IN A RECENT story in the Fort Worth Star-Telegram, Shell Oil Co. President John Hofmeister was quoted about what he has learned while on his current national 50-city speaking tour. In 2006, Mr. Hofmeister and other Shell executives toured 25 U.S. cities, with visits to another 25 burghs and hamlets on the calendar for 2007. During the visits, Mr. Hofmeister holds town meetings with local residents and public officials and gives speeches about the U.S. energy situation. The results of his tour, said Mr. Hofmeister, were “sobering.”
“I was shocked,” said Mr. Hofmeister, “at how many people actually believe in the Peak Oil theory.” Was he really shocked? Or perhaps he was, as the inspector of police noted in the movie Casablanca when he learned that people were gambling in a certain saloon, merely “shocked, shocked.”
Shell’s Mr. Hofmeister cannot be unaware of Peak Oil theory. The Peak Oil theory was, after all, pioneered in the 1950s by a geologist named M. King Hubbert (1903-1989), who worked for none other than Shell. It is not quite like the guy who runs General Electric dismissing the import of Thomas Edison or the development of the light bulb, but it is in the same ballpark.
Shell’s geologist Hubbert based his Peak Oil concept on the rather obvious point that you cannot extract oil that you have not discovered from the ground. So Hubbert reviewed mountains of data concerning oil discoveries, and oil extraction and production, dating back as far as the 1860s. Hubbert noted the common trend in oil field development for a new field to come online and oil production to increase as the field was drilled and developed. But then, over time, the inevitable effects of depletion would kick in and cause the overall production of the oil field steadily to decline.
In the days before sophisticated computers and elaborate spreadsheet programs, Hubbert crunched his own numbers. He cumulated the reserve figures for oil discoveries in the U.S. and the production histories of thousands of U.S. oil fields dating back almost a century. Hubbert observed and demonstrated, through a process called “reserve backdating,” that most major oil discoveries in the U.S. had occurred by the 1930s. That is, even though reserves may not have been listed on a company’s books until much later, they were, in geological fact, part of the original discovery many years before. And Hubbert focused on the point that after the largest oil fields had been discovered, in terms of both surface area and volume of calculated reserves, the “new” discoveries thereafter tended to be smaller oil deposits, or extensions of previously discovered oil fields and oil-bearing trends:
In a paper that he prepared and delivered in 1956, over the objection of several Shell executives, Hubbert postulated that total U.S. oil production would increase until about 1970 and then reach a “peak,” from which it would then steadily decline in volume over time:
Hubbert updated his 1956 predictions in the early 1960s and came up with essentially the same forecast of U.S. oil production peaking by 1970. Hubbert did not anticipate the 1968 discovery of the oil field at Prudhoe Bay, Alaska. But his numbers were prophetic, and eerily accurate, for the lower 48 states. Almost on cue in 1970, overall U.S. oil production peaked and commenced its long trend of irreversible decline, barely changed even by the development of Prudhoe Bay in the 1970s. Thereafter, the U.S. has imported more and more conventional oil to meet its daily needs:
So the discovery side of Peak Oil theory holds that mankind has identified and located, if not actually discovered, most of the conventional crude oil that there is to find in the crust of the Earth. The production side of Peak Oil theory holds that mankind has produced, and, of course, consumed, something near half of it. In terms of really big Peak Oil numbers, out of a worldwide resource base of conventional oil that is estimated by some knowledgeable commentators at about 2.2 trillion barrels, about 90% has been discovered and about 1 trillion barrels have been extracted and consumed over the past 150 years or so.
Mathematically, the history of oil production in any given region is a bell-shaped curve, with “tails” on each side and a relatively rounded top in between. In a very general sense, the initial increase of the first half of the curve is mirrored by the decline phase on the other side. It is like saying that “what goes up must come down,” but it is all rooted in the concept that you cannot produce what you have not discovered.
Applying Hubbert’s methodology to the global resource base, the world’s oil industry currently appears to be at the top of the Hubbert curve. Each day, the world’s oil industry is pumping the known oil reserves out of the crust of the Earth at a rate of about 1,000 barrels per second, or 85 million barrels per day, or about 31 billion barrels per year. And the global economy is consuming or otherwise burning up almost every drop of that oil. (Some very small fraction goes into storage, such as for the Strategic Petroleum Reserve of the U.S. or comparable reserves in other nations such as China. This oil, too, will eventually be burned or otherwise consumed.)
The balance between global supply and demand is precarious, such that if just a couple of hundred thousand barrels per day of production (near a rounding error from a production base of 85 mbd) go offline, there can be significant price moves, as occurred last August when BP closed the Alaska pipeline. Or consider what the traders call “political risk,” such as the result of hostilities closing a maritime control point such as the Straits of Hormuz. If even one oil tanker were to, say, hit a mine in the Persian Gulf, oil prices would skyrocket within hours.
The Edge of Secure Supply
Shell’s Mr. Hofmeister knows all of this. At a recent speech he gave in Pittsburgh, for example, he began his talk with a rather gripping story that dealt with the supply of refined product, as opposed to crude oil. But the story illustrates the point.
