The Reality of Peak Oil In 2012

Jim Brown
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What will it really be like when the peak oil age finally arrives a couple years from now? It won't be the Mad Max doomsday scenario but it is going to be really painful for those not prepared for it.

This is the third chapter of a series I started on Monday. You can read the others here.

What Will Really Happen in 2012?
Saudi Arabia Oil Production Has Peaked

To review, I believe peak oil will arrive in late 2012 if Saudi Arabia is really hiding the truth about their available production or as late as 2014 if they actually have as much production as claimed. When peak oil arrives will not be known for many months afterwards because of the millions of barrels in storage around the world. It could be a year or more after the actual peak before the stark realization of the problem dawns on the world's consumers.

Oil prices will rise before the actual peak. Like we saw in 2008 when spare capacity was less than a million barrels per day and the price rose to $148. As inventories slowly decline the price will tick slowly higher. I don't believe in the spike theory until shortages begin to appear but I do believe we will see prices rise as time progresses.

When refiners try to add to inventory and producers start allocating production farther and farther out to fill the orders it will cause a bidding war. When a refiner in March tries to buy a million barrel cargo for June delivery and producers say the earliest available is August the spot prices are going to start inching higher. Once producers understand supply is insufficient to handle all the demand they will start jacking up the prices. If ten refiners call a producer asking for oil and they can only supply five then the five highest bidders win.

Let's assume for the sake of this article peak oil arrives in late 2012 but the impact of those slowly shrinking inventories does not arrive until the summer of 2013. Between now and then prices have ticked slowly higher and $130 is the average price per barrel. Gasoline is $4 but still readily available.

Stories begin to circulate about shortages of light crude. OPEC again claims there is plenty of oil but their claims fall on deaf ears again. Refiners are starting to panic about the lack of light crude despite the OPEC claims. This was the problem in 2008. There was a shortage of light crude, the kind most refiners are setup to process. The majority of excess OPEC capacity is heavy or sour crude and most refiners can't process that oil without extensive modifications costing hundreds of millions of dollars per refinery and a long list of environmental permits to produce a high sulfur product and deal with the excess impurities.

Gasoline prices begin to tick higher and at a fairly rapid pace. Within a couple months prices are over $4.50 and realization is beginning to dawn that they are NEVER going lower again. Within six months prices are over $5.50 and still going higher.

Products made or transported with oil, which is nearly everything we touch today and almost everything we eat, are growing more expensive as each day passes. At first it is negligible. Ten cents here, 20 cents on something else but before the year is out the food bill alone has gone up 25% because of the extra costs involved in growing, processing, packaging and transporting the food to market. How much do you spend on food per month?

The Census Bureau claims a family of four on a "moderate" budget spends $217.50 per week or $972 per month. Add 25% for oil costs and that increases your expenses by $243 per month. These costs will continue to escalate as the cost of oil filters through the system.

In our mythical family of four the husband works outside the home and commutes about 50 miles per day round trip in a car that averages 15 mpg in the city. Add in other driving to the kids baseball game, weekend trip to Wal-Mart and maybe a visit to the inlaws and dad consumes 21.3 gallons per week.

Mom takes the kids to school and swaps with other moms in the neighborhood carpool. She makes trips to the food store, department store, dentist, gets her hair done, takes kids to soccer practice and baseball practice and goes to lunch with a friend. Even though all her errands are relatively local she ends up putting about 250 miles on her car every week. (National average is 250 per week) Mom has a car with better gas mileage but the in town, start and stop driving reduces that mileage to 15 mpg.

The adults end up with about 575 miles per week at 15 mpg. That is 38 gallons of gas. In the summer of 2010 that gasoline would have cost around $100 wk, $433 per month. ($2.65 per gallon) In the summer of 2013 it costs $209 per wk, $905 month. That is an increase of $472 per month. This is our hypothetical family. I suspect a real family today is driving much more than that. Three years from now they will be driving a lot less.

This increase in transportation expenses is not limited to families. City, state and local budgets are getting hammered. With fleets sometimes numbering in the thousands the fuel costs are a major problem. If your personal fuel costs doubled you know those running huge fleets of cars/trucks driving a lot more miles are really suffering with their budgets.

How does a city or state handle a massive increase in their fuel budget? They either raise taxes or reduce services. For reasons I will explain later they will not be able to reduce taxes. That means they have to cut services.

