National Commentary

The Peak Oil Crisis: The Credit Crunch

Last week the price of oil went down, down, down, until Friday when word arrived that a tropical wave, which could turn into the first serious storm of the 2007 hurricane season, had just slid off the Africa coast.

Some of the 9 percent drop in oil prices was speculators taking profits, chartists concluding that a run to $80 for oil was not in the immediate cards, and hedge funds deciding they had enough excitement for one week and needed the money elsewhere.

However, if you can believe the oil traders, a lot of the drop was predicated on fear that the U.S. economy was going into the tank and the demand for oil would soon drop precipitously. While this notion flies in the face of all sorts of other current trends – surging Chinese demand, record US driving, and sagging world oil stockpiles – for a few days the notion that major economic setback was close at hand dominated the market.

For years now, it has been the peak oil mantra that in some not-to-distant day, oil prices and shortages would rise to the point where they would inflict serious, if not fatal, damage on the world’s economy. The other side of the coin – a major economic recession knocking down the demand for oil – is rarely discussed.

Given the precarious state of the U.S. economy – deficits, trade imbalances, bubbles, consumer debts – a recession, should one occur, certainly has the potential for all sorts of financial havoc. I will leave to others to decide whether comparisons to the 1930’s are in order and whether our current monetary controls will be up to the job of forestalling serious troubles. Our interest here is the relationship of oil production and economic well-being.

Let’s assume for the minute that the economic situation goes really sour over the next year. The Dow drops by thousands; construction stops; unemployment surges; and a myriad of other bad things happen. In this situation, it is fair to say that the demand for oil would drop, perhaps even precipitously.

Since oil production is easy to stop – just turn the valve – we can presume that world oil production would drop. “Spare” production capacity would rise and prices would go down, perhaps even back to the “good old days” of $40, $30, or even $20 a barrel. In this situation, oil production graphs would show a real peak and decline that we could all look back on and say “that was peak oil.”

Such a “peaking” may not be exactly what we have been expecting. It would not be caused by depletion of oil fields, malevolent governments or terrorists, lack of investment, or environmental restrictions on drilling. The immediate reason for the peak would be that major financial setbacks left us too poor to buy as much oil as we had been buying – similar to what parts of Africa are currently enduring.

With a major drop in demand, the really expensive-to-produce oil we are currently pumping from miles below the sea, or melting out of Albertan tar sands, or refining from corn probably would not be economically attractive. While the resource would still be there, it would have little place in a seriously depressed world economy. Perhaps it would become economically viable again in another era.

If a major economic melt-down were to occur in the next few years and oil production were to drop significantly below the current 31 billion barrels per year, then it is difficult to envision it ever recovering to set new production levels. A major melt-down is likely to be a prolonged affair during which oil will obviously be produced at some level – probably somewhere between 20 and 30 billion barrels per year.

It is not difficult to imagine, even at these reduced production levels, reserves of cheap-to-produce crude would fall quickly and prices would rise again. In the aftermath of a major meltdown, it is difficult to imagine that much money available for investment in new, very expensive oil exploration.

As this is being written, the price of oil is gyrating between two forces. On one side is a hurricane, making its way across the Atlantic possibly to threaten oil production in the Gulf. On the other are sliding stock markets and hourly reports of bad economic news suggesting the demand for oil might be dropping in the near future. Even the OPEC Secretariat has noted the potential of the credit crunch to reduce the demand for oil later this year. This, of course, confirms the OPEC stand that there really is no need to increase oil production later this year.

At the minute, the hurricane-is-imminent sentiment seems to be in the ascendancy and the price of oil is rising again. But these are volatile times. The world’s stock markets continue to fall and odds are the hurricane will go spinning off to strike somewhere far from the oil fields.

All this is another way of saying the path to peak oil and much lower energy consumption may not be the same one we think we have been following. Sooner or later peak oil will come. It is as inevitable as the sunrise.

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