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Oil's Sesquicentennial; the Dream Becomes Nightmare

John Petersen

On August 27th, we'll celebrate the 150th anniversary of Colonel Edwin Drake's completion of the world's first successful oil well near Titusville, Pennsylvania. That discovery and the many that followed planted the seeds of an industrial, economic and cultural revolution that transformed America from an agrarian backwater into a global superpower. For the next 114 years, oil was cheap, plentiful and the solid bedrock of the American Dream. Since the early '70s, however, the dream has gradually become a nightmare as domestic and global oil production began an irreversible decline.

My first graph comes from the Energy Information Administration and shows the annual U.S. production of crude oil over the last 150 years.

My second graph comes from Wikipedia and shows both nominal and constant dollar oil prices over the last 150 years (click on the graph for an expanded view).

The most interesting feature of the two long-term graphs is the general shape of the constant dollar oil price curve. If you smooth out the price shocks of the '70s and '80s, the graph shows a pronounced albeit elongated U-shape. While there are many theories about where oil prices will stabilize when the global economy begins to recover, it seems safe to assume that the price won't be $20 or even $40 per barrel.

My third graph takes historical oil price data I downloaded from the Energy Information Administration, adds a price channel overlay on the ten-year trend and shows why I believe oil prices will stabilize around $80 per barrel later this year and continue to move upward in the price channel over time.

Barring unexpected major new discoveries, there's only one way for oil prices to go over the long term.

It doesn't take much reflection to see that oil production, consumption and pricing have become major problems that can only get worse as six billion people in emerging economies strive to attain the lifestyle that 600 million Americans and Europeans have enjoyed for decades. The harsh but undeniable reality is that oil cannot sustain global economic growth for the next 20 years, much less the next 150. This reality is the driving force behind a concerted global effort to identify and harness alternative energy resources that can offer relevant scale solutions to a looming global shortage. Unfortunately, many alternative technologies are even less sustainable than oil because they depend on a smaller natural resource base.

There are only four unlimited energy sources known to man. The first is the internal heat of the earth itself. The second is the movement of the hydrosphere. The third is the movement of the atmosphere. The fourth is the sun. Where the Ancient Greeks taught that earth, water, air and fire were the classical elements, the new science of alternative energy teaches that earth, water, wind and sun are the true classics. When it comes to harnessing that energy, however, the only thing that matters in the long run is the mineral wealth of the earth's crust and oceans.

Many alternative energy technologies including windmills, PV solar cells, fuel cells, advanced batteries, and advanced electric motors depend on exotic metals that were pretty scarce to begin with. Like oil, each of these exotic metals will have a U-shaped price curve and while they're relatively cheap and relatively available for the time being, each will eventually hit an inflection point where they'll no longer be cheap or available. According to experts like Jack Lifton, many critical natural resources will reach their price inflection points within a few years, rather than decades or centuries. So far, the only alternative energy technologies I've identified that do not face daunting mineral scarcity risks are concentrated solar power, or CSP, and geothermal power.

Historically, investors have not had to worry about how natural resource constraints might impair their portfolio companies because the required raw materials have always been available for a price. As we enter the Age of Cleantech, the sixth industrial revolution, those rules will be re-written in ways that many will find shocking. I've previously described how raw materials shortages will impact the battery and hybrid electric vehicle markets. Over the next few weeks I hope to expand my focus to consider the principal raw materials that are critical to the development of a truly sustainable alternative energy infrastructure. Unlike this article, future installments will identify companies that enjoy specific natural resource advantages or suffer from specific natural resource risks, and hopefully help investors identify the likely winners and losers.

Given the long-standing animus between environmentalists who see themselves as protectors of the planet and miners who see themselves as simple providers of essential raw materials, I'm not optimistic that humanity will be able to solve its energy problems without catastrophic conflict and horrific environmental consequences. If we are to have any chance at all, the environmentalists must come to grips with the fact that a clean energy future depends on the robust and responsible development and use of all the earth's resources.

Readers that want to develop a deeper understanding of the issues and opportunities in the energy storage sector may want to join me in San Diego for Infocast's Storage Week on July 13th through 16th. The speaker's list includes more than 80 thought leaders from the battery industry, the government, the utility and automotive industries, and the research and development sector. I'll be participating in three panel discussions and hope to return home with new investable insights that I can share with readers in future articles. If something important happens while I'm on the road I'll try to cobble a quick blog entry together. Otherwise, you can look for my next article in a couple weeks.

was posted on AltEnergyStocks.com.

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These findings are no surprise, and it is good that people are starting to look at this. About 2 years ago, I read the seminal German Aerospace Center (DLR) proposal for putting large solar thermal plants in north africa, and using high voltage DC lines to bring this to Europe underneath the Med. One of the things they did was analyse the complete chain, from resource availability, to energy consumed during manufacture, to environmental impacts to fish in the sea. This holistic sort of analysis is exactly what we need when looking at solutions to resource depletion and environmental impacts. For example, the awesome permanent magnet motor that my Zero dirtbike uses requires rare metals for the permanent magnets, found only in Russia an China. Thanks John.

