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The Peak Oil Crisis: The Next Price Spike

The peak oil thesis holds that the cessation of further growth in world oil production will be accompanied by wild price swings as the world attempts to adjust to the new state of affairs.

Now that mankind's oil supply has not grown significantly in the last four years despite some very high prices in the interim, many people believe that the peak has arrived in the form of a bumpy plateau and will soon begin the inevitable fall that must come with the depletion of a finite commodity. To be fair, some optimists don't see a significant decline coming for another 10, 20, 30 or more years, but few, including perennially optimistic government forecasters, predict significant further growth - at least not for conventional oil.

We already know something about the damage a contemporary oil price spike can do. In 2002, oil was selling for as little as $20 a barrel. In the next five years it rose steadily to reach $100 a barrel just as 2008 was beginning. The speculators jumped on board, the Chinese began stocking up for the Olympics and before you knew it, oil was over $140. As the US consumes roughly 20 million barrels of the stuff daily, our collective oil bill at the 2002 low was $400 million each day. By July 2008 the bill was up to $2.8 billion each day or a $2.4 billion daily increase. If you multiply this by seven, it means that collectively we had $16.8 billion less to spend on other things each week, or $72 billion less each month. Remember, two thirds of this money was being shipped out of the country to foreign oil producers. If that did not hurt our economy, at least a little bit, I don't know what will.

Some revisionist writers are beginning to question the conventional wisdom that the current recession was caused only by a combination of excessive lending to unqualified borrowers and poor regulation of Wall Street's leveraging practices. These writers are asking whether the cessation, or if you don't want to believe it has peaked, at least the pause in the growth of world oil production might have had something to do with the rapid spread of a U.S. housing bubble to a world wide recession. Needless to say, the $4-5 gasoline prices of last summer brought some reduction in demand for oil when prices were high, and dampened sales of SUV's and pickups. Nine months later, the bailout of Detroit was to cost the taxpayers $10's of billions more - and the story isn't over yet.

The high gasoline prices of July 2008 did not last long for the day the Olympics started the Chinese cut their oil imports by 2 million barrels a day (b/d) and this, coupled with the spreading recession and then some more help from friendly speculators, sent oil back down to $30 a barrel by the end of the year. The good news was that we Americans then had $2.2 billion more to spend on stuff other than oil and gas each day. We didn't even have to borrow it from the Chinese - it just appeared in our pockets.

Good things can't last forever, however, and before you knew it OPEC and the oil companies were screaming that $30 oil was preposterous. There simply was not enough money being made to find and develop more oil supplies and support the oil exporting countries in the styles to which they had become accustomed. So, OPEC cut the supply, some oil companies reduced exploring for and developing new oil fields and prices began climbing again.

Despite the global recession, oil climbed back into the $70's leaving some OPEC producers happy enough to start cheating on their production quotas to take advantage of the better prices. So there the matter rests - at least for awhile.

Recently, however, there have been reports that the demand for oil may be on the rise again, at least in the U.S., China, and India. The International Energy Agency is now forecasting that consumption in 2009 and 2010 will be 500,000 b/d more than they were predicting a few months ago. As the various stimulus packages take hold in the U.S., Europe and China some economic activity is starting to revive even as foreclosures and unemployment increases and house prices continue to fall. The Department of Energy is reporting that the demand for oil in the U.S. is starting to pick up.

If there is going to be another oil price spike in the next year or so, its origins are more likely to come from continued increases in Chinese and Indian oil consumption than from the U.S. and other OECD countries that still have a ways, perhaps a long ways, to go in working through a backlog of economic problems. A rough rule of thumb says that if a country is going to increase its GDP by a certain percentage, then its oil consumption will need to increase by half the percentage the GDP grows to support the growth. A couple of years back, China's GDP was increasing by 11 percent a year. With the global recession and drop in exports, Beijing is aiming for only an eight percent annual increase in GDP implying that, if the effort is successful, China will be increasing its oil consumption by some four percent each year.

While much higher oil prices three or four years from now, coming from new production failing to keep up with depletion of existing fields seem highly likely, the current issue is whether prices will climb into economy-damaging territory in 2009, 2010, or 2011. This is now an issue of how successful the U.S. and China are in stimulating their economies. If the GDP in the U.S. resumes falling steadily, and the recent spurt in China's growth turns out to be a government sponsored bubble, then it is unlikely we will see increased demand for oil next year. There are so many variations on this scenario -- such as the U.S. going down and the Chinese doing well with an outcome in the middle -- that it all becomes too difficult to see the immediate future clearly. The prudent among us will lean towards the side of pessimism.

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