Planning For the Peak

You will never wake to the headline, "World Runs Out of Oil."

Rather, global oil production will rise, reach one or more peaks, and decline. Well before production declines to very low levels, the peak will mark a point of no return that will be a watershed in the economic history of the 21st century. For the first time, industrial economies will be forced to a lower-quality energy source. And this decline will affect every aspect of modern life.

The notion of a world speeding towards a peak in oil production was made famous by the geologist M. King Hubbert. In the late 1950s and early 1960s, Hubbert used a simple bell-shaped curve to forecast the annual rate of production in the lower 48 U.S. states. At a time when oil production was increasing rapidly, Hubbert forecast that it would peak in about a decade (1965-1970) and decline thereafter. Despite provoking nearly unanimous derision, his forecast was remarkably accurate. Oil production peaked in 1970 and declined fairly steadily thereafter. A similar bell-shaped pattern appears in several other oil producing nations, such as Norway, the United Kingdom, and Egypt.

Subsequent research indicates that Hubbert's forecast was part genius and part luck. U.S. oil production is determined by the costs of production, the price of oil, and the quantity of oil "shut in" by the Texas Railroad Commission, which aimed to stabilize prices by opening and closing oil wells in Texas to ensure a balance between supply and demand from the 1930s through the early 1970s. Had prices evolved over some alternative path or had the Commission controlled production using some other criterion, Hubbert's prediction probably would have been less accurate.

The element of luck has been overlooked by those who use Hubbert's method to forecast the peak in global oil production. Their forecasts have consistently erred, suggesting an imminent peak, only to be revised when production continued to rise after the predicted date. Hubbert's methodology cannot predict the peak in global oil production because it mistakes the price-induced slowing of oil consumption during the 1970s and 1980s for the effects of resource depletion.

The genius in Hubbert's approach stems from a simple aspect of his bell-shaped curve: relatively large uncertainties about recoverable oil supply have relatively little effect on the timing of the peak. For example, updating Hubbert's analysis through 2003 and including Alaskan production indicates that about 230 billion barrels will be produced from fields in the United States, which is nearly 30 percent more than Hubbert's original estimate of 171 billion barrels. Despite this increase, the timing of the peak "backcast" hardly changes. Put simply, compared to pessimistic assessments, optimistic estimates for the amount of oil that remains only postpone the peak slightly. Given this fact, I can confidently state that the peak in global oil production will occur in my lifetime (I am 48).

The peak in global oil production marks a fundamental change in supply. Prior to the peak, production can increase significantly with little or no increase in price. This is possible because most of the world's supply is found in a few very large fields. For example, there are more than 14,000 oil fields in the United States. Of these, the largest 100 contain nearly 40 percent of total supply. Increasing production from these large fields is relatively inexpensive. But once these large fields are depleted, they are replaced with fields that are one-tenth or one-hundredth their size. These high-cost fields reduce the profitability of production even at higher prices.

The importance of production costs is illustrated by the history of U.S. production. Oil production in the lower 48 states increased more than ten-fold between 1900 and 1970, but the real price of oil barely increased. After 1970, real oil prices doubled and then tripled. This price increase caused drilling to double. Nonetheless, production declined nearly 20 percent. As a result, the oil and gas sector increased its fraction of national investment without increasing its contribution to GDP -- in effect, hundreds of billions of dollars were flushed down a dry hole.