Considering the End of Affordable Oil

May 21, 2004

Depending on where your attention is these days, much of the world is preoccupied with war and the economy or the end of popular TV shows. But there has been an intrinsically more interesting story brewing in the popular media during the past few months with analysts, scholars, politicians, and economists beginning to mumble about the world running out of oil. The concept was proposed many years ago and the past two decades have shown that companies were up to the task of finding more oil. But with oil prices at more than $40 per barrel on significantly increased demand, it is a good time to revisit the hypothesis that the world is running out of oil and hence prices are likely to remain above their long-term averages.

As shown on the next page, since 1960 the United States has doubled its consumption of crude oil and at 20 million barrels per day, it is still the world’s single largest consumer. However, in 1960, the US accounted for more than 45% of worldwide demand. Today it only accounts for about 25% as the growth in Japan and emerging markets in China and India have pushed consumption up to over 80 million barrels per day.

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World and U.S. Oil Consumption 80 50%

70

60 40%

U.S. Percentage 50 Rest of the World

d United States

p B

40 30%

M M 30

20 20%

10

IEA/Poten 0 10% 1960 1965 1970 1975 1980 1985 1990 1995 2000

While new discoveries in West Africa, Canada, the US Gulf and Russia are being uncovered, the world, according to several notable analysts, has peaked as far as oil reserves. Matthew Simmons, Chairman of the Houston energy- investment advisory bank Simmons & Company International http://www.simmonsco-intl.com has been at the forefront of the oil market observers who have been warning that the world is seeing the initial stages of peaking oil discoveries. In his stylistic prose and thoughtful analytical style, Mr. Simmons uses the term “rearview mirror effect” of an oil field reflecting that you only know the field has peaked after the fact. It’s not that the world will run out of oil in the short-run, he has said on several occasions, but rather there will not be enough to go around at the current increasing rates of worldwide consumption and hence price increases are inevitable as the world competes for what is ultimately a limited resource.

Is This The End of “Cheap” Oil?

While comparisons of oil to other liquid products (such as bottled water) suggest that it is a relatively inexpensive commodity, by comparison oil today is not “cheap”. At about $3.00 per barrel oil was cheap prior to the 1973 oil crisis. Given this low price, the chart on the next page shows what the trend in oil consumption would likely have been if oil remained a low priced commodity.

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World Oil Consumption & Past Trend Anslyses 80 x Oil Consumption Forecast Based on Low Priced Oil 70 Era of Low Priced Oil x 60 Oil Consumption

d Forecast Based on p High Priced Oil B 50

MM MM Era of High Priced Oil 40 Era of Moderate Priced Oil 30

IEA/Poten 20 1960 1965 1970 1975 1980 1985 1990 1995 2000

As seen above, the era of high oil prices abruptly changed the direction of the consumption trend line. Had oil prices remained high, oil consumption today would no doubt have been considerably less than what it had been for the past twenty years. But conservation moves as well as significant new oil finds in the North Sea and West Africa kept the supply curve ahead of the demand curve and hence prices have been moderate.

What About The Future?

The chart on the next page shows the trend if prices remain moderate. From the present level of 80 million bpd, by 2025, a bit over 20 years from now, we will be consuming 110 million bpd. Much, but not all, of this growth will take place outside of the United States.

If production can be added in sufficient quantity to match this increase in consumption, then prices will remain moderate. If not, then this may be the end of the era of “moderately-priced” oil.

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World Oil Consumption & Trend Anslyses Based on Moderate Oil Prices 120

110

100

d 90

p B

MM MM 80

70

60

IEA/Poten 50 1984 1989 1994 1999 2004 2009 2014 2019 2024

Oil is a commodity whose price is affected by supply and demand factors but as a financial commodity can also be affected by market psychology. Today’s announcement by Saudi Arabia to increase production in June had a short-term soothing affect on crude prices. But it is hard to envision a scenario in which crude prices fall back to the levels seen just five years ago. The consumption trend-line and outlook above seems quite clear. Worldwide oil consumption will increase. Crude price fluctuations will also continue, but the price trend will also be directionally upward as growing economies compete for what is at the end of the day a limited resource.

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