The Peak Oil Crisis, Part 8: Has It Started?

Falls Church News-Press

By Tom Whipple
June 23, 2005

Earlier this week oil prices surged to an all time high thus raising the question: “Has the crisis begun?”

Before examining the current situation, it might be useful to define what constitutes the “peak oil crisis.” The quick answer is, the crisis begins when worldwide demand for oil outstrips supply on a more or less permanent basis. This will lead to significantly higher gasoline prices (many dollars per gallon) and all sorts of very bad things happening to the U.S. and other economies.

We will only know peak oil has been reached some years after it happens by noting that worldwide oil production is indeed on the decline, and, shows no prospects of ever reversing the situation. As the world will only achieve peak oil once, nobody really knows what the actual peak will look like: gradual, flat, bumpy, or steep.

The key issue is the supply-demand balance, which, from all available evidence, is becoming very tight as we approach the half way point of 2005. It doesn’t matter exactly which year the statisticians someday proclaim the actual all-time peak oil production. If gasoline costs more than you can afford, or, is simply not available in the quantity you would like, then you have a crisis.

A fundamental principle of recent oil consumption is that demand is always much heavier in the second half of the year when the demands of the U.S. summer driving season and the buildup of heating oil stocks in the northern latitudes take place. Thus, even given no interruption of oil supplies, run-away price increases are more likely to develop in the last two quarters any year.

As we approach the second half of 2005, we should remind ourselves that several of the world’s major oil suppliers are far from bastions of political stability.

Iraq , Iran , Nigeria , Venezuela , Saudi Arabia , the former Soviet Union and even Norway (oil workers strike in the offing) are all involved in situations that could easily result in reductions of their oil exports during the next six months. Given the current supply-demand balance, an incident in any of these countries will almost certainly send prices up. Way up.

Even if nothing untoward happens, recent news affecting the supply-demand balance has been mostly bad. In the past month, no serious observer, without a political agenda, seems to believe the OPEC control mechanism that has regulated supply for the last 30 years is still working. Many observers believe OPEC currently is pumping flat out. Given most OPEC countries are now in the stage of declining production, the chances any significant new quantities of oil will appear on the world market in the next year are very low.

During the first quarter of this year, worldwide production was reported to average 83.8 million barrels a day. The International Energy Agency is now saying global demand is projected to reach 86.4 million barrels per day by the fourth quarter of this year— a 2.2 percent growth over last year. Given that reports from most producing countries talk of slowing or declining production, it seems almost certain a significant supply-demand gap will open later this year.

When this happens, we enter a period of “demand destruction”, when oil and gas prices rise and rise until they are high enough to bring demand back into line with available supplies.

Even though the world is not the same as it was during the 1970’s, our experience with the 1974 oil embargo and the Iranian revolution gives a rough guide to what might happen during a supply-demand imbalance later this year. In 1980, oil peaked at the inflation-adjusted equivalent of $95 a barrel or some $4.50 per gallon. Demand for gasoline in North America is notoriously inelastic and given the state of alternative forms of transportation, $4-5 per gallon (roughly $5,000 per year in gasoline costs for the average vehicle) may not dampen demand that much. Europeans have been paying a heavily taxed $5-6 per gallon for years.

The next number people are mentioning in the context of “demand destruction” is $7.50 per gallon. This is a number that will not bring transport to a total halt, but will make most of us think twice before turning on the motor. “Is this trip necessary?” Somewhere around $3-4 the bottom really falls out of the SUV market along with business that is dependant on discretionary/recreational travel. Needless to say, increases of this scale will set in motion significant economic turmoil that will lead to major economic restructuring.

The forces leading to much higher energy costs and eventually serious shortages are moving into place and should be apparent to all within the next six months.

Has the crisis begun? The answer to the question is increasingly looking like a solid “Yes!”

http://www.fcnp.com/516/peakoil.htm