Peak Oil

U.C.-San Diego economist Hamilton weighs in on 'peak oil' and the world economy

Many analysts have begun speculating that world oil production may be nearing its apex. Will energy companies be able to keep up with rising demand from the United States, China and other countries? If accurate, what exactly does the so-called "peak oil" phenomenon mean for the world economy, and how will consumers and businesses respond? In a speech at the American Enterprise Institute last week, James Hamilton, an economist with the University of California-San Diego, took an in-depth look at these questions, and more.

To find out more about this event, visit the American Enterprise Institute website here:,eventID.1171,filter.all/event_detail.asp


James Hamilton: I'm honored you're here. I'm pleased to be here. I know some of you may be less worried about whether the world is going to have less oil as you are whether the room is going to have less chairs. But I'm honored you're here, and I hope you all have a chance to see from where you're sitting. This is a vertical cross-section of one of the very mature oil fields from Saudi Arabia. The green is the actual oil. The red is a gas cap on top of that and the blue is water which has been pumped under the oil to help force it to the top to where it can be gotten out of the ground more easily. And presumably all that blue used to be green. The thing I like about this picture is it sort of drives home the physical reality that there is this physical pool of oil down there in the ground. It's being taken out of the ground and once you've taken it out of the ground if you want to keep producing oil you've got to find another field. And if you want to keep producing more oil you've got to keep finding more fields faster and faster. Moreover, an incredibly large proportion of the world's oil has been produced from the super giant fields. And it's hard to imagine that we've somehow missed great numbers of huge oil fields down there. So can we keep on always finding more and more oil at a faster and faster rate? Well for the United States at least I think the answer is very clearly no. This is a plot of the daily U.S. oil production from the United States going back to World War II. And you can see that that peaked in 1970. And it's been on a steady downward decline since 1970. There was a bit of an upward temporary glip there from the Alaskan production. That was one of the super giants, which was discovered over this period. But otherwise it's a clear downward trend.

And right at the moment in the United States we're actually producing the lowest level of oil as we have in the last 50 years. And it's certainly not the case that cheaper imports somehow pushed out the U.S. production, in fact, it's the exact opposite. Shortly after U.S. production peaked in 1970, and we started to import more and more oil, that's when the world price of oil started to shoot up. The OPEC embargo and the quadrupling of oil prices in '73, '74, I think in part was a response to this fact that the U.S. was no longer increasing production. And I think it's lower U.S. production that's forcing up the world price of oil and that's the nature of the connection. Nor was this decline in U.S. production a result of the lack of trying. Here's a measure of U.S. drilling efforts in millions of feet of wells drilled per year. And you can see that following the peak in production, which was in 1970, there was a huge increase in effort at producing oil and gas in the U.S., a big surge in oil drilling. So that decline came really despite continuing increases in efforts. Now, it is true that there is a reduction then in the drilling after '81. And I'll be talking about the trend for that. But I think it's pretty clear, in the U.S., the story has been declining production.

Now the same thing, it seems to me, in terms of the geology is eventually going to happen on a global scale and the only question is when. In terms of answering that, let me start with the easy aspect of it. It certainly hasn't happened yet. This is a plot of the total production of oil from all the world. A moment ago we were looking just at the U.S. For the world as a whole it is the case that production seems to keep going up year after year. We have succeeded on a global basis in always finding more oil to replace what disappears. Now if you'd been sitting in 1981, 1982, it might have looked like we were at a peak there in terms of global production. There was a significant decline in world oil production there for several years following 1981. But I think it's pretty clear that that decline had nothing to do with geology and everything to do with geopolitics. And you can see that pretty dramatically if you look at this graph. This is a plot of the monthly crude oil production on a per day basis for three of the countries that have added to a lot of the interest in oil markets over the last few years, Iran at the top, then Iraq and then Kuwait. And what you see here for example is in 1978-79, with the Iranian revolution, very dramatic, a sudden huge plunge in world production. And it actually came close to 10 percent of total world production at that point. That Iranian production rebounded a bit and then with the Iran-Iraq war both the Iranian and Iraqi production fell. Again, that decline amounts to about another 10 percent of world production. Those two events were really the key thing that was going on for that decline in production. They resulted in a huge increase in the price of oil between '79 and '81. And that increase in the price of oil is what prompted a big decrease in demand and that was part of the development we were seeing.

