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Commodities Economics: What Is Peak Oil?

With all of the recent discussions surrounding the possibility of electric cars, many economics investors have already started to move beyond crude in search of the next technological revolution.  

But the reality is that the world economy is not even close to eliminating the use of fossil fuels, and it will be quite some time before market analysts are truly able to forget about this commodity.  For these reasons, it is a good idea to gain an assessment of how crude oil prices are likely to move over time.  This is because energy prices impact all of us, not only investors, as higher energy costs can have a detrimental impact on society.  

Energy Productivity Levels

First, it is important to know that the gasoline at the gas station is not in its natural form.  These are resources that must be found and extracted from the Earth, and there are different rates at which this productivity maneuvers.  During certain portions of the year, oil production levels might be higher than others, and this can have a strong impact on the underlying price of oil itself.

Based on the work of Shell geologist M. King Hubbert in the 1950s, the term ‘peak oil’ refers to the point in time when crude oil production reaches its extreme maximum levels. This is important on many different levels, and it is a situation that is ultimately inevitable given the fact that crude oil is a finite resource.

After peak production, supply will decline and oil prices will rise.  This is because there is still the same number of consumers in the market, and they will now be chasing fewer and fewer goods.  When physical commodities are more scarce, they will almost always rise in value.  This creates some interesting investment scenarios for those that are able to play the long-term trends in these market assets.  

Interestingly, the peak production point is actually more important than the point at which all fossil fuel supplies eventually run out.  This is because price surges will be so extreme after this point, that the market volatility will make crude almost unreliable as an instrument.  It also means that it will be much more difficult to locate oil supplies, and this suggests that there would be very few people left in the world that would actually be able to profit from these assets on a consistent basis.  

In the chart above, we can see the countries that will be most heavily impacted by these types of trends going forward.  By far, the economy of Saudi Arabia depends on crude oil exports more than any other country in the world.  Saudi Arabia makes up more than 16% of the world’s proven crude oil supplies, and this puts the country in a vulnerable position once oil supplies reach their point of exhaustion.

Here, we can see some of the same figures separated by region.  This chart shows that the Middle East has already reached ‘peak oil’ and that the forecasts expect declines or the region in the years ahead.  For the global economy as a whole, petroleum geologists predict that we will reach peak oil very soon, and this would ultimately lead to surges in energy prices.

Of course, energy prices do not only impact the success or failures of oil companies.  All industries depend on the energy market to some extent, and higher oil prices can make it more difficult for some industries to generate strong profits (i.e. the airline transportation industry).  

For all of these reasons, crude oil markets will continue to be important and impactful for decades and decades. With all of the recent media attention that is being paid to tech products and electric vehicles, it can be easy to miss the longer-term trends.  But, those have not yet changed in energy markets.

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