If I were asked to recommend an energy advisory team for the next President I’d start with Robert Hirsch.   Hirsch is a defense planning expert who has headed up major consulting assignments for the Defense Department among other clients and in 2005 published a major study of the impacts and potential mitigation of Peak Oil.  It famously forecast that a successful transition from oil dependency would need to start 20 years before oil production peaked.

In the interview below published on a web site operated by Allianz, the German financial giant, Hirsch outlines the problems of Peak Oil as he sees them today.  He believes the crisis will be upon us within a few years, which is consistent with the predictions by other experts such as Simmons, Skrebowski, and Maxwell  as I have previously reported, all of whom believe oil production will begin declining within a few years. 

What Hirsch adds uniquely is a more nuanced vision of the limits to our economy’s ability to cope with peak oil. Hirsch’s discussion of the economic constriction and great weakness in financial markets that he expects will constrain our normal capacity for remediation of the problems is particularly sobering because of his expertise in evaluating exactly such macroeconomic questions.  He adds that voluntary reduced oil production (hoarding) by some oil exporting countries will exacerbate the scarcity of oil itself.   His essential point is that the dimensions of the global economy’s dependence on oil are so huge that its scarcity will be crippling and will preclude any easy solution.

I think Hirsch is essentially correct.  But I am more optimistic that electrical transportation solutions to the oil shortage can be substituted in OECD countries at a faster pace than Hirsch seems to think is possible, thus perhaps limiting the most extreme economic difficulty to a period of only five to ten years rather than twenty.  After all, if the U.S. could go from a standing start in 1940 to substantial war production just a couple of years later, we could accomplish a similar transformation of our transportation systems in a shorter period than might be able to be forecasted.  The technologies for making cars that get 100 mpg or even more are already in development.  The question rests on whether we will have the same political will that was demonstrated by Roosevelt to deal with the oil shortage crisis.  Some countries - Israel and Denmark - have already begun down this path.

The Saudi Vision

Contrasting with Hirsch’s longer term view of peak oil is the Saudi’s belief, shared by many others, that currently high oil prices are mostly a function of financial market speculation and secondarily of lack of refining capacity.  On the second point the Saudis are undoubtedly correct in that a great deal of high-sulfer heavy crude is available but cannot be used because the refinery capacity for such inputs is insufficient.  After all, Iran reportedly has 25 tankers of such oil floating offshore that are unable to unload due to lack of appropriate refining capacity. 

Over the next few years a good deal more refining capacity in a number of developing countries for heavy sour crude will come on stream and will no doubt help alleviate the supply problem.  The Chinese recently started up one such facility.  On the other hand, that won’t have much impact in the next year or two and by the time it comes the decline in conventional oil production after 2010 will probably make supply constraints so much more acute than they are now that the net result will still be much higher oil prices.

The more immediate vision of relief that will apparently be offered by the Saudis tomorrow, according the The Wall Street Journal today, is an end to financial speculation - if the OECD countries take appropriate action.  In other words, the Saudis are suggesting that current supplies are sufficient (the same tune they’ve been singing for the past year) but speculators are hoarding supplies.  This is a theory the truth of which is hotly debated by experts above my pay grade.  I take no sides (but color me skeptical), but I do hope that Congress and/or the S.E.C. and/or other agencies will take measures to find out if the theory is true.  

I have no problem with the idea of banning hedge funds or other large speculators from the oil pits.  Clearly the potential understanding of the reality of high oil prices that would come out of such actions would be a far greater benefit to society than the loss of a bit of freedom for hedge funds.  Whether speculators have anything to do with currently high oil prices is an important question that we must put to rest.  Of course, whether the Saudis in fact have the oil reserves they claim and whether Ghawar is at near term risk of declining is another bit of knowledge to which the world should have access.  Somehow, it seems doubtful that the Saudis will offer this important insight this weekend. 

What seems clear to me, however, is that if the Journal’s report is correct and the extent of the new short term oil production offered this weekend is fairly limited, the likely result will be higher oil prices in the near term.  If that is the upshot, I suspect the Saudi meeting will be seen as a disaster and an indication that there are no real near term solutions for tight oil supplies. 

Are We There Yet?

We know that Hirsch is right; there will come a time when oil scarcity will hobble the economy so severely that the stock market will crash and it will not be profitable to own any stocks, even energy stocks.  As I finished reading this interview, I asked myself a question that I find is recurring more frequently.  Has that time come already? 

