There is enough oil to satisfy human demand for at least the next hundred years. We are not at any risk of running out of supply. The problem is that getting it out of the ground is becoming increasingly difficult. The International Energy Agency (IEA) recently warned that price declines have triggered a sharp reduction in exploration and new field investment, which could cause significant future market imbalances. This could have a big impact on your prosperity if you fail to insulate yourself, and could be a great profit opportunity for those with an appetite for risk…
Most of the world’s oil comes from a few major fields, all of which are old and experiencing declines in output. The days of easy oil may very well be coming to an end, despite the collapse of crude prices this fall. In Twilight in the Desert, Matthew Simmons laboriously analyzes and casts doubt on the Saudi government for obscuring oil reserve data. He postulates that the world’s largest fields, particularly those of The Kingdom, will not be able to produce enough supply to match growing future demand.
The IEA recently calculated that established field production is declining at an annual 6.7 per cent rate, which is scheduled to accelerate in the near future. On top of this, the IEA predicts demand to grow to 106 million barrels per day (b/d) by 2030, from 85 million b/d last year. To meet demand growth, an estimated 45 million b/d additional capacity needs to be found and brought to market.
My bet is that this will not happen. Prices will have nowhere to go but up to balance increased demand with insufficient supply. The very loose logic:
- Required investment schedules to meet increased production are lagging…significantly so! The IEA estimates that in 2007 the world had to invest $450bn to find and develop capacity; only $390bn made it, despite record prices of $147 per barrel. Governments and corporations are drastically scaling back investment now that prices have collapsed.
- The oil business is becoming increasingly socialized, with an increasing capacity taken from free markets and relegated to governments. Think Russia, Venezuela, Iran, Sudan, and Saudi Arabia, to name a few – these are not free countries with free markets maximizing production.
- Increasing political risks are driving investment reductions: Think “windfall profits” tax. When companies invest hundreds of billions and lose money shareholders suffer; when they happen to earn a return, government takes it away. This is not a recipe for increased capacity!
- Most of the world’s oil is found in inhospitable climates or political environments. Every few months Nigerian rebels decide to blow up a rig, pipeline, or abduct oil workers. Every few years the Russian government bullies another company out of its investments after they’ve proven fruitful. The Iranians talk of obliterating Israel. The Sudanese sponsor genocide in Darfur, there’s civil war in the Congo, Chavez would love nothing more than to see America collapse, the Bolivians and Ecuadorians nationalized their oil industries, and Russia targets West-flowing pipelines for bombardment whenever it can (think Georgia).
Prices are down in the short term to reflect the slumping global economy. At some point global commerce will recover and we will realize that we have a serious oil problem. When this happens prices will skyrocket. If you lack the risk tolerance to make blatant long bets on price appreciation, at least do yourself a favor and hedge this risk out of your portfolio.
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