Global Warming, PEAK OIL, and Your Portfolio

A friend of mine has a skeptic's interest in global warming. Recently he dragged me along with him to a lecture on this topic. The presentation was, if anything, a sad example of the decline in quality of education in America. The lecturer claimed to be "an educator" but I have no idea what he was educating us about, and his old school slide show was a mix of random "man is bad" photos and personal anecdotes (like I got a bad sunburn on vacation last year - maybe from the hole in the ozone or global warming or something...).

Anyway, I actually am an environmentalist of sorts and have always been concerned about the environment so I don't want anyone to get the wrong idea. I drive economy cars that get nearly 40MPG, I use compact florescent lighting in my house, use heating and cooling sparingly, etc. Even though I'm skeptical about everything including global warming and peak oil scaremongers, I still think its prudent to think about various future scenarios and how you can thrive under any circumstances.

If you read some of the more balanced reviews of "THE INCONVENIENT TRUTH" over at Amazon you will see that it is unbalanced, contains quite a few errors, omissions, inconsistencies, and unsubstantiated opinion. Some scientists today believe the current warming trend has actually peaked, others recognize global warming and man's contribution to it but insist that the empirical data indicates that it is not and will not be a serious problem (for example see Meltdown: The Predictable Distortion of Global Warming by Scientists, Politicians, and the Media (written by Patrick J. Michaels, a professional climatologist with a Ph.D. in Ecological Climatology, who is a professor of environmental science at the University of Virginia). But perhaps one of the stranger aspects of the debate is that the global warming doom and gloomers generally talk about a couple degree temperature change over the next 100 years despite the evidence that we are unlikely to be dumping massive quantities of greenhouse gasses into the atmosphere for another 100 years.

This is one reason I'm not that concerned about global warming (not to mention that its even possible more people would benefit from warming than would be harmed). Peak oil is in my opinion a much bigger potential issue. We have become utterly dependent on cheap, easy oil and we are currently living in the great oil empire era. None of our ancestors had to face a problem like peak oil, so it's just not on the public's radar.

Last night I watched a documentary called The End of Suburbia

It’s all about peak oil. First let me say that the film is full of sensationalism and political nonsense, and the peak oil junkies in the film will probably be wrong about almost everything :) That said, I'd recommend you check it out if for nothing else, just to stimulate thought. Apparently most oil industry experts and geologists agree we will reach global peak oil before 2030 (the consensus range is more like anytime from right now to 2030 with many pointing to the 2015-2025 timeframe). I should also note (and you won't see this in the film) that some experts (like the execs at Exxon and Saudi Arabia's Aramco) believe we have over a 100 years worth of supply at today's consumption rate so the peak oil timeframe is very much in debate. That said, the only way we will stay at the existing consumption rates is if we conserve (improve efficiency or alter usage behavior) or have zero global growth which is extremely unlikely.

Yes, many of the peak oil junkies are similar to the global warming junkies. They correctly identify a trend but badly gauge the “how soon, how severe, and who cares” aspects. Global peak oil will probably happen sometime between 2020 and 2030. The biggest variable is simply what kind of energy demand changes we will see. 3 trillion barrels of reserves (if even accurate) may not be all that much in the grand scheme of things depending on demand. For example India’s automobile sales jumped 18% last year and its truck and bus industry is growing at a 30% pace (China is similar). Over the next 20 years India and China alone could end up with 2, 3, 4 times the energy demands of the United States (why not, they have 10 times our population). Meanwhile the US is currently using more than 25% of global oil production while at the same time oil production is in decline in 33 of the 48 largest oil producing countries.

I think the decline of global oil production after we hit peak oil will probably mirror what we saw in the US when we peaked in the 70’s – a pretty steep decline but obviously not instantaneous. The rapid rise in prices will stall the decline and give us time to move towards viable alternatives. I don’t think it will be the end of the world, just the end of the world as we know it! :) The new world will be even better than the old one; energy will probably end up being cheaper, cleaner, and more abundant than it is now, which will lead to new records in productivity and quality of life.

