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By Robert Rapier on Apr 23, 2006 with no responses

Peak Lite

Is Peak Oil upon us? This opinion seem to be gaining in popularity due to the recent price spikes in crude oil and gasoline. Many feel that the markets are signaling that the peak is here.

I have previously written several articles about the rise in gasoline prices. Gasoline prices are increasing due to a number of factors, including rising oil prices. However, the principal reason for rising gasoline prices is falling gasoline inventories, which have been exacerbated this year by some refineries still being off line due to damage from Hurricane Katrina.

Oil prices are a different matter. There are certainly some supply/demand issues, in that there is less excess capacity than there used to be. Geopolitical events have a greater influence than ever on worldwide oil prices due to the tight supply/demand issue. There is a major fear premium built into the price of oil right now, particularly due to uncertainty over Iran. Another factor affecting oil prices is increased speculation. A number of economists are suggesting that the price is higher than market fundamentals would dictate:

Economists at TD Bank Financial Group are warning that oil and base metal prices are ripe for a 20-per-cent correction later this year.

The authors of the current TD Economics commodity price report say the recent buying wave is due more to speculation than to market fundamentals.

Speculation in oil and gold, they write, has been led by geopolitical worries. In base metals, the report authors say, the speculative frenzy has been driven by little more than momentum.

The co-authors say the pull back will be triggered by signs that U.S. economic growth is slowing, which they say should happen by the end of the summer.

“In the meantime, we don’t rule out further speculative activity driving prices even higher,” they wrote. (1)

Ron Scherer reports in The Christian Science Monitor (2):

“Almost everyday it seems some pension fund is dedicating a portion of its assets to invest in a commodity index,” says John Kilduff, an oil trader at FIMAT, USA. “And, energy dominates most of these indexes.”

Since 2004, Mr. Kilduff says some $125 billion has been directed into these funds. As the investment pool grows, the financial institutions running them buy futures contracts. “It causes more participation, it helps to push up prices,” says Kilduff.

The same report indicates that it is not a shortage of oil that is driving oil prices higher:

“I think we’re due for a pause here,” says Mark Routt, of Energy Security Analysis Inc. in Wakefield, Mass. “All the bad news you can think of is in the market, and here we are.”

OPEC members have offered oil companies extra deliveries but have been turned down – an indication that there is plenty of crude oil available, Mr. Routt says. In addition, he points out that the current quarter is usually the low point in demand for crude oil. Refineries are busy conducting maintenance or shifting over to the summer blends of gasoline.

This opinion is also consistent with what I know about spare capacity in various areas. Producers are shutting in production in the Williston Basin due to low prices. (3) There is spare capacity in Canada, primarily due to pipeline limitations and bottlenecks in downstream refineries. Kuwait is reportedly offering to release another 2 million barrels a day if OPEC agrees. (4)

Nationwide, crude oil inventories are still hovering near an 8-year high, far above the average for this time of year:

Source: This Week In Petroleum at http://www.eia.doe.gov/

My point here is to argue that the current spiking prices do not signal a true Hubbert Peak, but are instead due to other factors. Someone asked me yesterday why it matters exactly when the Hubbert Peak occurs. Here was my answer:

Here is why I think it matters. If everyone calls for a peak this year, and production increases, what do you think the public is going to do the next time everyone calls for a peak? What I worry about is that premature calls of peak will cause the public to ignore it when it is very clear that a peak is imminent.

You are correct, in that it won’t matter much if peak is 3 years from now and people are calling for a peak this year. But if the peak is really 10 years away, and this is apparent in 3 years, we have some time to start preparing. But if we start warning people in 3 years, it is going to be hard to get their attention when they say “Didn’t you call for a peak in 2006?” That’s already happening to Deffeyes and Campbell. A lot of people have stopped taking them seriously.

I am primarily concerned about loss of credibility by false predictions of a peak. This is too important an issue to have the public ignore warnings of a peak, but this is exactly what’s going to happen if people keep saying “The peak is now”, only to retract again and again. On the other hand, I understand the flip-side. We certainly don’t want to say “The peak is in 20 years”, if the peak is in fact in 2 years. What we have to be certain of is that when we are making peak forecasts, we are not ignoring important pieces of data that will cause those forecasts to be off.

The argument over the timing of the peak may be merely academic. If Peak Oil occurs in 2010, it isn’t going to matter much that a lot of people were calling it in 2006. But if the peak will actually be in the 2015-2020 range, the debate over timing becomes more important. If we call a peak in 2006, and then another in 2008, combined with failed predictions in 2000 and 2003 (5), we will approach peak with an understandable level of public skepticism over the matter. This will make it much harder to convince the public and the government of the need to take serious steps aimed at mitigation.

Peak Preview

A more pressing matter may push the debate over the timing of the Hubbert Peak to the sidelines. I do believe that oil production will continue to increase for several more years. However, oil production has been increasing for the past 3 years (from 77 million barrels a day to over 84 million barrels a day), yet prices have climbed from less than $30 to over $70 a barrel. The reason for this is that spare production capacity has vanished because new production has not been brought online as fast as demand has grown.

To me, this is the real story. It’s like we are worried about starving to death (Peak Oil) in a few years, but we didn’t consider that the food we are consuming may already be insufficient to sustain us. If population grows faster than food production, people will starve even though food production may be growing. That’s the situation I see with petroleum right now. We don’t have to forecast a supply/demand imbalance. It is here. Strong demand growth in China and India ensures that this problem will not be going away anytime soon, and will probably be the reality right up until production actually does peak.

What does this mean? For all practical purposes, if my hypothesis is correct, the early effects of Peak Oil have arrived, without a true production peak. I think of this as “Peak Lite”, or a “Peak Preview” of things to come. As long as demand growth continues to outpace new production, it will have almost the same effect as a true decline in production. Prices will stay very high. The biggest difference is that Cornucopians may continue to point to increasing production as a sign that we don’t yet have anything to worry about. Meanwhile, prices will probably continue to trend higher (long-term; corrections can and do happen) which will put pressure on personal budgets, governments, businesses, and the economy as a whole. In reality, barring a worldwide recession, Peak Oil is here, it just doesn’t look like you expect it to. It reflects an inability to secure the energy supplies you need to keep economies growing. It means that rationing is here, but it will be rationing by price (at least in the beginning).

References

1. “Commodity price correction coming, TD Bank economists warn.”Yahoo Canada News, April 19, 2006.

2. “Why so high? Oil markets riding new currents.” The Christian Science Monitor, April 19, 2006.

3. “Regional oil prices drop off.” Billings Gazette, March 11, 2006.

4. “Survey: Gas up 25 cents in two weeks.” CNN.com, March 23, 2006.

5. The Many Wrong Predictions of Ken Deffeyes.