Is The Peak Oil Theory Really Dead?

MSN Money February 7, 2012

2/6/2012 7:57 PM ET

By Jim Jubak

No, we're not running out of oil, as some predicted. But petroleum -- like some other commodities, including copper -- is getting more expensive to find and produce.

Now that oil is a long way from the $145 per barrel peak it hit in July 2008 and nobody on Wall Street is predicting -- as Goldman Sachs did in 2008 -- that oil is headed to $250 a barrel, we're not hearing much about peak oil anymore.

The peak oil model, initially developed by oil geologist King Hubbert and used to predict a peak in U.S. oil production between 1965 and 1970, says that the production from an oil field grows exponentially over time, then peaks and finally declines. The model has been applied to individual oil fields, national oil industries and global oil production.

Back in 2008, the fiercest proponents of peak oil as a global model were predicting that the world would start running short of oil sometime around 2020.

Now that the world is awash in oil, the only people talking about peak oil are those who oppose the idea. They are dancing on what they depict as the grave of what they call a "theory" that wasn't worth the graph paper it was plotted on.

Well, I still think that the peak oil model is a useful description of what we see happening in the oil industry today -- even if West Texas Intermediate, the U.S. benchmark, closed at a twitch under $100 a barrel on Friday, Feb. 3. (Brent crude, the European benchmark, closed at $114.58.)

The debate over peak oil

And, I'd go on to say that the peak oil model is the best way to understand what's happening to the prices of other commodities, especially copper. (Full disclosure: I predicted that oil would go to $180 a barrel shortly before it began its collapse from the $145 a barrel high in 2008. And full, full disclosure: The only one predicting $250 a barrel oil right now is Iran, which is threatening that prices will reach that level if developed economies impose tougher sanctions on the Iranian economy in an attempt to slow or stop that country's development of a nuclear bomb.)

Let me explain why I still find so much value in this "discredited" theory.

Jim Jubak

The most damage to the peak-oil model resulted from the overenthusiasm of its friends during the commodities boom that topped out in 2008. A view that I've called "hard peak oil" held that Hubbert's model had predicted that world oil reserves were about to go into decline, that oil production was about to plunge and that the world was about to run out of oil.

Those were all extensions -- unjustified in my view -- on Hubbert's model. Hubbert's formulation addressed only production rates and wasn't a prediction of the measured levels of global oil reserves. Hubbert's model used a relatively narrow definition of oil, not surprising in an era when the conventional oil production of Texas, California and Louisiana dominated the U.S. industry.

When oil companies continued to find oil and global reserves and estimates of global reserves continued to climb, peak oil theory took a ding. Then the global oil industry discovered huge, unconventional sources of oil in the Canadian oil sands and the tight shale formations of first the United States and then Argentina, China and Europe. That revived production in mature oil-producing countries, such as the United States, and made the theory look loopy.

But to see how useful a peak oil model can be to an investor, look at the latest quarterly results from the big international oil companies.

Spending more to get less

Let's start with Royal Dutch Shell (RDS.B, news).

Production volumes fell 5% year-over-year in the fourth quarter. Full-year production was down 3% from 2010. Shell told shareholders that it would reverse that downward trend and increase production in the low single digits in 2012.

What interests me is how much money Shell will invest in its attempt to reverse declining production. Shell will increase its total capital investment to $32 billion to $33 billion in 2012 from $31.5 billion. The actual increase in the capital budget for oil exploration, development and production will go to $24 billion in 2012 from $20 billion in 2011. That's a 20% increase.

And what will Shell and its investors get for those bucks? If recent history is any guide, not as much as they used to get. Shell's return on average capital employed in 2011 fell to 15.9%. A few years ago, when oil prices were much lower, return on average capital employed checked in above 20%.

Shell has had trouble increasing production in recent years, but the drop in return on average capital employed is an industrywide problem. For example, Chevron (CVX, news), one of the international majors that has been most successful at adding reserves in recent years, showed a return on average capital employed 20% lower in 2011 than in 2008. Exxon Mobil (XOM, news), which is historically more profitable than its peers among the international majors, averaged a return on average capital employed of more than 27% from 2006 through 2010. In 2010, the company's return on average capital employed fell to what was still an industry-leading 22%. (Exxon Mobil's big acquisition of XTO Energy in June 2010 makes it tough to compare figures for 2011 with previous years.)

These trends are just about what you'd expect from the peak-oil model. As reservoirs mature, oil produced from them gets more expensive as companies have to invest more in methods to extract oil. As fields and national reserves mature, companies can continue to add new oil discoveries, but the cost of each new discovery is likely to rise.