The time (perhaps a decade or two) we have before peak oil is exceptionally long when it comes to technology and investing, so I’m optimistic that alternatives will become viable before oil supplies become seriously constrained. We will have many years, decades maybe, of post-peak oil (albeit with tight supplies and elevated prices) giving us time to work out and deploy alternatives. Nothing is going to happen over night. There is a lot of promising research going on right now in the fields of battery design, solar and geothermal energy, hydrogen, organic based fuels, and many others. I have even personally made my own biodiesel in 55 gallon drums from waste vegetable oil (acquired from local restaurants) and run it in a friend's Ford truck. Biodiesel is a great renewable alternative, but we are talking about MASSIVE changes that must take place before alternatives can be rolled out and some argue that they CANNOT be rolled out at the required scale (for example due to land constraints or manufacturing capacity constraints, or the cost of deployment, particularly in a post-peak oil world). Many also question the net energy equation of alternative fuels like ethanol, hydrogen, and biodiesel (the energy that must be put into producing and delivering the fuel vs. the energy that the consumer will pull out of it).

There will undoubtedly be some new oil and gas discoveries, some benefit from being able to extract more from existing wells, and some supply from non-traditional sources like the Canadian tar sands and deep offshore drilling. But most experts suggest that these will not be enough to satisfy global demands.

One of the more famous geologists of the 20th century, Hubbert, predicted in 1956 that the US would hit peak oil by 1970 and he was pretty much right on (we peaked in ’71). One of the worlds biggest oil companies, chevron, now has their own discussion web site related to peak oil (http://www.willyoujoinus.com/) so even big oil players are taking this seriously. Here’s a quote from Chevron's site: “While supplies are currently abundant, they won't last forever. Oil production is in decline in 33 of the 48 largest oil producing countries, yet energy demand is increasing around the globe as economies grow and nations develop.”

When we first hit peak oil, it will be somewhat uneventful. In fact, we won't KNOW we hit peak oil for at least a year after we reach that milestone. Then prices will rise more rapidly. Perhaps slowly at first, then more dramatically. People will first search for explanations, then they will play the blame game. In fact we have already seen this in 2006 - we had a dramatic rise in prices with all sorts of mixed explanations and LOTS AND LOTS of blame game and political posturing - this has led some to suggest we have already hit peak oil. This is unlikely though, in fact oil prices have fallen pretty hard over the last few months, production levels have hit new highs, AND OPEC recently announced production cuts - so by definition we have not hit peak oil). On the other hand Bank Credit Analyst announced last week that “Global oil production growth has been decelerating for almost two years, and is now nil. Moreover, there is a marked divergence between global oil production (decelerating) and total global industrial production (accelerating). The deceleration in oil production is striking given that the number of operating rigs has climbed by almost 50% since 2004.” So a big increase in operating rigs and very little increase in total production - what does that tell you?

Of the three largest oil fields in the world, two have peaked. Mexico announced that its giant Cantarell Field entered depletion in March, 2006, as did the huge Burgan field in Kuwait in November, 2005. Due to past overproduction, Cantarell is now declining rapidly, at a rate of -13% year over year. In April, 2006, a Saudi Aramco spokesman admitted that its mature fields are now declining at a rate of 8% per year, and its composite decline rate of producing fields is about 2%, thus implying that Ghawar, the largest oil field in the world, may have peaked.

Anyway, after the initial price increases, it's only going to get worse. Of course things will move in cycles, as higher prices and shortages reduce demand. Everyone will feel the squeeze at first, then only the "rich" countries will be able to afford substantial supplies. That means we might keep the pumps flowing in the United States for many years after we hit peak oil (assuming the middle east cares more about money than ideology which remains to be seen). But the decline will be terminal.

Only if technology does not save the day (an unlikely scenario): We would be forced to virtually eliminate long commutes and there would be a new build out of mass transit, especially rails. Many would be forced to either live in cities or live in the country and grow their own food - exactly the way it used to be before the great modern oil era. There will be a surge in organic farming (which could be a good thing, although expensive and labor intensive). Domestic manufacturing will have a big resurgence because it will be prohibitively expensive to import goods from low cost of labor countries as we do today. And of course by that point there will be a frenzied focus on alternative energy. More nuclear and coal power plants will be built (for as long as we have coal and radioactive isotopes) and more people will heat their homes with wood, possibly resulting in deforestation.

I can't emphasize enough the fact that any serious consequences from the end of the oil age could be completely avoided given technological advancements so you can't go betting the ranch on a disaster that probably won't materialize. But I can guarantee there will be exceptional investment opportunities as a result of peak oil, disaster or not. There are going to be BIG winners and BIG losers resulting from the inevitable changes that will occur and you should be thinking about how to invest accordingly and what to look for in the future. If and only if no viable solutions emerge, the transition will be very painful for financial markets, with international indexes taking the biggest early hits. The optimists usually triumph, but every investor should be cognizant of long range trends that may impact investments and behavior.