And then more recently of course you can see on this graph, also very dramatic, the first Persian Gulf War in 1990-91, when Iraq and Kuwaiti production were knocked out. That's a little less dramatic on this plot we're looking at, going back to that graph of world oil production. Here's the 1979-80 effect, 1990-91 was very temporary, you see that as sort of a temporary blip. And then also on this graph you see other events. The OPEC embargo that I mentioned is this drop in oil production. And you see a decline in oil production from cyclical factors. Among the recent ones, in 1997 with the East Asian crisis you saw a big drop in world demand and production came down with that. And then with the 2000 and 2001 economic slowdown, again, you saw a drop in production. But those drops are all of a geopolitical cyclical character, nothing to do with geology.

So what's been going on in the most recent period, the last two years? Well look at the last two years at that graph. There's been no decline in production. In fact, there's been a huge surge in production. That graph slope, there for the last two years, is about as steep as you find it anywhere on the plot. What we've been experiencing worldwide for the last couple of years is not a reduction in supply. It's been a tremendous surge in demand. Well where's that surge in demand coming from? A lot of people talk about China. Why would you pick on poor China? Last year, for example, China only accounted for 8 percent of the total world consumption of petroleum. It seems like that shouldn't be such a big deal. The U.S., by itself, is accounting for a quarter of the world oil production. And if you add the U.S. together with the other OECD countries, the major developed countries, they account for 60 percent of the world production. So why aren't we talking about those countries, the ones that are really using the oil rather than China? Well the reason is if you're interested in the question why did that graph take off? Why was that slope so steep? The question is what accounted for the change between 2002 and 2004? Who's doing stuff differently now from what they did two years ago? And here's the graph that summarizes that. And what you see is that China, although it's only accounting for 8 percent of the world consumption, accounts for a third, all by itself, of that growth. So the answer to the question why has growth in oil use worldwide suddenly taken off? When somebody says the answer is China there's the reason. In fact you'll also see if you add together the U.S. and the other OECD countries you're getting substantially less than half of the increase coming here.

So in terms of where is that surge in world demand for oil coming from? The answer I think is pretty clear. It's coming from the developing countries, particularly China, rather than the major developed countries. And let's take a look at that Chinese oil demand in particular. So here's a graph of China's oil demand going back to 1990. And that's a terrific slope there. It turns out that's a 7.5 percent growth per year, every year for 15 years going up 7.5 percent. And if you grow at that rate you're going to pretty soon start to be a pretty major player on the block. And that's exactly what happened. Now if you show a graph like this with a nice exponential trend to it to an engineer, the first thing they want to do is extrapolate that trend. So let's see what we get. Let's extrapolate that trend out, 7.5 percent growth per year. Here we are in 2005, well you project that out by another 20 years and China will be consuming something over 30 million barrels of oil a day. So for a comparison in the U.S. we're talking about 20 million barrels a day today.

In other words, if this keeps up China is going to be consuming 50 percent more than the U.S. Now one an engineer looks to the graph like that the next question they ask, being an engineer, is oh my gosh, where is that oil going to come from? Where are we going to get the fields to pump it from and the tankers to haul it from and the refineries to use it? And the engineer says we've got some problems here. I don't think this can be done. And you put what the engineers are saying, or would want to say, just extrapolating that trend. It's about to go way off. With what the geologists are saying, which is well there ought to be some peak here in production. You put the two together and the two of them together can get quite worried about things.

So here is an example of the kind of graph that you often see from people who talk about this problem or worry about it a great deal. Designation, we are here. Demand is going up at this tremendous exponential rate. Supply is often limited. And we could maybe argue about how much more oil are we going to find? Are we going to put off that peak 10 years or 20 years, whatever? But whatever your answer to that, no matter how optimistic you wanted to be, if you put it together with these kind of exponential trends of 7.5 percent growth in places like China sooner or later you're going to be overwhelmed. It's just the simple math of the situation.

