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Why the coming oil crisis will last

CBS Editor's note: This is the second in a three-part series on oil by MarketWatch columnist Paul Erdman. See Part 1

HEALDSBURG, Calif. (CBS.MW) -- Before considering the effect of surging global demand for energy on the price of crude, I would like to discuss the potential structural change in the supply of oil.

This change will have deep-seated implications beyond the cyclical supply/demand crisis we are experiencing at present.

In 1956, M. King Hubbert, an American geophysicist working at the Shell Oil research laboratory in Houston, came up with a startling prediction: Oil production in the United States would peak in the early 1970s, signaling the beginning of an irreversible decline in the domestic output of crude petroleum. This event would be merely the precursor of a peaking out of oil production on a global scale, signaling the onset of the end of the Age of Oil.

Almost every energy expert on earth rejected this thesis out of hand -- until the early 1970s when, indeed, exactly that happened. Output of crude oil in this country peaked in the year 1970, and it has been falling ever since.

This event has since become known in industry circles as "Hubbert's Peak." Despite its fundamental significance where the future of our oil-based economy was concerned, for decades it turned out to be a scientific thesis that remained generally unknown. For those who had heard of it, it was derided as just another of those crackpot "end of the world as we have come to know and love it" theories that are usually espoused by gold bugs or other doomsday prophets of the same ilk.

That has now changed. Its acceptance by the academic world is evidenced by the recent publication of two books dealing with this subject:

* "Hubbert's Peak: The Impending World Oil Shortage" by Kenneth. S. Deffeyes, professor emeritus at Princeton University and a former colleague of Hubbert at Shell.
* "Out of Gas: The End of Age of Oil" by David Goldstein, vice provost and professor of physics at the California Institute of Technology.

These scientists have applied the same methodology developed by Hubbert in his analysis of the outlook for American crude oil output to world oil production. They have come to the conclusion that global output of crude oil now also is on the verge of peaking out and that when this happens, contrary to all expectations, the amount of crude of oil flowing into the world market will most probably begin fall by somewhere between 5 and 10 percent annually.

This conclusion runs contrary to all previously held expectations, for two reasons:

1. It was assumed that rapid new discoveries of oil reserves would continue well into the 21st century, ensuring that the future supply of oil would continue to stay well ahead of demand, just as it had during the entire 20th century.

2. Aside from the impact of new discoveries, given the amount of crude petroleum known to have been in the ground when we first started to pump it -- roughly 2 trillion barrels -- were we to continue to pump oil and consume it at the rate we are doing now, we will not have pumped the last drop for at least another 40 years. And it is only at that point where the so-called supply crisis will occur.

Those who subscribe to Hubbert's theory tell us that both of these expectations are dead wrong:

1. As regards new discoveries, they point out that the last great oil field, the Ghawar field in Saudi Arabia with reserves of 87 billion barrels, was discovered 45 years ago. Since then geologists have scoured the earth searching for major new fields -- to no avail. The largest remaining unexplored area is the South China Sea, which is considered by geologists to be promising but not spectacular.

But as Goldstein points out: "Let us suppose for one euphoric moment that one more really big one is still out there to be discovered. Even if we were to stumble onto another 90-billion barrels field tomorrow (the equivalent of another Ghawar field) Hubbert's Peak would be delayed by a year or two, well within the uncertainty of the present estimates of when it will occur. It would hardly make any difference at all."

2. Regarding timing, the bell shape of the history of crude oil output dictates that the supply crisis will begin in earnest not when the last drop of oil has been pumped out of the ground sometime in the hazy future, but rather when we have used up half the oil that existed, not all of it. Once we have reached that halfway point, existing oil fields will start to become exhausted faster than the new oil fields can be tapped. The rate at which oil can be pumped out of the ground will then start to decline.

This, as Goldstein points out. is the essence of the bell-shaped curve hypothesis. There is a growing consensus that the crucial turning point in output will probably occur in the second half of this decade, in or around 2007.

The crucial remaining question is: how fast will the gap then grow between supply and demand? All other things being equal, the decline side of the curve will be a mirror image of the initial increase. But of course there will be mitigating factors, such as energy conservation measures or the development of substitutes to oil as a primary energy source, ranging from hydrogen to nuclear to solar.

But the odds seem overwhelming that none of this will happen in time to head off an energy crisis that will dwarf anything we have ever experienced.

CBS Editor's note: The author of this series has equity positions in three major international oil companies: ChevronTexaco, ConocoPhillips, and ExxonMobil.

Economist and author Paul Erdman is a columnist.

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