Peak Oil: Objects in Mirror May Be Closer Than They Appear

by Richard T. Stuebi

One of my favorite PowerPoint slides about the peak oil phenomenon comes from the dearly-departed Matt Simmons.  The slide depicted a mountain peak in an automobile rearview mirror, the implication being that we would only know for sure when peak oil production has been achieved after it has been achieved and followed by the inevitable decline.

Over the past decade, there has been a lot of debate as to when the date of peak oil would occur.  (It is worth noting that most of the argument has been about when, not whether, peak oil would occur.  Some of the more optimistic forecasters, such as Cambridge Energy Research Associates, have consistently projected peak oil a few decades out.  Some of the more pessimistic observers, such as long-time oilman Simmons himself, worried that peak oil would come much sooner, perhaps within a few years.

Now, according to a new parsing of the data in the World Energy Outlook 2010 by the International Energy Agency (IEA), it might be that peak oil production actually occurred in 2006 at about 70 million barrels per day.  This is a big shift from the IEA’s prior analysis in 2008, in which it projected that conventional oil production would slowly climb for decades to come.

To be clear, there is a bit of semantics at work here.  “Conventional” oil production represents black crude coming out of the ground in liquid form via wells, and that type of oil production may have peaked.  For sure, it’s getting harder to get:  big finds of conventional oil these days are the exclusive domain of multi-billion dollar big oil companies, working in the deepest places in the remotest places on the globe.

But, as you might have guessed by now, demand for transportation fuels (which historically are derived almost solely from oil) hasn’t peaked.  So, what’s backfilling the decline in conventional oil production?  Unconventional oil production – primarily tar sands from places like Alberta, and to a lesser extent natural gas liquids and (maybe more in the future?) coal-to-liquids – and biofuels are making up the difference.

What can declining conventional oil production mean?  For sure, it can only mean upward pressure on crude oil prices.  It also means that alternatives for crude oil in transportation markets become more economically appealing and more widely utilized.

However, the economics and availability of substitutes for conventional oil remains a great concern.  According to a recent study published in Environmental Science and Technology by researchers at the University of California, Davis, the stock market is projecting that the substitutes will not be economically-viable in large quantities at anywhere near the pace that they may be demanded.

Of course, the stock market is not a perfect predictor of anything.  However, if one accepts that the stock market reflects an incredible quantity of information processed by many very sophisticated market participants and further that on average stock prices are properly valued, the findings suggest that the market in aggregate isn’t seeing any huge near-term opportunities to replace oil in a major way.

If peak oil has indeed already occurred and if alternatives aren’t at the ready at competitive price points in meaningful volumes, then it is almost a virtual certainty that we will see some combination of significantly higher oil prices and/or oil demand destruction through reduced economic activity. 

It’s not a pretty picture staring back at us in the mirror.