Now I want to talk about that math in just a moment, but first let me just give a little more insight into why this urgent demand is coming now from the developing countries and what we maybe should expect to follow after that. Suppose we go back in time to say to 1960 and take a group of about a dozen countries. In the horizontal axis here we're looking at how rich was that country in 1960? The farther to the right you are on that graph the richer that country was in 1960. And the vertical axis tells us how rapidly that country increased its petroleum use on a per year basis, from 1960 to 2002. Now what you see there is a very clear negative correlation that the poorer countries are the ones that have the fastest growth. But this has been a very standard part of the industrialization, moving to a manufacturing economy from an agricultural economy. You start out that with a very rapid growth rate of petroleum. But if you then follow a particular country over time, so for example, this looks at France, Germany and Japan. Germany and Japan of course in the '50s and '60s were sort of like China is today, these real powerhouses of growth. And they were doing the same thing as China then. There were tremendous growth rates per year in their petroleum use. And what you saw in those countries is that the richer they got the more that petroleum use growth rate slowed down. So that's the first bit of good news here. You can't possibly expect that 7.5 percent growth of China to continue. As China gets richer and richer, and they're doing that in a hurry, I certainly expect that growth rate to slow down. So there's going to be some mitigation, even if you just want to play this game of extrapolating the trends.

But again, the math is hard to quarrel with. Okay, not at a 7.5 percent exponential curve, but some slower rate, you'd have the same basic issue. And what's going to happen? Well geologists are going to give you that gray curve. The engineers maybe want to give you the yellow curve, but economists want to point out there's a third variable here, which is actually critical, and that's the price, the price of oil. And an economist would take this graph from the engineer and this graph from the geologists and say well wait a minute. Something's got to give in this system and the something is the price. If what you're telling me is true the price of oil has to rise to choke off that demand. Particularly choke off the demand from the developing countries, but choke off demand from the developed as well. Choke off the demand in order to keep those two together. That's the basic insight in economics. The price is going to have to rise, to the extent that those extrapolations are right, to keep supply equal to demand to prevent that 7.5 percent growth, prevent the growth from outstripping supply.

Now have we seen that? Well China has been a little bit slow in adjusting its petroleum use despite the increases in price we've seen. In part that seems to be because China is insulating its citizens to some degree. They're still paying below the world price. There are price controls in China. And here's an example of what you get from that, a long line of poor taxi drivers trying to get their gasoline. You control the price and you're going to see shortages, but that really doesn't change the reality. One way or another China is going to have to slow down their use of oil, maybe it will be because of price, maybe it will be because of rationing, but the fundamental reality is there. But I think that has delayed, a little there, the response of China to the incentives that are out there right now in terms of prices. And in the U.S. I see something a little bit similar in that the sales of the bigger cars were certainly in decline as of the beginning of 2005. And GM responded to those declines in sales with these huge employee discount incentive programs. And they succeeded in selling a lot of big cars in the summer of this year, but they did so at a tremendous loss. They've lost, GM alone, nearly $3 billion on their North American operations as a result of these subsidized sales in effect, trying to stick their thumb in the dike as I see it against the decline in the sales of the big cars. Now they've given up on that and what do we see? Well here's, for example, the sales of some of the big vehicles for the U.S. Comparing September of this year to September of the year before and you can see where the bloodbath has spanned. Just one after another those big gas guzzling vehicles just plummeted in sales. And we had the October figures this week, which I don't have up for you, but it's even more dramatic in the most recent figures. So that's what we kind of thought would happen. Consumers are going to respond to these prices by economizing. And one way you economize is by buying cars that have better gas mileage. I think, again, the response was a little bit delayed to that, but now it's under way.

