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The peak oil crisis: On contemplating $100 oil

For the last few days, the press has been full of stories about the possibility of oil reaching $100 a barrel this winter. As prices have been bouncing around in the low $80s for the last couple of weeks, another $20 increase will do it. The theory behind the $100 forecast is that supply and demand is very tight and that China, India and oil-exporting countries are growing their domestic consumption so fast that even if the U.S. goes into a recession the situation will continue to tighten.

Throw in increased interest by speculators, the sagging dollar, soaring coal prices and $100 oil this winter is starting to look like a good bet — even without hurricanes or terrorist attacks. A couple of writers have even noticed that world oil production has not increased for over a year now while demand continues to grow.

Last Saturday, the Wall Street Journal, which for obvious reasons doesn’t take well to the notion that world oil production will soon peak, ran a piece entitled “How the Economy Could Survive Oil at $100 A Barrel.” This front-page story is of interest for several reasons. First is the implication that just perhaps things aren’t going so well down at the old gas station, and just maybe we won’t be back down to $30 oil anytime soon. Maybe there is a need to start thinking about the unthinkable in case it should happen.

Of even more interest is the Journal’s well-caveated conclusion in answer to the question, “How well could the world economy survive $100 a barrel?”

According to the Journal, “The answer is quite well — so long as several conditions still hold true. The price rise would probably have to be gradual. Inflation couldn't get so bad as to force big interest-rate hikes. Oil-rich nations would need to pump their profits back into U.S. and European economies.”

Moreover, showing that they are in touch with reality, the Journal notes that the aforementioned tight oil supplies and weak U.S. dollar suggests that oil prices just might break 1980’s all-time inflation-adjusted high of $101. This in turn could “hit consumer’s pocketbooks — especially in the U.S.” where consumer spending has become the primary engine of growth.

In defending its case that the world can handle $100 dollar oil, the Journal relies on the difference between now and oil price spikes of 30 years ago. Those were triggered by wars and came suddenly. Today’s high prices come from a long economic boom across the world. U.S. households are now so rich that we only spend four percent of our disposable income at the gas pump, vs. over six percent in 1980.

The most interesting difference is that in the bad old days, the Federal Reserve responded to the inflationary pressures of spiraling gasoline prices by raising interest rates. We now know that this was the wrong thing to do and cutting interest rates to forestall a recession will hopefully lead to better results.

In the interest of fairness to other opinions, the Journal notes some believe that $100 barrel oil would be “too powerful for the U.S. to overcome.” Detroit has not been doing too well at $80 a barrel, so adding another 50 cents or more onto the price of gasoline is obviously not going to help SUV sales.

Toward the end, the Journal sets forth the current Wall Street consensus on oil. “For now, most economists expect oil prices will stay high through next year. An unexpected hurricane in the Gulf or a sudden disruption to oil flows from a big producer like Iran or Mexico could push oil to $100.”

Now all this is very nice. Indeed, we just might weather $100 oil for a while, but there is one glaring flaw in all this. There is absolutely no reason why oil will stay at $100 a barrel or anything close.

To emphasize how well the world’s economy is doing at the minute, the Journal points out that the IEA in Paris sees world oil demand in the fourth quarter rising by 2.3 million b/d over last year to nearly 88 million b/d.

What they don’t tell you, however, is that in August 2007 world production (all liquids) was estimated by the IEA to be 84.6 million b/d down by 854,000 b/d from August 2006. In 2006, and so far in 2007, world production has been just about 85 million b/d, some 3 million b/d less than we are forecast to consume in the current quarter.

We could of course take the extra 3 million b/d out of the world’s stockpiles, which would then be dropping by 90 million barrels a month — not really a long-term solution. Will OPEC bail us out with a 500,000 b/d increase in production? Could be, but considering that 140,000 b/d of that increase is supposed to come from Venezuela, where production has been stagnant for years, I wouldn’t count on it.

So there you have it. From the perspective of imminent peak oil, $100 oil is not something to weather for a while. It is merely a milestone on the way to still higher prices. The Journal’s bold conclusion that we can handle $100 “quite well” may be perfectly true, until you ask “then what?” and the only possible answer is higher and higher prices. Somewhere the bubble will burst, for at the close of every day, the world’s oil reserves are 85 million barrels smaller and smaller and smaller ...

There was nothing much of note in this week’s stockpile report. Crude stocks were unexpectedly up a bit and gasoline stocks down a bit. Those of you who are aware that world petroleum exports are becoming a problem should note that thus far in 2007 we have imported a daily average of 12.2 million b/d of crude and other petroleum products. This is down from 12.6 million b/d or 2.9 percent from last year. Domestic production is up 1.4 percent, but so too is demand — up 0.4 percent. A day of reckoning is coming.

Editorial Notes: A "preview" of the Wall Street Journal discussed by Tom Whipple is online. The full article appears at Cattle Network. -BA

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