Friday’s market seemed like a foreshadowing of that time.  The market averages were down nearly 2% partly in reaction to higher oil and gas prices.  The EIS portfolio made up almost entirely of companies that benefit from higher oil and gas prices was down about .5%.   Losing money is not the objective of any investor, so the fact that I lost less than some other portfolios is really not comforting to me. 

Maybe the current weakness is primarily a function of the continued implosion of the housing and financial sectors.  But clearly these sectors’ problems are seeping into the general economy and starting to destroy consumer demand.  My concern is that if oil prices keep rising on the trajectory that has been in place for the past fifteen months, the economy may simply not be able to make a normal recovery. 

In other words, oil prices are rising rapidly even though oil production may not yet have actually peaked.  If oil supply continues to be very tight, the oil price may simply continue its rise, anticipating the advent of peak oil, regardless of whether production has yet peaked.  If that is the way that 2008 and 2009 play out, then the impact on stocks that I anticipate will happen in a few years could be starting to take place already. 

The end point of this exercise will be a portfolio made up of high quality bonds, ETF’s that mimic the price of oil and gas (USO, OIL, and UNG), and perhaps some very high quality long term oil and gas assets like SU and COSWF and perhaps DVN, APA, XTO, and CHK that will ultimately be bought out for cash by the oil majors.  Even the oil service companies may be too risky to own when everyone is cashing out of the stock market in a panic. 

For the past year such stocks are lagging the commodities, indicating that they still represent excellent value.  But the early stages of a market decline driven by fears of oil shortages is likely to bring a concentration of funds allocated to the oil and gas sector resulting in fairly good gains in most stocks in the EIS portfolio.  Oil and gas stocks, including the service and drilling companies to a lesser extent, will probably behave like the Nifty Fifty of the 1970’s.  When that happens, when values in these stocks have discounted higher future oil prices instead of lagging behind current oil and gas prices, it will be time to sell them and go to the portfolio of high quality bonds and oil and gas ETF’s.  

Here is the interview with Robert Hirsch:

Energy Future: A Significant Period of Discomfort

Energy expert Robert Hirsch says the world would need 20 years to prepare for peak oil. But declining global oil production could just be a few years away. Read how we can prepare and ultimately “beat” this problem.

Robert Hirsch, energy advisor and author of U.S. study on peak oil

“We are racing towards a future that will be very difficult, and we have to do what is necessary to not economically kill ourselves.” (Photo: Hirsch)

Robert Hirsch, energy advisor and author of U.S. study on peak oil

“We are racing towards a future that will be very difficult, and we have to do what is necessary to not economically kill ourselves.” (Photo: Hirsch)

You were the lead author of a groundbreaking 2005 study on future oil production and declining reserves. How is the situation three years later?
Today, the situation is worse, and the reason for this is that it is now obvious that world oil production is already on a plateau. It has reached a high level, and has leveled off. The point at which oil production will decline is probably not far away.

If the world started (to implement solutions) 20 years before the peak oil problem, we would have stood a very good chance of beating the problem and could have avoided significant negative consequences for our economy. As it turns out, we now don’t have 20 years; we don’t even have 10. It wouldn’t surprise me at all if oil production begins to decline within the next few years.

What happens when we reach a peak in oil production?

Anybody can see how important oil is in our everyday lives. Oil is basically the lifeblood of all modern economies. When world oil production goes into decline, the decline rate will be three to five percent, maybe more if there is withholding from oil producers. Those numbers don’t sound very big, but when it comes to conserving or replacing that missing fuel, they are huge.

Oil prices are going to escalate dramatically. They were about 130 dollars this morning. That’s going to be a low price compared to what they are likely to escalate to. There will have to be rationing, and there will be huge problems as different countries try to get the oil they need to sustain some kind of economic well-being. We are racing towards a future that will be very difficult, and we have to do what is necessary to not economically kill ourselves.

What about new oil discoveries, like the recent ones in Brazil? Can they turn the tide?

They definitely cannot. To bring those new oil fields into production will require something like five to ten years. The infrastructure needed to drill and produce that oil is very significant. Contributions like Brazil will be of value, but there is no conceivable discovery or discoveries that can possibly turn the tide.

