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May 05, 2008 12:27PM
http://www.sprott.com/pdf/marketsataglance/04_2008.pdf

Peak Oil: Alive and Well

Although it’s been a year and half since we’ve written an article devoted to the Peak Oil/Hubbert’s Peak theory, rest assured we haven’t forgotten about the subject. Quite the contrary, the topic is alive and well and currently playing at a theatre near you. When we first wrote about Peak Oil exactly four years ago (“Slipping and Sliding Down Hubbert’s Peak”, April 2004), there were those who thought we were off our rocker. After all, the price of oil back then was $35 per barrel and, save for a handful of visionaries, the problem of imminently peaking global oil supply was on nobody’s radar screen. How things have changed since then! We believe there is no more compelling vindication of the Peak Oil theory than the situation the world finds itself in currently. Namely, in the midst of a global financial meltdown resulting from the popping of the credit bubble, a recession in the world’s most oil-intensive economy, and housing prices that are falling throughout the world, here we are with oil prices hitting record highs topping $115 per barrel, up $30 in the past three months and almost doubling over the past year. Who would have thunk it? The tie between economic cyclicality and the price of oil seems to have been thrown to the wind.

We believe only Peak Oil can explain this phenomenon, and as such are writing this article as an update to what we’ve already written about in the past, taking into account recent developments. Although there are those who blame high oil prices on a combination of US dollar weakness, geopolitical risk, and speculation, we believe the real problem is one of peaking oil supply. Our main argument, and the argument of those who are expert on the subject, has always been that, at its core, Peak Oil is all about the decline rate of producing conventional oilfields. The reality of decline rates, which we estimate average somewhere around 8% per year for conventional production, impose a mathematically insurmountable hurdle to the prospects for continually rising oil supply. It’s just not in the cards to overcome the loss of 6 million barrels per day of production each and every year when significant discoveries just aren’t there to make up for the shortfall, let alone contribute to rising global production. Peak Oil is set in stone – the question is not if, but when.

We believe, and recent data continues to suggest, that Peak Oil is here and now. For this reason, it comes as no surprise to us that optimistic projections made a few years ago on the future production of key players in the oil market have been way off the mark. Let’s take Russia as the first case in point. Having recently overtaken Saudi Arabia as the world’s largest oil producer, many forecasters have heralded Russia as the non-OPEC saviour of the oil market, with production expected to grow about 3% per year for the next several years. Last week, the International Energy Agency (IEA) reported that Russian oil production in the first quarter of the year fell 1% compared to the first quarter of last year – the first reported decline in 10 years. This represents a 400,000 barrel per day swing from what has been expected which, needless to say, is quite shocking for the oil market. As it turns out, even Russia isn’t immune to the impact of decline rates. The decline in Russian production is largely being attributed to aging Western Siberian oilfields, which are likely to experience (if they aren’t already doing so) the same type of depletion as has already been seen in Prudhoe Bay, the Gulf of Mexico, and the North Sea. According to a Lukoil executive, the Russian oil industry will need $1 trillion of investment over the next 20 years just to maintain current production of 10 million barrels per day. Conclusion: Those who are expecting Russia to save the world from Peak Oil are likely to be greatly disappointed.
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