts it would take 20 years to make the transition without substantial financial and societal impact. Shorter transition periods would result in massive to moderate liquid fuel shortfalls.

While the shortfalls haven't hit us yet, there are already worrying trends in reserves versus demand (Figure 2).

Some disagree with Hirsch's assessment of the danger. Economist Michael Lynch argues that oil production is closely tied to price. Lynch says the error Hubbert modelers make is assuming geology is the sole motivator of oil discovery, depletion and production. Lynch says the drop off in oil discovery we have witnessed is not due to geological constraints but instead supply and demand. "To an economist, the drop in exploration reflects optimal behavior: they do not waste money exploring for something they will not use for decades." (PDF: "The New Pessimism about Petroleum Resources: Debunking the Hubbert Model (and Hubbert Modelers) " (2004).)

Others argue that as traditional fossil fuels begin to run out, alternative fuels and new methods of extraction will fill the void. Daniel Yergin, the chairman of Cambridge Energy Research Associates (CERA), says the danger of peak oil is a myth, stating the current crisis is the fifth time that the world was supposedly running out of oil.

"Each time whether it was the 'gasoline famine' at the end of WWI or the 'permanent shortage' of the 1970s technology and the opening of new frontier areas has banished the specter of decline. There's no reason to think that technology is finished this time."

The Day After Effects of Peak Oil

Apocalyptic Vision

What the days after the peak will look like is up for debate. It is very possible that the peak will have massive consequence for society as we know it today, especially if alternatives can't be found. The development of the U.S. economy and lifestyle has been fundamentally shaped by access to abundant, cheap oil.

• Fuel prices Oil scarcity is likely to cause oil prices to increase several-fold, predicts Hirsch in his report. "The decade after the onset of world oil peaking may resemble the period after the 1973-74 oil embargo, and the economic loss to the United States could be measured on a trillion-dollar scale." (For tips on how to cope, readGetting A Grip On The Cost Of Gas.)
• Food prices - The price of food is closely connected to the price of fuel. As shipping costs skyrocket, food prices will follow closely behind. This effect could be exacerbated by demand for ethanol. Fields that would normally be used to grow food crops are already being converted to grow corn for our gas tanks; in just three years, from February 2005 to February 2008, overall global food prices increased by 83 per cent, according to a report by the World Bank entitled "Rising Food Prices: Policy Options and World Bank Response" (PDF). Increased biofuel production has contributed to the rise in food prices, the report stated. (To learn more about alternative energy, readThe Biofuels Debate Heats Up.)
• Urban Migration - Municipalities could also be hit hard by peak oil. Suburbs could become ghost towns with Abercrombie & Fitch catalogs blowing in the dust like tumbleweeds. Transportation costs for both individual commuters and city transit could become prohibitive, forcing a mass exodus from the suburbs as people move closer to work. Land user patterns may also change, creating pressure for new public infrastructure. This concept is explored in-depth in the peak oil documentary "The End Of Suburbia".

Opportunity for Evolution

Others don't share this dystopian view. Instead of a disaster in the making, Cambridge Energy Research Associates (CERA) an energy advisor to companies, governments, financial institutions and technology providers sees peak oil as an opportunity. CERA predicts an oil plateau after 2030, rather than a peak or bell-shaped curve, during which oil production levels off. This scenario would provide time for unconventional liquid fuels to fill the gap. CERA points to production from heavy oil sands, gas-related liquids (condensate and natural gas liquids), gas-to-liquids and coal-to-liquids.

Solar energy, wind energy, hydrogen fuel cells, biofuel and ethanol could all see new innovations. (To learn about alternative energy, readBuilding Green For Your House And Your WalletandUnearth Profits In Oil Exploration And Production.)

Preparing For Peak Oil

Even conservative estimates predict a peak in years, not centuries. The question now is what will we do to be ready for it? Education is the first step. It's shocking that an issue that has such potentially massive long-term ramifications is not understood by more people. This article has only touched on this issue, but it's possible to make consumer and investment choices today to help prepare you for what could be a massive global shift by seeking out more information.

To learn what investments will do well as peak oil sets in, readPeak Oil: What To Do When The Wells Run Dry.