Now another point I want to emphasize is that these vehicles sales are not really going to affect this year's gas consumption so much of next year. And next year as more cars are replaced with more fuel efficient vehicles you'll see another drop in demand and so on for the following year. It's going to take several years for this process, that's clearly under way now, to effect demand. And similarly in terms of gas sales per se, this is a plot that each week's gas sales in the U.S. A lot of noise in those data, but basically the red line on top is the 2005 figures. The blue line on the bottom is 2004. And you can see up through the first part of the summer we were consuming even more gas than the year before despite the higher prices. But beginning in August and September you start to see gas use way down. Now as gas prices have come back down we're starting to see some erosion of this effect in the numbers that were released just today. But again I think there's no question you're going to see consumers respond, but it's going to take time for all these changes to have effect.

So the economists say that there's a missing variable here, the missing variable is price. Price is going to cause those demand paths to adjust, it has to, but it can take a lot of time. And in particular when you look at events like I was talking on a moment ago, the Iranian revolution, the Iran-Iraq war, you've got to reduce consumption very quickly. And if you have to reduce consumption very quickly those prices have to go up a very great deal. And you see those adjustments then overtime, you can have prices come back down. But that's one of the realities we face.

There are also tremendous delays on the supply side. So here is a graph of the worldwide expenditures on exploration, development and production in petroleum and gas going back to 1981. And what you'll see here is the black line is exploration, the blue is development, the red is production. All of those were in a long run decline there, going back to '81, up until very recently. The last couple years you start to see an increase. Now why is that? Well let's take a look at the price of oil. But rather than looking at it in dollars, let me adjust it for inflation. So let's look at the real price of oil. Take every year's oil price and convert it to current dollars based on how much the CPI has changed between then and now. So here's the plot going back to 1970. And you see that in real terms the price of oil actually peaked in '81 in response to those geopolitical events I was talking about. If you converted the price then to current dollars using the CPI you'd be talking about something like $95 a barrel. And basically with the OPEC embargo you had a big surge in price. With the Iranian revolution, Iran-Iraq war, you had another big surge in price. You had demand responses, which took several years to manifest. In response to those demand responses price started to come down. Eventually there was a collapse even in the nominal price of oil in 1985. There was a brief blip up in the price of oil, in real terms, in 1990-91, which was the Persian Gulf War that I commented on. But we saw that that was a very temporary disruption. And if you sort of ignore that what you see if there is a very broad trend there of declining real prices of oil from 1981 to '97. There's a particular acceleration of that trend after the East Asian crisis in '97, which brought demand down. But overall there's a long run declining trend in the real price of oil, which is saying that over that period the engineers were able to keep ahead of the geologists basically. And they did succeed. The world did succeed in finding more oil each year to replace what was gone.

As the world economies recovered there from the Asian problems you had a surge in prices. And again if you kind of take this long run view it seems to me we've entered a new phase. I mean this not just a temporary blip here the last couple of years. It's really for a dramatic move in the real price of oil and I persuaded myself that the reason for that is basically these demand surges. Now with the price coming up we should expect that decline in exploration spending to be reversed. And I see some indication of that. To be sure you can see those curves start to turn up a little bit even going back to 2003. In terms of a recent survey of the companies it looks like that spending may be up 13 percent or more for the current year. So we're certainly seeing some surge in exploration spending. That may help the problem, but again we're talking about very long lead times. You spend the money today and it's not until many years down the road that you see an effect. So that's true for both supply and demand, that there are these huge lags.

And if you look for example at the production of the 10 biggest publicly traded oil companies in the world, here they are. This is going back for the last three years. What you see is that as a group those countries seem to be having trouble keeping their production up. As many of them have had actual falls in production over this period as have seen increases. In part that's because the world is shifting away from sources of oil that these integrated majors were able to use, namely that's in free open economies, capitalist economies. More and more of the oil is in the control, physical control, of host governments. And that's part of what we're seeing here in this diagram. So the point is both the responses of supply and the responses of demand to the price incentives are going to take considerable time. And the key factor, certainly from the supply side, is expectations. If you're talking about a project you invest in today, it doesn't pay off until five or 10 years down the road. What really counts is what you expect in terms of the future.