And I'd add this corollary to Hubbert's original model: As oil prices rise, oil companies invest in unconventional oil reserves, but producing oil from these unconventional sources -- whether from the Canadian oil sands of Alberta, the tight shales of Eagle Ford or the deep ocean pre-salt formations off Brazil -- is more expensive than producing conventional oil. The world can certainly continue to expand its reserves of oil, but only by increasing its investment in exploration and development.

Continued on the next page. Stocks mentioned include: Pioneer Natural Resources (PXD, news), National Oilwell Varco (NOV, news) and Ensco (ESV, news).

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29CommentsNewestOldestBestWorstControversial12 Paul Meyer15 minutes ago

These things seem apparent to me:

(1) People predicting the timing of peak oil have so far, been wrong.

(2) New sources of petroleum are still being found.

(3) The near future is often easy to extrapolate from the present.

(4) The distant future doesn't usually reflect current trends.

(5) The volume of the earth is not infinite.

(6) Petroleum is not regenerated in the earth on a human time scale.

Conclusions from these premises seem to be that though peak oil may or may not happen in our lifetimes, it will happen eventually.

We won't know when until the graph of oil production vs. time curves downwards long enough to show a consistent trend. The facts that production and reserves have continued to trend up over time does not mean this trend will last forever.

0 0ReportSpamgkp bau1 hour agodopes... big oil does not control the price of oil. OPEC does . 0 1ReportSpamFactsandLogic1 hour agoewent, I really have no words for you other than your understanding of business and economics is less than that possesed by a snail. God, help us, as you are not alone in your stupidity and ignorance. Idiots will not stop until they ahve distory every entity producing goods and services and national wealth. ANd then they will look around at their pitiful nation and pitiful lives and still blame the gooses that were the engine of their prosperity. 2 5ReportSpamFactsandLogic2 hours agoWOw, I am in awe. Say it is not true, that we drill cheap oil first and then it steadily gets more expensive the deeper we have to drill. Wow, why did I not think of that! Of course this is true and this is why it is stupid to spend five or ten times the price of oil on wind and solar and algea. Just stupid. When oil gets more and more expensive then other technologies will make sense, but until then why do I want to pay 30 cents a KW for wind power when I can pay 10 cents a KW burning coal? Only if you are stupid is that a good idea. 7 5ReportSpamIce Cold Sangria3 hours ago

Big oil stocks pay big dividends. I'm waiting for March 20 to bottom feed some more shares of Exxon. In the words of Angry Birds: "Weeeeeeee!!"

3 2ReportSpamTimber11173 hours agoI am a Registered Independent But Bill Oreille has been going after Greedy Oil Companies for a long time. And I tend to believe him on this subject Big Oil is Greed driven and is killing the Working Class. My Wife and I drive over 100 miles to work and back,And we have two small cars and it still is hurting us And our kids are gone. I know it must be hurting families with kids still in the home. And the President has said he likes the ideal of 5 dollar gas. May be great for the Environment but its killing the Working Class. 13 4ReportSpamAgemingle. com3 hours agoOh great article ,Age ain't nothing but a number for these loved-up A-Listers. My BF and I both think so! He is almost 10 years older than me .We met via~~--Ａge'Ｍｉｎｇｌｅ .ＣOM~~ a nice place for younger women and oldermen, or older women and younger men, to interact with each other! Maybe you wanna check it out or tell your friendsWhere will they export it? The Middle East, Central and South America don't need it. So that leaves Europe. One problem with that. Will Big Oil reduce their prices to levels that are affordable for Europeans should they manage to pinch that market from OPEC? So, competitively, Europe isn't a good market for exportation either. 0 4ReportSpamewent3 hours ago

American consumers have borne the costs of business expenses for far too long. When you buy gasoline, you should only pay for the gasoline...not Big Oil's exportation costs, overhead or any of the other things it now segregates from what it likes to call "profit". It isn't profit until all of their bills are paid. That's why Americans are getting juiced with predatory pricing for decades.

Profit is only exacted after all expenses are paid. The way today's idiot corporations manage their finances, all "revenue" is "profit". Then, when they spend it as "profit", they find themselves short when it's time to pay their bills. So they dump the bills on consumers using the excuse that "their business costs" have gone up. What a load! Sure their business costs go up when they hand themselves obscene salaries and buy themselves mansions, private jets, etc out of working capital and incoming revenue that leaves nothing left to pay bills.

Thus, in effect, Americans are not just buying a single product or service. They are buying the product or services plus the cost of the business making the offering. Extortional transactional distortion?