According to Mr. Hofmeister, in the aftermath of hurricanes Katrina and Rita in 2005, almost all of the U.S. Gulf Coast refineries were down due to flooding and other storm damage. Shell had 300,000 barrels of refined product in storage at its Baytown, Texas, refinery, which was essentially the only supply available to the entire U.S. Southeast region, but there was no electricity with which to run the pumps. Whoops!
Shell employees and contractors were working feverishly to rig up electric generators at the Texas facility, but it was a race against time, over a 48-hour period, until the Plantation and Colonial pipelines — – the major trunk carriers for refined product between Texas and the Southeastern U.S. — went dry. If word escaped of the predicament, Shell executives believed that many members of the consuming public would have panicked. Then panic-buying would have immediately kicked in and rapidly drained whatever fuel was left in the supply system. The entire Southeast, home to about 60 million souls, could have been caught in a situation in which there was be no fuel available anywhere. It fell to Shell’s Mr. Hofmeister to call the U.S. secretary of energy and deliver the bad news.
But like the cavalry arriving near the end of a John Ford Western, Shell’s hardworking people hooked up the Texas facility with electric power, with all of about 12 hours to spare. Shell started pumping gas into the pipeline system. There were, you may recall, spot shortages of fuel in the Southeast, but no regional lack of product. Still, as Mr. Hofmeister put it, it was a close call and the U.S. was and remains “on the edge of secure supply.”
Same Thing With Crude Oil
Mr. Hofmeister’s story concerned gasoline, but he could have told the same story with respect to crude oil or natural gas. The Gulf of Mexico hurricanes of 2005 wrecked oil and gas production facilities all along the littoral, to the point of toppling over offshore structures that are the size of World War II aircraft carriers. The hurricanes churned the water column down to the seafloor, and ripped up or displaced underwater pipelines, subsea production equipment, and much else of the Gulf Coast oil infrastructure on which the U.S. relies for energy supply. In addition to the damage to property, tens of thousands of members of the oil industry work force were displaced from their homes and job sites by hurricane damage. The Gulf Coast oil industry still has not recovered, 18 months later.
So yes, “we are on the edge of secure supply” from prospect, to drill bit, to pipeline and refinery, to the gas pump. And a lot of people are starting to figure that out and think about it.
Peak Oil theory is one way of making sense of quite a bit of what goes on in this world, beginning with the supply of conventional crude oil and with implications for the rest of the energy mix of the world’s advanced industrial societies. There is a certain geological coherence (even elegance) to the idea of Peak Oil, and a mathematically demonstrable basis to the concept.
So it should not “shock” anyone, let alone the president of Shell Oil Co., that “many people actually believe in the Peak Oil theory.” In fact, I think that Peak Oil theory makes Mr. Hofmeister’s job easier. Once people understand the key issue behind the nation’s energy supply, it is more probable that they will be willing and able to design a solution.
Until we meet again…Byron W. King
February 16, 2007
Byron King is the editor of Outstanding Investments, Byron King's Military-Tech Alert, and Real Wealth Trader. He is a Harvard-trained geologist who has traveled to every U.S. state and territory and six of the seven continents. He has conducted site visits to mineral deposits in 26 countries and deep-water oil fields in five oceans. This provides him with a unique perspective on the myriad of investment opportunities in energy and mineral exploration. He has been interviewed by dozens of major print and broadcast media outlets including The Financial Times, The Guardian, The Washington Post, MSN Money, MarketWatch, Fox Business News, and PBS Newshour.
Next month, for major countries will become full members of the Shanghai Cooperation Organisation (SCO). That will increase the population of SCO member states to 3.05 billion. But why should you care? As Alasdair Macleod explains, this move could have a very important impact on the US dollar. Read on...
Precious metals get a bad rap from most investors. But in the midst of so much central bank money creation, they still provide an excellent hedge against inflation. Dan Amoss relays one great investment idea in this sector with plenty of upside potential as precious metals look poised for a significant comeback. Read on...
Over the last two years, few innovations have had as big of an impact as 3D printing. But as important as this technology has become, one new tech story is about to leapfrog over it. And as Wayne Mulligan explains, early investors in this new innovative technology could make a fortune by getting in early...
Traveling the world can be expensive. Between airfare, dining costs and hotel accommodations, travel expenses can add up quickly. And the last thing you want on your vacation is to be stretched too thin. Chris Campbell explains how you can eliminate one of the biggest travel expenses entirely, with one simple trick. Read on...
The S&P finally closed above 2,000 yesterday - a new all-time high. And that has some investors comparing it to the heady days of the late 1990s, when the S&P soared through 1,000 and didn't bother to look back. But as Greg Guenthner explains, that run up wasn't without its pitfalls, and this one won't be either. Read on...
The fall of the US dollar-based monetary system will happen much like Hemingway's description of how one goes bankrupt: "gradually, then suddenly." And, as Dave Gonigam explains, when the inevitable finally happens, there's one group of investors who will be happy they listened to folks like Jim Rickards. Read on...