Peak Anxiety

It isn't easy to remain agnostic about Peak Oil. Every rise in oil prices above the previous record seems to validate the market's perception about the proximity of a peak in global oil output, and every bit of bad news concerning production serves as an indicator of its approach. The news that Russia's oil output has declined slightly, 1Q'08 vs. 1Q'07, serves as the latest such signpost. That this was a foreseeable consequence of the Russian government's clampdown on aggressive producers such as TNK-BP is either a reasonable interpretation, or entirely beside the point, depending on how ardently one embraces the Peak Oil narrative. The same logic also applies to optimism about the latest Brazilian oil discovery.

A couple of fundamental changes in the dynamics of global oil supply and demand have created a situation in which it is very difficult to tell whether the oil market is dealing with the consequences of geology, or of economics and geopolitics. The April 11, 2008 Oil Market Report from the International Energy Agency includes a useful sidebar discussion on a key aspect of this, the disappearance of a large cushion of global production capacity. As recently as 2002, spare crude capacity stood at around 7 million barrels per day (MBD), or nearly 10% of demand. Today's cushion of around 2 MBD, less than 3% of demand, has been a major factor in higher oil market volatility and prices. In the course of five years, the rapid growth of demand in Asia and the Middle East absorbed 5 MBD of spare capacity, and the constraints on access and the competing demands on the world's engineering and construction capacity make it very difficult to rebuild that margin of comfort. The IEA refers to this as "just-in-time capacity", and it certainly doesn't appear to be in OPEC's interest to shift out of that mode, even if they could.

When I first started blogging on the topic of Peak Oil in 2004, the rationale for this phenomenon was rooted firmly in the geology of oil basins and the statistical distribution of the size, age and decline rates of the world's oil reservoirs. While that still forms the core of the Peak Oil narrative, it has expanded to encompass concerns that I saw then--and still see now--as likely to overwhelm the geological constraints on oil production: limitations on access by oil companies to the most prospective oil geography, including known deposits that are off-limits for geopolitical or environmental reasons; the shifting demographics of the industry, including the maturing and shrinking workforce of the investor-owned oil companies; and the time-lags and capital- and project-management challenges involved with queuing up new production from large conventional and unconventional sources. As a result, the version of Peak Oil that I encounter most frequently, in comments I receive on this blog and in the articles and blogs I read, sums up all these factors to predict an imminent stall-point in the long, upward trajectory of global oil production.

This would be fine and good, if there weren't a fundamental difference in the possible outcomes of the disparate views that have been absorbed into today's notion of Peak Oil. If what we are seeing is the onset of true geological limitations on oil production, with the decline of existing fields beginning to overwhelm the fastest rate at which new--and generally smaller--fields can be brought onstream, then no change in policies, economics or geopolitics will alter the outcome: less oil within a few years than we have today, and prices that will make yesterday's $111/bbl look like a bargain. If, on the other hand, we still have another 10-20 MBD of potential growth before we reach such a point, then OPEC and non-OPEC producers could continue to eke out just enough incremental output each year to keep pace with the growth of demand--expected to add another 1.7 MBD of consumption this year--but without restoring any of the lost spare capacity. That implies continued market volatility and price increases, but without the exponential spikes that would result from permanently stalled global oil output.

Now, why should this distinction be of more than merely academic interest? First, if we are indeed entering the outer suburbs of Peak Oil, then we are about to discover just how tardy we have been in our preparations. Energy efficiency and alternative transportation fuels take time to ramp up, and that interval may last longer than the residual upward trend in oil output can sustain us. Prices would then have to rise by enough to destroy a couple of million barrels per day of existing, rather than potential, demand every year. At the same time, belief in the likelihood of this outcome--whether correct or not--by an increasing number of oil market participants rules out for them the possibility of a drop in oil prices back towards a realistic floor--somewhere around $60/bbl, based on the actual cost of incremental supply--that might otherwise deter unbridled speculation in oil commodities. In other words, whether or not we are truly on the threshold of Peak Oil, the more that people believe we are, the higher oil prices will go, even if that's not justified by the market's fundamentals. Only the passage of time will reveal which interpretation is correct.