Peak Oil

April 7, 2004

Recently, the theory of peak oil is coming back into vogue. The theory in a nutshell predicts that the world's oil production rate has reached a peak and will begin a steady decline, ruining global economies and causing massive geopolitical unrest. Supporters of this theory point to the price of crude oil standing at over $35 per barrel, and several major petroleum companies recently disclosing significant overestimation of their oil and gas reserves, as a sign of the impending crisis. Rational thinking shows, however, that a disaster is not looming just around the corner. However, oil production may well be at, or even past, it's apex.

The most important thing to keep in mind when discussing peak oil is the impact of market forces on the petroleum economy. The world as a whole, and the United States in particular, consumes a lot of oil. We use so much of it because, frankly, it's cheap. At $1.79 per gallon, regular unleaded gasoline is cheaper than any alternatives. (It's also cheaper per gallon than soda, juice, bottled water, and just about any other mass-produced consumer good that exists in liquid form.)

However, if, as the peak oil theory suggests, production of oil begins to significantly decline, prices will necessarily rise. With rising oil prices will come three major forces which will alleviate the pressures on the economy that the high prices inevitably create: reduction in demand, increase in alternative fuel use, and an increase in oil production from alternative methods.

Perhaps the most drastic effect of high oil prices was witnessed first hand by Americans during the 1970s. As the price of fuel becomes too high to bear for many individuals, they simply find ways to use less of it. People buy more fuel-efficient cars; they carpool to work or take mass transportation; they put on a sweater instead of turning up the heat when it gets cold. All of these things, while inconveniences, are minor when compared with the notion of sizeable utility bills and commuting costs. Just as with individuals, the economy as a whole tends to prefer minor inconveniences to budget-breaking expenses. It may not be optimal, but it won't be crippling.

Similarly, people will look to alternatives to oil for their various needs if prices get too high. Right now, research is being done on the creation of synthetic fuels, typically made from ethanol or other corn products. While these fuels are currently far from perfect, they do have potential. As oil prices creep higher, the demand for an alternative will spur additional research, which will make ethanol-based fuels, (as well as other new synthetics,) cheaper, more efficient, and less environmentally damaging. Even now, at a production cost of roughly twice that of gasoline, we may even start to see a small number of early-adopters of these alternative fuels.

The third factor, an increase in oil exploration and production, is only a temporary setback. Yet, it is also the most likely immediate solution. Peak oil doesn't mean we've totally run out. It just means that the rate of oil extraction is declining. But as prices rise, more expensive methods of production become justified, since the higher prices make these methods profitable.

Imagine an oil field as a table full of milkshakes, and an oil rig as a straw. The straw is only one inch long though, and the milkshakes are all in big tall glasses. You're thirsty, so you start to drink from one of the shakes. You soon drink all that you can with your one-inch straw. You want some more, but you can't reach any more with the straw you have. You can pay someone $10 for a longer straw, or just move on to the next shake. Since you're still thirsty, you just stick the straw into the next milkshake and drink all you can out of that one. Eventually, though, you'll polish off all you can with your short little straw, and you'll have to pay up if you want to drink more.

Now apply this to oil exploration. Much of the oil that has been extracted already has been pretty easy to get to. Many of the older wells that have been "depleted" still have plenty of oil in them. It's just not so easy to get to it. Once all the easy oil has been reached, extraction will resume in older wells to get out what wasn't taken during earlier efforts. This extraction will certainly be more expensive, but if oil prices are high enough, it will become profitable to revisit these wells again and again.

Overall, oil supplies will one day run out. In fact, it's possible that production has even peaked already. However, it is illogical to assume that a peak in production will wreak havoc across the globe. More likely, we'll see a soft-landing as prices slowly rise, yet alternatives pick up the slack as they become relatively resonably priced. Economies adapt. Despite the importance of oil to our economy, we can, and will, learn to adapt to this situation as well.