Remind yourselves that it isn't now nor ever has been the responsibility of consumers to keep businesses profitable. That's what CEOs are for.

15 13ReportSpamewent3 hours ago

If Americans possess nothing else of greatest value, they possess the most unusual ingenuity. So what if oil runs out? Is that the end for all of us? You bet not. In 30 years from now, gasoline powered vehicles will be the Edsels of energy options. As for Big Oil jacking prices higher, let them. Americans will run in droves to other sources of energy that now have a proven track record of success. And what's to stop one of our younger engineering and chemical engineering geniuses from coming up with a far more resourceful form of energy in the next decade?

Sometimes when a bully monopoly industry thinks they have American consumers boxed into a corner, that's when Americans are at their most ingenious best at finding options of survival. Change is the vein that channels the lifeblood of this country in the most effective, innovative way.

If we fall prey to the veils the oil monopoly has thrown over all of us, we cannot possibly hope to see our options.

10 4ReportSpamWhoopityDUE3 hours ago

Mike Bris two posts on the money. Buffet says all cars electric in 20 years....back in a speech at Rice University in 2009. I would say he has better insight than Mr. Jubak with all due respect.

The tar sands and shale oil has been known about for decades. An oil patch friend of mine who has been in the biz for +30 years laughs when he reads people stating they were just "discovered". The technology (fracking) has even been around for decades and used on occasion in my area. The oil price has finally risen to a level where the cost of production is outweighed by the revenue stream. That is why these lesser quality sources of oil are being utilized. The reason price has risen is the low hanging fruit has all been picked. Lack of low hanging fruit has made it now a necessity to purchase ladders to reach the high up, harder to extract fruit. Some fruit in a tree can never be extracted just as oil. The fact the hardest to extract and refine oil is now being consumed is a blazing sign the fruit tree is about to be picked clean just as the world populations are booming. Don't forget the amazing rate at which the Chinese and Indians are trading in bicycles for cars creating even greater demand for the shrinking oil resources. This will speed up the rate at which it is exhausted.

Buffet hasn't become rich by being a fool. Cars, electricity, 2030.

9 3ReportSpamewent3 hours ago

From an investment point of view, Big Oil saw its most profitable days when it began to export US Oil. This is the covert agenda they are after again. Their idea is to revisit the ability to produce so much oil that it can export at huge profits. One question remains: Where will they export it? The Middle East, Central and South America don't need it. So that leaves Europe. One problem with that. Will Big Oil reduce their prices to levels that are affordable for Europeans should they manage to pinch that market from OPEC? So, competitively, Europe isn't a good market for exportation either.

Then, there's the little matter of a reduction in demand in the US. Of course, Big Oil was thrilled when Detroit was producing millions of gas guzzlers. Big Oil profited most from that stupidity. But like all greedy monopolies, it jacked the price of gasoline and then the recession took away all of their well planned profit busting ideas.

Enter hybrids, smartcars, electric and natural gas powered cars....Big Oil's worst nightmare. Now, even major transit vehicles are already off the oil addiction. That leaves only the airline industry from which to profit. Giving American consumers such options for alternatives to oil is their real nightmare. Now, if Big Oil thinks it can continue its predatory price gouging, all that will do is make even more American consumers run to the alternatives. While Big Oil runs for the Kaopectate.

6 2ReportSpamewent4 hours ago

When you are more than 5 decades old in age, you begin to see profit patterns far more clearly. So..in almost a century, Big Oil had a Black Gold Rush. They could fudge numbers and tell us oil is going to run out due to demand and up went the price of oil. Or, even better, they could at present use the excuse that oil production is down and up go the prices. Either way, their obscene profits still roll in...whether demand is too high or too low.

The problem for Big Oil today is as stated in this diatribe "finding new oil"...Is that the problem? Or, is it that Big Oil wants to expand drilling rights because it regularly receives billions in taxpayer subsidies. Kind of makes sense when your profits are what you'd like them to be that jacking oil prices and then helping themselves to taxpayer subsidies based upon a flimsy excuse that they need to "find more oil" would be an adorable way to reach their peak profit margins.

So...now, of course, the US government (read taxpayers) once again must help a corporation do what it's supposed to do on its own steam: earn profits. Let's see how fast Big Oil cronies in Congress jump on the "find more oil" bandwagon and pass legislation that will further increase US debt just so those Big Oil subsidies keep rolling in.