Their fuel is not the only problem their transportation divisions will face. With automobile usage falling and the cost of asphalt going up more than double an obvious choice would be to use less asphalt. Fill fewer holes, lay less blacktop, scale back on maintenance and new road construction. They will buy fewer trucks and heavy equipment.

If they have less work to do because of limited funds then they need fewer workers. Laid off workers won't go out to eat at restaurants, take as many clothes to the dry cleaners, spend less at the grocery store and avoid the malls. Layoffs will occur in every industry not just state and local governments. A laid off worker will eventually miss mortgage payments. Homes will be foreclosed and housing prices begin to fall.

Businesses that depend on consumer traffic will be forced to raise prices to compensate for increased fuel costs. However, consumers already in a bind over fuel costs themselves will stop spending, not because they don't want to but because they have no money. Adding $1000-$1500 in monthly expenses to the majority of homes in America will cause terminal results.

Commuters will quickly see the benefits of moving closer to town and closer to work. Homes in the suburbs will quickly lose value as for sale signs sprout like weeds in subdivisions farthest away from the city. Home and apartment prices near the city will skyrocket in value as those early movers bid up the prices. Those suburb dwellers who were slow to get the picture will see the value of their homes quickly decline below the value of the existing mortgage. They will be trapped with the home and the commute and unable to pay for both.

The rise of foreclosures will be worse than in 2008. Entire blocks of commuter homes will go empty as they abandon the homes to move closer to the city. Previously unacceptable apartments and run down houses in the inner city will suddenly be occupied by suburbanites willing to pay any price for a roof over their head and be close to work.

Unfortunately businesses of all kinds and sizes will be hit with the same halt in consumer spending. Once consumers stop spending it is only a matter of time before businesses stop spending. The economic cycle will grind to a halt as the worst recession in a century grips not only the U.S. but the world.

States and local governments will not be able to raise taxes because of the flight out of the suburbs. Raising taxes on an empty house does not gain you much. With rising job losses swelling the unemployment roles governments will be hemorrhaging cash. Raising taxes on unemployed workers is a losing proposition. There is no way out for the state and local governments other than cutting services to the bone.

This is the end of the cheap oil age and it will take several years to play out because initial denial of the facts will be the easiest medicine to swallow. Everyone will believe the constantly rising gasoline prices will eventually come down because they always have in the past. Unfortunately the geological facts are working against the consumer thought process. Depletion will continue forever but exploration and new production has been slowing since the 1970s.

Even a sudden and concentrated effort to increase production is doomed to fail. If there were a new 10 billion barrel field discovered in the deep water in the Gulf of Mexico when the peak oil problem was first announced in early 2013 it would not produce any measurable oil until 2020. It takes 5-7 years from the first discovery to harvest any material production. Deepwater wells take months to plan and drill, months to years to complete into producing wells and years to design, build, outfit and launch production platforms to collect and process the oil.

Shifting into high gear after peak oil arrives will only reduce the pain years into the future. Depletion is still going to take 4-6 mbpd out of existing production every year while those new fields are being explored. By 2020 when crude oil production could be 10 mbpd less than demand the addition of a 1 mbpd field will help but it won't solve the problem. We will be too far behind the curve to ever see daylight again.

The only factor that will make all of this pain somewhat bearable and slow the onset of a truly ugly future is the "undulating plateau" of the initial peak in production. The spike in prices will destroy demand. $4.50 gasoline will cause that family of four to cut back on nonessential driving. Demand will decline slightly and inventories will rebuild. As consumers get comfortable with $4.50 gasoline they will begin to drive more. Inventories will decline and prices will rise again. The next level of demand destruction could be $5 or $5.50. Whenever it is reached demand will again slow and the cycle will repeat. This undulating cycle of price driven demand destruction will keep final demand exactly even with production for several years. Eventually depletion will tip the scales to the point where prices will rise faster than consumers can cope and we will be in for a lost decade of our own.

This weekend I will conclude this series with plans I believe every investor reading this letter should take to reduce the pain headed our way. It is not going to be fun but compared to the alternative it is the best choice.

Jim Brown

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The OilSlick Newsletter is based on the expectations for global oil production to peak and begin to decline in the 2012-2014 timeframe. This is called "Peak Oil." This is the point where global production of conventional oil supplies can no longer be supplemented by enough oil sands production, deepwater oil production, biofuels and natural gas liquids to offset the decline in existing fields. The roughly 6% annual decline of existing production due to depletion is larger than the rate of new discoveries and new production being added each year. The Peak Oil countdown clock is ticking and time is growing short. Peak Oil is coming, are you prepared?