What about the people that say, once the oil price is high enough, new and unconventional sources like tar sands in Canada can be used to produce oil?

The point is directionally correct. The problem is that it takes a very long time to build the machinery that is necessary to exploit oil shale, oil sands, coal-to-liquids or heavy oil. In our 2005 analysis we looked at a worldwide crash program to bring these things into being as fast as possible. We made a number of aggressive assumptions, because a crash program is different from business as usual.

But the problem is that the magnitude of oil production loss each year will be so large and the time required to implement these alternatives is so long that the problem runs away from you if we wait too long. And we have waited too long to seriously start. Eventually, these otions and energy efficiency will catch up. It is not as if the world is going to die. But right now, we are looking at a global recession that deepens each year for more than a decade because we are not prepared.

Picture Gallery (click on the image to start)

How much oil is left? This gallery shows the ten countries that have the biggest share in proven oil reserves worldwide (Photo: Reuters)

Picture Gallery (click on the image to start)

How much oil is left? This gallery shows the ten countries that have the biggest share in proven oil reserves worldwide (Photo: Reuters)

How is the situation outside the United States?

No one has really started to work on the problem anywhere in the world, except maybe in China, where they calculated a few years ago that oil decline might occur around 2012. China has begun with coal liquefaction and other technologies. In addition, they have gone abroad and bought into oilfields around the world. They have probably done more than anyone else to prepare. In most places, the problem is still unthinkable and not politically correct. Most of the rest of the world is not in very good shape to deal with the problem.

Why do you think peak oil is such a taboo?

The thing that is foremost in people’s mind when it comes to energy is climate change. People have pushed hard and governments have taken actions to cut down on the emissions of CO2. But in many cases, decisions are opposite to what we need to mitigate the problem of declining world oil supplies.

For example, coal liquefaction will make very good sense in many areas of the world. Using and liquefying coal is an available technology, but under current conditions, there would be a great deal of CO2 released from making liquids out of coal. So people say, “no, we are not going do these things because of CO2.” They do not recognize that if we don’t take action on the impending oil decline, populations are going to suffer beyond what most can imagine.

Many Americans dream of energy independence. Is it still possible?

Energy independence in the next three or four decades is impossible for most countries outside of OPEC. The reason is that the magnitude of the problem is enormous. There are a few countries that could conceive of energy independence, the United States being one. But we really haven’t started, and we can’t even agree on what we really want and what’s important. Sadly, that is one of the reasons why it is going to take a deepening recession and a great deal of personal hurt to get people to rethink their values and get motivated to do what’s needed to pull us out of the problem.

The International Energy Agency says we do not have a problem with resources, we have a problem with investments. So the situation is not that bad?

Yes, there is an investment problem, but what is hard to understand for many economists and most people is that there is a conventional oil resource limitation, and that oil is what provides more than 90 percent of the liquid fuels we are using today. We are reaching the maximum in production. It will tail off over time, but at a rate that will be extremely difficult for us to catch up to.

Will producing countries profit heavily from such a situation?

The folks that have the resources will make much more money once prices escalate. They will be in a very strong financial position.

Most people don’t recognize that those countries don’t have an obligation to produce their oil for us. We might think that those people are financially motivated, but OPEC countries now are swimming in money. They are having trouble finding places to use their money.

So when the peak oil scenario hits, a number of oil exporting countries are likely to cut back on oil production. It makes sense for them to conserve their resources for future generations. So the situation will be worse than it might be from a purely geological or investment standpoint. The King of Saudi Arabia recently said that any new oil fields discovered in Saudi Arabia will not be developed; they will be saved for future generations. It is the sensible thing that many of us would do if it was our responsibility to run an oil-producing country.

What about renewable energies? Are they a real alternative for the future?

People think that renewable energy can solve all of our problems. They don’t understand that renewable energy is very limited. Everybody knows that the sun doesn’t shine at night and that the wind doesn’t blow all the time. These are fundamentals when you seriously consider at solar cells and wind energy. People have to get off the idea that if we just went to renewable energies, everything will be fine.

Tags: peak oil energy investments

This entry was posted on Saturday, June 21st, 2008 at 10:15 am and is filed under Canadian Oil Sands Trust (COSWF), Economic Strains of Peak Oil, Investment Ideas, Peak Oil, Predictions, Suncor (SU), oil supply. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.