Peak Oil

What is it…and why we should care?

Peak oil is the point in time when the maximum rate of global supply extraction is reached, after which the rate of production enters terminal decline. This concept is derived from the Hubbert curve, and has been shown to be applicable to the sum of a nation’s domestic production rate, and is similarly applied to the global rate of petroleum production. Peak oil is often confused with oil depletion; peak oil is the point of maximum production while depletion refers to a period of falling reserves and supply.

M. King Hubbert (a geo-physosist from Royal Dutch Shell in the 1950’s) created and first used the models behind peak oil in 1956 to accurately predict that United States oil production would peak between 1965 and 1970. He was “right-on” and his work is now referred to as Hubbert peak theory, and its variants have described with reasonable accuracy the peak and decline of production. According to the Hubbert model, the production rate of a limited resource will follow a bell-shaped curve based on the limits of exploitability and market pressures. In general, the Hubbert curve suggests that production stops rising and then declines. Supply shortfalls will cause increased energy prices, unless demand is mitigated, often by higher prices, conservation and/or alternatives.

Optimistic estimations of peak production forecast the global decline will begin by 2020 or later, and assume major investments in alternatives will occur before a crisis, without requiring major changes in the lifestyle of heavily oil-consuming nations. Pessimistic predictions of future oil production operate on the thesis that either the peak has already occurred, oil production is on the cusp of the peak, or that it will occur shortly.

Whether the optimistic or pessimistic view is taken, one thing is clear; because the future is un-known, and the possibility exits that crude oil production has peaked…and this means there is a price risk in the future. This price risk can be prudently hedge against.

This long term view (regarding “peak oil”) further cements the importance of knowing your energy budget objectives and analyzing how much risk you can “stomach” should an event like “peak oil” go against your desires. One cannot control whether “peak oil” becomes a reality, but one can control the price exposure should production peak, casusing a shortage in supply and thus higher energy prices.