National Commentary

The Peak Oil Crisis: A Steepening Slope

Thus far, last week’s OPEC production cut of 1.5 million barrels a day (b/d) has done little to stem the slide in oil prices.

Immediately after the cut, prices went down another $4 on the theory that the cut was too small. OPEC of course is trying to maximize its revenue in real dollars. If they cut oil production more slowly than world demand slows then oil prices will continue to slide and revenues will go down. If they can agree on more substantial cuts, then they will almost certainly drive prices back up hurting demand and eventually setting off a round of inflation that will reduce the value of their revenue. For OPEC, it is a tough call.

At the minute, the oil and other commodity markets seem seized with the notion that a rip-roaring, world engulfing depression is on the way that will demolish oil consumption. People are actually starting to talk about oil falling all the way to $20 a barrel again. Is this likely or even remotely possible?

Start with the International Energy Agency, which is still forecasting that worldwide demand for oil will grow during 2008 and 2009. They have of course reduced their growth estimates in the last six months, but they still are talking about actual growth in world consumption – not declines.

In thinking about who might slow their use of oil in the world these days, let’s start with the oil exporting countries as this is where consumption has been growing the fastest. Most of these sell their oil products domestically at discounts, some substantial, to world prices. Their foreign exchange earnings are obviously hurting from much lower prices at the minute and they are starting to talk about slowing economic development projects, but there certainly has been no sign of lower domestic consumption for now.

Oil consumption is so ubiquitous today that, somewhere, oil is used by people in all walks of life – from multi-billionaires to those who are just getting by. As hard economic times descend, it is obvious that people at the bottom of the economic scale will stop consuming oil first. Reduced consumption then will climb right on up through the several billion of us who are at least moderate oil consumers until we get to those who are so rich there is almost no price that would force them to lower their consumption.

Where do we find lots of people who are not particularly well off, are likely to be hit hard by the coming economic problems and who use lots of oil? The answer, of course, is in North America where we consume on the order of 1,000 gallons per capita per year largely because most of the transportation is by automobile. While the rest of the world drives private cars too, they are more likely to be in economically stronger hands, get much better mileage, and are not driven very far. Thus it is not surprising that in the last 12 months of increasing economic difficulties and much higher gasoline prices, consumption of gasoline, diesel, and jet fuel fell by nearly nine percent in the U.S. while consumption in the rest of the OECD countries where they consume about half the oil per capita as in the U.S., consumption was basically flat.

Another place where oil products, especially kerosene and propane, are consumed by relatively poor people is for daily cooking fuel across the underdeveloped world. While this fuel is nearly essential to sustaining life once one is trapped inside a city, in most cases, it is subsidized by the national government and is not consumed in particularly large quantities per capita. There are, of course, millions of small gasoline-powered bicycles and scooters across the world, but most are using small amounts of subsidized fuel.

The message here is that as oil prices drop, it is not at all clear that there will be large reductions in the demand for oil products – at least until the economic situation becomes far more precarious. Discretionary driving such as lengthy motorized vacations and aimless driving by teenagers seems to have declined in the U.S. in recent months. There has been some reduction in the transport of goods due to the weakening economy. We may however be deceiving ourselves that oil consumption is going to drop precipitously in the near future. Oil has become so ingrained in our lifestyles and economies that it may take months or even years of harsh economic conditions before we see significant drops in worldwide demand.

The other side of the coin is oil production. Hardly a day goes by now without a report of some major oil development project being cancelled or placed on hold due to high costs and the unavailability of capital. While these delays may have little immediate impact, a few years down the line the results will be disastrous as world oil production will be declining very rapidly.

Always keep in mind the basic proposition of peak oil that the world is still burning oil at the rate of 31 billion barrels a year. Seventy five million barrels a day are coming from currently producing fields that with each passing year will produce anywhere from 4 to 8 percent less oil. It is simple arithmetic to show that with current production declining, fewer new oil producing projects under construction, and major declines in demand a dubious proposition, shortages are in the offing. Thanks to the worsening economic situation the effects of declining oil production – much higher prices and shortages – look to be even closer and more severe than before the financial crisis emerged. Falling prices at the gas pumps are only a temporary distraction: the real troubles are getting closer all the time.