Editorial Commentary
No Peaks Without Valleys --- The price of oil follows a well-trod path
By Thomas G. Donlan
500 words
21 August 2006
Barron's
W35
English
(c) 2006 Dow Jones & Company, Inc.

In 1956, geologist M. King Hubbert predicted that the U.S. would hit peak oil production in 1970. He was right. No matter how fast wildcatters have found new reserves or producers have drilled wells, new supplies have not offset declining production from older wells.

Hubbert died in 1989, but his followers now make the same prediction about world oil production: Between 2004 and 2030, the world has reached, or will reach, the peak, and no amount of furious searching will ever replace all the wells that are running dry.

There's a lesson here, but not the one that oil prognosticators offer. The lesson is not to ask geologists about economics. Hubbert's prophecy holds only as long as the price of oil defines the supply.

We have no idea how much oil there is still to be found. What we do know is that the more that oil prices rise, the more oil will be produced. Furthermore, the more oil that is produced, the more likely it is that prices will fall.

A quick look around the world finds undefined oil in many places. Venezuela has more oil than Saudi Arabia, if you count its ultra-heavy crude and tar sands. Canada has more than Saudi Arabia, if you count its tar sands. The U.S. has more than Saudi Arabia twice over, if you count its oil shale and coal, which could be converted to gasoline and diesel fuel.

Price is the problem, not geology. At the $20 per barrel average market price (adjusted for inflation) that has prevailed for decades and determined what oil can be produced at a long-term profit, tar sands, oil shale and coal conversion have not looked like good investments. It costs too much to build the extraction industry and rebuild the refining industry, so these resources aren't counted as reserves.

Once upon a time, however, it cost too much to drill in a far-off desert and build a fleet of supertankers to carry the oil to customers. Once upon a time, it cost too much to drill offshore and build underwater pipelines to carry the oil to customers. Then, when some critical oil field in Pennsylvania or Texas reached peak production and market prices rose, the required investments suddenly made sense. Once the industry adapted to the new definition of producible oil, the new supplies supported by new infrastructure overwhelmed the market and the price fell back to that inflation-adjusted average of about $20.

We can't tell how high the price of oil has to go this time, but we should be nearly certain that the process of boom and bust will prevail at least once more.

Oil at $70 means oil at $20 eventually.

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