Some questions about Peak Oil from a reader. And by the way, while we don't always have space to publish your questions and comments in the e-mail edition of the Daily Reckoning, there is plenty of room in the comments section under any post on the website. You can respond directly to other readers, too. Here's a question:
"Are we really running out of oil? Greg Palast discusses this at length in 'Armed Madhouse' and I'm inclined to agree with his assessment. We are running out of "cheap" oil i.e. it don't [sic] cost much to pull it out of the ground but at the same time the high price of oil has made the harder-to-get-at oil economically viable and profitable. Enter Venezuela with 1.36 trillion barrels of heavy oil that is now worth pulling up not to mention Canada with significant oil reserves in tar sands. It's not a supply problem in the sense that the Earth is running on empty. It's a supply problem in the sense that production is limited in the pursuit of higher prices. Oil reserves are a measure of oil you can pull up at a certain price, the higher the price the greater the level of world reserves. At US$15 a barrel oil reserves are small indeed. At US$70 it's a whole new ballgame."
We sense some circularity in this logic. Do oil reserves really expand as oil prices go up? Well, rising prices do make previous projects economically viable. Projects with high costs make more economic sense when you can sell the finished product for more. But here's an important point: the total energy return on energy invested tends to get much lower in the further you get away from high quality high oil reserves.
The real issue is that most of the high-quality cheap oil that's powered the world for the last 50 years has already been produced. "Peak Oil" doesn't mean the world is going to run out of oil. That will never happen. But oil will cease being the cheap, abundant, dominant fuel of the industrial world.
Peak Oil really means the cost of energy as an economic input is going to rise for a very long time as the world struggles to produce more and more oil from more remote and costly locations. High prices are not a sign of impending abundance. They are a sign of economic scarcity. They are also, of course, a sign of emerging opportunity for other fuels and energy technologies that can replace the work oil does.
"Dear Editor,
"It was with fascination that I read your newsletter and contrarian views. Pardon my ignorance, but all this money supply and high asset prices... and the printing of money... what sort of things could happen that stop this merry go around?
"What are the potential shocks? My concern is that for those of us that are getting wiser reading your email, what do we do? Stay in cash? We do not want to miss out on the boom either? If you have the time, your reply will be most appreciated."
Ah yes, a great series of questions. Those are the ones that keep us up at night, too. That and our brother's 5-year old African grey parrot named Albert.
Two things happen at the end of every bubble: credit tightens...and investors return to their senses.
The re-rating of subprime risk has the potential to return investors to their senses AND tighten the availability of global credit, all at the same time. That's why markets are so nervous about it.
In the broader sense, the decline of the world's reserve currency means massive falls in dollar-denominated stocks and bonds. Just what will happen to cash, precious metals, and the stocks of firms that produce tangible assets...is unknown. That's why it's worth reckoning every day. More on this next week.
More mail. And by the way, we're happy to publish the critical e- mails too. We just haven't been getting many of them lately. All you malcontents out there, don't be so shy.
"Dear Sir,
"I just subscribed to your fantastic comprehensive and eye opening truly "The Daily Reckoning" just a few days ago and I really loving it. [Thanks. Glad to hear it.] One question: if the demand in China drops once a major slow down occurs in US, which is possible considering what is going on with their housing market, then what do you think would happen to Australia which is supplying the raw material such as iron that you have talked about just recently? By the way do you see a come back for US dollar or is this time it is the real crunch time and there she goes?
"Regards, Tony B."
A big picture question. In the larger historical scheme of things, the age of American economic ascendance is over. That is, America can no longer afford to be the engine of global growth. The US economy has been red-lining it on debt for far too long.
Who will replace the American consumer as the chief source of global demand? Well, no one is ready to step in and take that role right now. The Euro is enjoying a great run because investors correctly identify Europe as a high-savings, decent-growth region to own while the greenback implodes. But the next 50 years belong to the Far East.
Eventually, the great source of new consumer demand in the world lies in the Middle Kingdom and India. Right now, all the investment opportunities from Asia's rise are in resource-intensive industries and infrastructure. This explains Australia's golden age. In the next few years, you'll see a gradual shift to retail and consumer opportunities in Asia's vast domestic markets. It will be time to buy Chinese stocks. And the next Warren Buffett will spend his time sifting through the 7,000 publicly listed companies in India, 6,500 of which are covered by one analyst at the most, and usually none at all.
