Peak Oil Means Much Higher Prices

12/07/2010 3:21 pm EST

Focus: COMMODITIES

Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

Ian Wyatt, chief investment strategist of Global Commodity Investing, writes that crude output has peaked and is destined to fall far short of future demand.

It's official: We've passed the peak in conventional oil production. That's the conclusion of the latest annual World Energy Outlook from the International Energy Agency (IEA).
 
The report didn't set off alarm bells, however. In part, that's because the IEA failed to draw the logical conclusions of what peak oil means for the world. The organization continues to cling to the notion that oil yet to be discovered, coupled with rising production of natural gas liquids and oil from unconventional sources such as Canada's tar sands, will not only make up for the expected 80% decline in conventional crude production between now and 2035, but will also satisfy rising demand.


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The IEA has historically been overly optimistic with its forecasts. In its 2005 outlook, for example, the organization believed that by now oil consumption would have reached 92 million barrels a day and that by 2030 it would climb to 115 mb/d. Now the organization forecasts that oil consumption will climb to only 96 million barrels per day by 2035. And of that total, conventional oil output "reaches an undulating plateau of around 68-69 mb/d by 2020, but never regains its all time peak of 70 mb/d reached in 2006."

The Price Is Wrong
Perhaps the most laughable aspect to the IEA's outlook is its price forecast. It states that recently announced policies to develop alternative energies could make a difference, but fall well short of what is needed for a secure and sustainable energy future. It goes a step further by concluding that the age of cheap oil is over (though it holds out hope that policy action could bring lower prices than would otherwise be the case). Yet despite that statement, it believes the price of crude oil price will only reach $113 per barrel (in year-2009 dollars) in 2035. Such a low-ball estimate is comical when you consider we were at that level a little more than two years ago, when oil demand wasn't all that far above current levels.

As we saw in 2007-2008, even a modest increase in the demand relative to supply can have a powerful impact on prices.

We're also troubled by the IEA's assessment of unconventional oil filling the gap. Whether it's tar sands, natural gas liquids, or biofuels, each has limitations and no combination of them will be a long-term panacea for declining conventional oil production.

Bogged Down in the Tar Sands
Producing one barrel of synthetic crude oil from the Canada's tar sands, for instance, requires mining two tons of sand that must be processed using 250 gallons of water and 1,400 cubic feet of natural gas. In the process, 240 pounds of carbon dioxide will be emitted—three times more than conventional oil production. [Despite those challenges, several tar sands producers, including one recently recommended by Curtis Hesler, are already profitable at current crude prices—Editor.]

And tar sand production has never lived up to supply expectations. The water required alone has already become an issue and simply isn't available in sufficient quantity for a sizeable scaling-up of production. So extracting oil from tar sands is likely to contribute only moderately to the world's future energy needs. And given growing carbon emission concerns, it makes no sense to use clean-burning natural gas to make synthetic crude oil.

Ethanol doesn't scale either. If our nation's entire corn crop were used to make ethanol, it would replace only a small fraction of our current oil consumption. Indeed, using all of the green plants in the US—crops, grasslands and forests—wouldn't come close to doing the job.

Unconventional natural gas locked up in shale deposits is another source or energy people have pinned their hopes on. On the surface, it's easy to see the attractiveness of pursuing shale gas. With oil finds becoming increasingly scarce and largely confined to hard-to-get areas such as the deep waters of the Gulf of Mexico and off the coast of Brazil, natural gas readily being found right in the US would seem to be the answer.

NatGas Glut Could Prove Fleeting  
Unfortunately, shale gas fields tend to play out quickly, with production dropping off by as much as 65% in the first year. Over the long haul, the cost of extracting the gas, in terms of energy required, for water injected and for other resources such as transporting the gas, is likely to be high.

The bottom line is we suspect the topic of peak oil will in the future further permeate the world's consciousness. And the IEA will continue to move closer to sounding the alarm on the implications of peak oil. At some point, hopefully soon, the US will get serious about adopting renewable energy.

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