The SMH has a beginner’s introduction to peak oil, claiming geological limits “don’t matter” because economic limits kick in first – Why peak oil doesn’t matter.
There’s only one reason why you’d invest in the oil and gas sector; because you’re confident that, over the long term, the price of oil is going to rise.
In this piece, and the two that will follow, I’ll take you through the key points of that argument, starting with the fashionable “peak oil” theory.
In 1956 the delightfully named Marion King Hubbert, a Shell geologist, predicted that by the 1970s US oil production would peak. He was labelled a madman.
For almost a century the US had been one of the world’s largest oil producers and conventional wisdom held that there was plenty of oil left. That view was proved wrong and “Hubbert’s Peak” did in fact come to pass. Since the early 1970s US production has declined by almost 50 per cent (see chart).
Peak oil theory takes Hubbert’s hypothesis and applies it to global oil production, suggesting that worldwide oil production will rapidly decline following its peak, thought to be around 2010.
Geologically speaking, this makes perfect sense. Oil fields that perform splendidly in their early stages will progressively deteriorate as they age. But in an economic sense, the marginal cost of oil production trumps peak oil theory every time. And this forms the crux of the argument for higher oil prices.
As more hydrocarbons are taken from a reservoir, extraction rates deteriorate. A geological rule of thumb is that the average field will naturally decline by about 5 per cent a year, caused by a combination of deteriorating pressure, increasing levels of water production, or damage to the reservoir rocks.
A large proportion – up to 50 per cent or more – of the original oil resource cannot be profitably extracted because it’s simply too expensive to get the stuff out. Long before geological limits are imposed on oil production via peak oil, economic limits kick in.