7 1ReportSpamJonnyboiler4 hours agoIt's no mystery that we have no foresight or ability to plan for the future in this country. The leadership of our country can't see past the next election. Also people can't seem to comprehend things they've never experienced. The volume of the earth is finite, just like the volume of any other sphere. It's actually pretty easy to calculate if you've had a geometry class. Most of this sphere we call home is filled with iron and rock. It's stupid to think that somehow a finite volume holds an infinite amount of oil. Eventually oil will either run out or become too expensive as an energy source. What are we going to do when that happens? Other countries are much better equipped to deal with it when it does happen, but our way of life will quickly grind to a halt. We need to demand of our leaders that they plan for the future and not just in matters of oil. 15 2ReportSpam_Cygnus4 hours agoSome other writer(maybe here on MSN), said that we are experiencing peak oil in conventional, cheap oil but not in non-conventional, expensive oil. We will always have oil as long as we are willing to pay whatever the going rate is.IMO, the real foreseeable problem is at what point does oil get so expensive, that it is not worth to use it as an energy source anymore? What impact will that have on the global economy and to living standards? I believe the high oil prices has already hurt the global economy to some degree. 7 0ReportSpamSomeone (CKTVT)4 hours ago

Jim,

I tried to post a second comment but your filter blocked me, claiming that it looked like spam or a hyperlink. I've tried every modification I can think of to get past your gatekeepers but to no avail. Trust me, my post only looks like spam or a hyperlink to a very dumb algorithm. Please ask your techies to upgrade the filtering algorithm.

4 1ReportSpamloving ok5 hours agoF big oil. Buy a Telsa model S, and install solar panels on your roof. So many tax incentives right now they almost pay for themselves. And no this isn't an ad but my honest to God plan for 2013. In IL you get about 60% of it as a non-refundable tax rebate plus other property tax benefits. Most states have their plans, find yours. 11 9ReportSpamSomeone (CKTVT)5 hours agoThe question has never been "When will we run out of oil (and gas and coal)?" I say this because these fuels will always be extractable at some price. The real question has always been "How fast will the cost of fossil fuels rise in the coming decades?" In the age of fracking, oils sands, and shale, the answer seems to be "Not as fast as we once thought, and probably not fast enough to be a genuine threat to the world economy". I think a more important question today is "Will the sustained abundance of reasonably-priced fossil fuels lead us to wreck our natural envoronment because it represents the path of least resistance?" 17 2ReportSpamraymagnumx5 hours ago

Quoted text:

Now that oil is a long way from the $145 per barrel peak it hit in July 2008.

So let me get this straight....in my area when OIL was $145 the pump price was $4.00 a gallon and now at $100 a barrel I am paying $3.49 a gallon. If my math is correct I should be paying $2.70 a gallon which is .79 cents less. So other than GREED I guess it is safe to say we are all getting the royal screwing at the pump...way to go Government & Wall Street!!!

51 5ReportSpamOn an island5 hours agoGood perspective Jim. The original oil supply and demand models assumed a fixed supply and increasing demand but we always knew that the supply side of the equation was open to modification. Germany taught us that during WW2. Now we have bio fuels and substitute corn for oil and oil stabilizes while food prices jump 10%. The problem is that as investors we can try to predict changes but no one has done anything about the demand side of the equation. Population times technology (usage). This is no longer just a simple capital appreciation model and in 20 years the rules will change dramatically as shortages in food lead to changes in social values (war). One example is the building of the Aswan dam led to an increased need for fertilizer in the Nile delta (since the spring floods no longer fertilized the land), a shortage of food and finally revolution in Egypt. This was predicted 20 years ago by some NASA scientists but never widely published. I would be interested in seeing your perspective on the doubling of Chinese food imports every year. 5 1ReportSpamusual suspects7 hours agoHydrogen is a never ending source of energy. You won't hear much about it until Big Oil owns all the patents. They aren't going out of business quietly. 30 9ReportSpam12 Add a commentReportPlease help us to maintain a healthy and vibrant community by reporting any illegal or inappropriate behavior. If you believe a message violates theCode of Conductplease use this form to notify the moderators. They will investigate your report and take appropriate action. If necessary, they report all illegal activity to the proper authorities.CategoriesSpamChild pornography or exploitationProfanity, vulgarity or obscenityCopyright infringementHarassment or threatThreats of suicideOtherAdditional comments(optional) 100 character limitAre you sure you want to delete this comment?/**/ DATA PROVIDERS

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But to see how useful a peak oil model can be to an investor, look at the latest quarterly results from the big international oil companies.

Let's start with Royal Dutch Shell (RDS.B, news).

Continued on the next page. Stocks mentioned include: Pioneer Natural Resources (PXD, news), National Oilwell Varco (NOV, news) and Ensco (ESV, news).

Is The Peak Oil Theory Really Dead?

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