The Contrarian View

One of the consultants I used to work with liked to remind workshop attendees of a psychological phenomenon called "availability bias." As he described it, this explained the difficulty most of us face in trying to imagine a world much different from the one we observe today. When the price of oil had dropped into single digits in the late 1990s, few industry leaders could envision it returning to $25/barrel, even though it had been there only eighteen months previously. Now, with oil at $60+, who sees it reverting to $25? Apparently, at least a few people do, and here's a good example, from a blog that takes a view diametrically opposed to the adherents of Peak Oil and other scarcity scenarios.

The argument it makes is sound economics: higher prices should spur innovation and more production, while dampening demand, thus eventually restoring prices to pre-crisis levels. This proposition has history on its side, as the author notes. Things might just turn out that way again this time. However, I think it's important to understand why this argument won't always be true, because of a close relative of our old friend, compound interest. The demand for oil grows the same way that interest compounds in a passbook savings account. The rate of growth may change from year to year, but each year it is applied to the entire previous year's quantity, which includes an increment over the year before, and so on.

That's how oil demand grew from 63 million barrels per day (MBD) in 1980 to 84 MBD today. If consumption continued to grow at 2% per year, then we'd be at 93 MBD in 2010, 113 in 2020, and 138 MBD in 2030. Considering the potential of China and India, it's not hard to imagine this kind of growth for the next 25 years, at least in the abstract. But the result, compared with holding demand steady at current levels, would be incremental consumption over this period of 235 billion barrels. In effect, we'd burn an extra Saudi Arabia. By 2050, growth alone would have consumed almost a trillion additional barrels, which is roughly equal to current global proved oil reserves.

As long the quantity of recoverable oil in the earth's crust is finite, whether it's one trillion barrels or 17 trillion, we can't play this compound growth game forever. At some point, higher prices won't yield more oil, anywhere. If we don't have our alternatives in place at that point--not on the drawing board, but tested, built and ready to go--the dislocations are going to be severe. The only question left is when this will happen, and the reality is that no one can tell you until we are there, not M. King Hubbert, not Matt Simmons, and certainly not me.