So let me talk a little bit about that. So we've seen is very dramatic surge up in the price, both in nominal terms and real terms, in the last couple years. Let me just pick up a little bit here. So in terms of economic theory one contribution of the supply today is how much is physically being brought to the market, but another contribution to supply is storage. Anybody who's got an inventory of oil could always sell it in today's market if they wanted to. And the sales that come out of inventory are part of today's supply of oil. For that matter you can think of storing the oil, not just in some big vessel above the ground. In effect, you can store the oil in the reservoir by pumping it out a little bit more slowly. And let's think about the incentives for either of those calculations, for storing oil in whatever form you might have it that rather than selling it today.

So let's just take a hypothetical scenario. Let's take today's price of oil, it's about $60 a barrel, and that suppose you said that because of these supply constraints, demand continuing to surge, you looked at some elasticities and you said the only way this can work out is if the price of oil shoots up dramatically. Say we're going to need $200 a barrel of oil a couple of years from now in order to have supply equal demand. And there are some people talking about numbers like this. Well what would economists say about a scenario like that? If somebody says the price of oil is $60 today. It's going to be $200 in a couple of years. Well an economist would say if you've got some oil don't sell it today. Keep it in that storage tank for couple of years and you'll triple your money. And that's a pretty good deal. If you've got an investment out there which will do that by all means take it. Everybody should take it. Everybody will take it. If you've got oil in the reservoir don't pump it out today at $60 a barrel. Wait until its $200.

Well, let's follow this analysis one step further. So suppose we said the price was $60 today. Suppose we thought the price was going to be $200 in a couple of years. Suppose we agree that the incentives that that situation produces is that everybody is going to want to store the oil now rather than sell it later. What does that mean? Well if you're storing the oil now, you're not selling it now. There's not as much oil on today's market. It's going to drive today's price up. You're bringing that oil that you had to sell into the market in 2007. You're selling more oil in 2007. It's going to drive the price down. In other words, whenever there was this kind of gap, if oil prices are about to suddenly surge up there's a powerful economic incentive for the market to undo that. And the way the market would undo that would be we'd see the price of oil go up today even though it's not until a couple years that we're really going to have the production problems maybe. But the price would go up today in response to that, in response to investors trying to make as much money as they can.

And you might recognize that as an illustration of a principal of arbitrage. Usually we talk about intratemporal arbitrage, which would be at any given point in time a profit opportunity from a differential in the price. So for example if the price was very high in New York today and very low in London there'd be a way you could make money off of that. What should you do? A speculator should buy where it's cheap, London, and sell in New York where it's expensive. You're going to make a profit and your efforts to do that are going to drive those prices together. We call that arbitrage. It's kind of like the word arbitrate. There's a difference of opinion between New York and London, well, the speculators will arbitrate that difference. Force them to be together. Phil introduced me as an arbiter of this debate. I tend to look at markets to do that arbitration for us.

Well there's a similar issue with intertemporal, between different periods of arbitrage. Same sort of thing, if the price is low not in London, but today and high not in New York, but in the future, there is again an opportunity to buy low sell high. And that's basically what this storage does. And the force of that argument is the storage, if you want intertemporal arbitrage, will tend to force those prices together. Now not literally together because there are storage costs and some other factors, but it will keep them from being as wildly apart as that $6,200 that we were talking about. And both of these are very powerful forces. You can basically count on the fact that the price of oil is never going to be that different in New York from London just because people want to make a profit. And if there's a profit opportunity they're going to jump on it right away.

Now the point is that that speculation about today versus the future is going to create the incentives today to deal with a pending problem. If speculators are responding to that reality, holding the oil off the market today because they're storing it, making the price today higher, consumers today are forced to use less. And those high prices today are providing the incentive to producers to try to produce more. So it's not like a market economy is just waiting to run off the edge of a cliff if the engineers and geologists don't warn us and don't force us to make a plan. The market economy, just from people trying to make the most profit they can, is already taking account of that reality, that danger. And if it were true that we're just about to run out of oil what economists would expect is not that the price is going to suddenly jump from $60 to $200. Rather what they'd expect is that the price is going to start to go up well before we run out of oil, going to start to force that conservation well before we're actually at the point where it's completely mandated and hopefully to see a more smooth transition. So as I say rather than a cliff it's more a managed process. But it doesn't require the government getting in and managing it. There are incentives there from people just trying to make profit off of it.