You're right about the rare earth metals in your permanent magnet motor coming from China, but it doesn't have to be that way. While China currently produces 97% of the global supply of rare earth metals (including lanthanum for NiMH batteries) we have substantial rare earth metal resources in North America that could be mined if getting the necessary permits was not such a herculean task.

If we continue to make responsible metal mining economically impossible, we'll end up paying whatever the foreign producers demand and my experience in relying on the kindness of foreign monopoly producers of anything is not good.

I like the new direction, but the idea that oil might "stabilize" at $80 seems very unlikely to me.

Not that oil won't go back to $80... I expect to se $80 oil several, or even many times in the next decade.

The thing is, the oil price is not going to stabilize; it will become more and more volatile. The reason is that oil demand (especially in the short term) is highly inelastic (non-responsive to price changes), and because oil production capacity no longer exceeds demand, it, too, has become inelastic. Hence small fluctuations in supply or demand can cause giant swings in price, as we have seen over the last year... but it's only going to get worse as we move farther into the post-peak oil world.

Fasten your seatbelts, the price roller-coaster has only begun.

Tom, thanks for pointing out a poor choice of words. The $80 per barrel was a short term prediction, not a suggestion that the price of oil would ever flatten out. To make the sentence a bit more clear, I've added the following text after $80 per barrel:

"later this year and continue to move upward in the price channel over time."

Although I have enjoyed and respected your previous work, I agree with Tom that expanding your writing beyond energy storage can be a good development.

As regards this article: 1) You mention that the U shape of the oil price curve is interesting. At least as interesting is the repeated peak at approximately $150/bbl. 2) When considering future oil price, global production is more interesting than historic US production. 3) Rather than highlighting solely oil price, I suggest you also consider volatility. Oil price volatility during the last 2-3 years has been comparable only to previous "disruption events" such as the first Gulf War or the oil embargos. It is my belief that volatility, coupled with an upward bias will be the key story for the next 2 decades. During that period there will be significant crosscurrents including: global demand growth; aging of existing fields; slow development of new fields; increased vehicle efficiency; cost competitive alternative fuels; speculation; production/transportation disruption; legislation; currency valuation; etc. Little of this is truly predictable, certainly not with accuracy regarding extent or timing. Multivariate interaction is even less predictable. Thus, my belief is that the the key phenomenon to consider for the investable future is volatility. Sure there is a potential for major price excursions. And, an upward bias, perhaps consistent with your price channel, seems likely for the forseeable future. But, as the airlines have discovered, volatility can cripple you in both directions. And, indications are that ongoing high price volatility is the most likely future.

malexy, a man ought to know his limitations and I can assure you that analyzing short term volatility in the oil market is beyond mine. We have two troubling macro-trends in the oil markets; increasing consumption and relatively fixed (if not declining) production. As the trends mature pricing will become more and more problematic.

My biggest concern is that we're setting ourselves up for comparable but much nearer term price shocks in some key AE commodities that could take a lot of the luster off of some of today's stellar performers.

John Petersen, I heartily agree regarding limitations...my wife frequently explains mine to me.

Regarding oil, in the short term I suspect upward pressure will moderate. The economy will continue to sputter. The KSL has "several million barrels" largely developed and ready. Nat gas is becoming "plentiful" between the various US shales and the new liquifaction trains activating this year and next. (And I happen to think that Pickens is gaining supporters, which could further pressure oil downward.) Obviously things can change...but...

Regarding the key AE commodities to which you refer...again I concur, although I don't think this wil be a short term issue. Thus I have a developing stake in Lynas and others.

Actually, my big concern is Mexico collapsing. Their four biggest sources of income are: oil (and the Cantarell is depleting quickly); remittances from workers in the USA; tourism (and swine flu did not help); and manufacturing (how many cars do you think they are producing?). As our #2 source of oil, what will they do when their production matches their domestic demand, likely within the next 3-5 years?

malexy, I don't have any kind of opinion over the short term prices of oil and gas because I've never been any good at that kind of forecasting. The last time I tried it cost me a small fortune. It's far easier for me to speak with confidence when I can stretch things out to macro-scale.

I plan to work with Jack Lifton on the series of AE commodity articles and Jack's nowhere near as sanguine about short-term supplies as many are. The Chinese have too much control and even when things go well it can take several years and hundreds of millions of dollars to permit and develop a new mine.

One of my favorite subscription services is from Stratfor and they also see major potential problems with Mexico on the long-term horizon. It could become a problem more quickly but that kind of geopolitical forecasting is more an interest than an expertise.

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