But before that happens, the whole global economic growth model has to reorient itself away from America. Asia has to stop gearing its currency and growth strategies through exports to the United States. That's been an extremely useful and profitable strategy, however, for the last 50 years. No one is going to change until they are forced to. The dollar's steady deterioration is doing the forcing.
Don't expect a seamless transition, though. Imagine changing the engine in your car while going full speed down the free way. You couldn't do it. There would be a wreck and all sorts of twisted metal.
Dan Denning
The Daily Reckoning Australia
P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.
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About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
Comment by B.K. on 13 July 2007:
You make some relevant points regarding the cost of producing (extracting) oil.
One important point you didn't touch on was ERoEI (Energy Returned on Energy Invested). Simply stated, it takes oil energy to find, extract, transport and refine oil. In the early days of Texas oil all one had to do was introduce a drill bit to an easily accessible oil field and whoosh! out came the oil - often in a 'gusher'. The returns in those instances might be as much as 100:1, i.e. for every barrel of oil energy spent searching you got 100 barrels out.
Nowadays in the North Sea the ERoEI is estimated at more like 15:1 - so still quite positive but not as nice as the good old days. With resources such as Athabasca tar sands in Canada the ERoEI was actually negative for a long time. So in addition to the phenomenal economic and environmental expense it was actually spending more oil than it was producing. This has apparently been turned around now but is still not better than 2:1 from all accounts.
Biofuels and hydrogen are generally calculated to be net energy losers - it takes more oil energy inputs in the whole process than the energy that is produced. Only government subsidies make it all profitable.
So in summary, once you have reached a point where your ERoEI is approaching 1:1 no matter what the price of oil is, you might as well sit around on your hands as spend your time and effort searching, drilling and producing the resource. Of course with government subsidies etc. it could still be profitable, however, to continue producing after that point will actually be using up the oil faster. Witness the major oil companies acquiring smaller companies and buying back their own shares whilst winding back exploration. They understand ERoEI and the impact on their profits when it falls.
Comment by Rod Campbell-Ross on 13 July 2007:
Oil consumption is about flows, not reserves. You could have reserves the size of the moon, but if they only can be produced at 100,000 barrels per day, that is all they are woirth. The tar sands of Canada may be called "oilsands" but that doesn't change the fact that it is tar. And tar doesn't flow very well.
For several reasons its production will never exceed 3m barrels per day.
The story in Venezuela is similar.
Schlumberger say that oil flows from existing fields will decline by 24m barrels per day by 2010. It is not clear from where this decline will be replaced. Some will be replaced of course, but there is a real danger of shortfall.
The IEA has done the same sums and is alarmed. That was the point of the report they issued this week.
It is time to to do something, that is for sure. Panic would be understandable, but wouldn't help. Our pathetic excuse for a government hasn't even recognized that there is a problem let alone worked out what to do.
Comment by Randy Park on 13 July 2007:
I echo all the above regarding peak oil. Further, to those who say "don't worry, the market will take care of it" - i.e. high prices will bring supply and demand into line - the question is "how high?"
Here is some insight. At the AFRES.org web site there is a Gasoline Price Calculator where you enter the parameters a typical trip such as a commute, your transit alternative, and what you value your time at. It calculates what you should rationally pay for gas. The median response is 8 times current prices, or about $24 per gallon.
Further evidence? Gas prices and gas consumption BOTH going up. Gasoline does not work like a normal good...
Comment by Dave on 14 July 2007:
I think too much is made of the return on energy investment. For example, right now they're considering building a nuclear plant in Alberta to power their mining operations.
The point is, your return on energy can be less than 1 (you're using more energy to produce the oil than the oil provides), and the operation can *still* be profitable. And this is without subsidies.
The profit results because gasoline is portable, and electricity isn't. If we all had infinitely long extension cords for our cars, or affordable + durable + compact batteries, this wouldn't make sense.
But batteries are currently so expensive that it's still cheaper to use gasoline, even if RoEI