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The Peak Oil Crisis: The Summer Ahead

The situation is not good. Our average gasoline price just climbed past $4 a gallon and all indications are that it will continue to rise. After Goldman-Sachs made headlines by telling us that oil is going to $150 or maybe $200 a barrel in six months or maybe two years, Morgan Stanley announced that oil was going to $150 dollars a barrel by the 4th of July. Not to be outdone, the CEO of Russia’s Gazprom, weighed in with a forecast of $250 oil in the “foreseeable future.” As oil jumped $11 in a single day to just below $140 last week, all of these estimates seem plausible.

Everyone agrees that oil has gone up faster than gasoline this spring so that gasoline prices are likely to increase by at least another 20 cents before the summer is over. Even our normally reticent Department of Energy is forecasting $4.15 gasoline by August.

A good place to start looking at the current situation is with the latest International Energy Agency (IEA) and Energy Information Administration (EIA) monthly reports which were released earlier this week. As could be expected, high prices have led to a drop in demand now projected to be 280,000 barrels a day (b/d) in the U.S. and other OECD countries during 2008. This drop however is easily offset by a 1.2 million b/d increase in demand by other countries such as China, India and the Middle East.

Growth in worldwide oil supply is not doing well. Non-OPEC production is sagging and is expected to increase by only 310,000 b/d this year and OPEC currently is close to producing flat-out out with new projects slipping. OPEC’s production is now expected to grow by only 500,000 b/d during 2008, half of the amount anticipated earlier this year. The bottom line is that supply is not keeping up with demand.

The most troublesome aspect of the IEA report is that OECD crude stocks fell by 8.1 million barrels in April – a time of the year when they typically increase by 30 million barrels. Preliminary numbers suggest that the drop is continuing in May and June. The world is living off its stockpiles, a situation that will not long endure. If it turns out that supply only grows by about 500,000 b/d while demand increases by 800,000 b/d, it should be obvious that prices are going up until the demand falls.

The debate as to just what prices will substantially cut demand continues. The current $130-$140 a barrel is tearing the world’s airlines apart with inefficient planes being grounded, schedules slashed and merger partners sought. The bottom line for the air carriers is whether on not they will be able to increase fares enough to cover the cost of fuel without pricing their discretionary passengers out of the market so that they are left flying half-empty planes into bankruptcy. For Detroit, the issue is whether they can get by selling token numbers of their formerly profitable SUVs and pickups while they retool for much higher mileage cars.

Declining car sales and airline flights will not bring about the reduction in demand that will be needed. Even if we were to ground all of our civilian aircraft, we would only save about a million barrels of fuel a day, about 5 percent of our daily consumption. It will take decades to swap out our fleets of inefficient cars for something more suitable. It is going to take a lot more than cancelling a few flights and slowing the addition of inefficient vehicles to our fleet. It seems as if it will take “really high” prices or, of course, shortages to cause a significant – 10 or 20 percent – drop in oil consumption. This week the IEA announced that gasoline sales in Britain where they are paying $8.50 a gallon, but have very good public transit, have dropped by 20 percent.

While not yet precarious, the supply/demand/stockpile balance in the U.S. is becoming a cause for concern. Keep in mind that the U.S. must import two-thirds of its crude oil and petroleum products each day. So far this year domestic crude production is down by 1.6 percent over last year, but imports of crude and products are down by 7.5 percent. Over the last month the situation has grown worse with crude oil imports down by 8 percent and net product imports down by 25 percent.

Although some maintain the U.S. refiners can import all the oil they can use, others are concerned that the drop in exports from Mexico and Venezuela, coupled with continuing insurgent interruptions in Nigerian oil production, means that three of the U.S.’s top suppliers are no longer sending us our accustomed quantities.

Now this would be all right if we were reducing our consumption by an equal amount. So far this year however, U.S. consumption is down by only 2.8 percent and according to the EIA during the last month, U.S. consumption of gasoline and other petroleum products is down by only 1.3 percent. Like the rest of the world, we are living on stockpiles.

This situation obviously cannot go on. During the last month, U.S. crude stockpiles have dropped by 18 million barrels out of a total commercial reserve which is now just over 300 million barrels. Remember that much of that 300 million is below the minimum operating threshold and as a practical matter is not useable.

Most of the drop in U.S. crude stocks currently is along the Gulf coast where imports from Mexico and Venezuela usually arrive. If, or when, shortages develop, they likely will start there. With the first shortages, there naturally will be great pressure to dip into the Strategic Petroleum Reserve, especially before the November election, to keep the wheels turning for a little longer.

Over the longer run, the only alternatives are much higher prices or massive emergency conservation measures, likely including rationing, much economic hardship and undreamed of changes to our lifestyles.


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