Now you can actually buy oil today for future delivery on the New York mercantile exchange for example. And here are the prices as of Monday. I don't think they're too different today. So if you wanted to buy oil for delivery next month, in December, you'd pay a little under $60 a barrel. You could also sign a contract today that you wouldn't have to pay for, wouldn't take delivery of the oil until year from now, December '06. The price you'd pay for that is about $61. A little bit higher, a price rise of a couple dollars. You can take that as a guess of what the market thinks might happen to the price of oil between now and next year. Because again if the market thought the price of oil next year was going to be $80 what you should be doing is buying one of these contracts. If somebody's willing to give you the oil a year from now for $61, by that contract, take it and then you think you can turn around and sell it to somebody else for $80. The fact that this number is 61 says the market doesn't believe it's going to be $80, or at least that's not their best guess. It could be, but that's not the best guess. And interestingly if you look out to longer and longer contracts, two years from now, the price of that contract is actually lower than the price today. And going out to December '11 it's down to $55 a barrel. So that's saying the market is guessing we might have a little bit of tightness over the next year, but less and less a problem as you go farther into the future.

Now all these numbers are very close. So it's not a big difference between any of them. And that, in fact, is something you always see. It doesn't matter when in history you looked at these numbers you'd never see a huge radical change in the price from one year to the next or one year to five years. Why? Because of that intertemporal arbitrage, it's another thing you can count on. That these prices are going to move together just the same way that the New York and London price are going to move together. That's already built in, that the market doesn't expect huge dramatic changes. But there are some small movements and to the extent they're there, the market is saying well it looks like a tight problem for the next year perhaps, then things loosening up. Presumably some combination of these demand incentives are going to start to be more and more effective in a couple of years and that increased production is maybe going to be helpful.

Now if you're a believer in peak oil of course and think there's a crisis just around the corner, as I say, what you should be doing is buying these contracts. And rather than blabbing to the world about it go make yourself rich. It's right there, it's an opportunity. I talked about arbitration a while ago, to me this suggests that well we're not quite on the edge of the cliff yet. We did have a very serious issue with demand, particularly in places like China, surging and there just wasn't the physical production capacity to meet that demand. The only way you could deal with that is with a price rise, a very dramatic price rise, because of the gradual response of both consumers and suppliers. But I see that as, at this point, more of a matter of the demand than of the supply side, a least looking at numbers like this.

Now on the other hand there are some other numbers that seem very interesting to me. Here's an example of one. It's a chart of the quality of the crude oil that's being produced by the non-OPEC countries going back to 2000. The blue is a measure of specific gravity. The lower that blue bar becomes the cruddier the oil is. It's more viscous, more waxy, going to be more costly to use. And the black line is the sulfur content. The higher that black line gets the higher the sulfur content of the oil, the less useful it is, the more costly it is to refine. And what you see here is a very clear trend. We're getting cruddier and cruddier oil every year. That again is exactly what economic theory would predict. You use up the good stuff first. But the fact that this is as dramatic as it is, and as clear a trend as it is, is another indication to me that, yeah, this has been a very real process. We really are using up the best stuff. That's disappearing. We're more and more turning to stuff that's not quite as favorable as what we started off with.

In addition to that the fact that the quality of the oil is worse in terms of the sulfur content, the U.S. and countries all around the world are asking for more in terms of environmental guidelines. There are stronger and stronger restrictions in the U.S. and everywhere else on how much sulfur can be in the final product. Here's the plot that I just think is a fun kind of graph of the different requirements for fuel in the U.S. You can see they actually differ on a county by county basis. You could drive through seven contiguous counties out where I live in California, Arizona and Nevada, and in each county you'd be required by law to buy a different kind of gasoline. And that's been, in my opinion, a very costly policy in terms of the demands it places on crude oil. And I think we have to evaluate some of those policies given the reality of the product that's available.

But the combination of higher environmental goals and lower quality of the oil that's available has meant not only has the price of oil and going up, but the price of good oil has been going up relative to the poorer quality. So here for example is the spread between Brent crude which is a light sweet crude, very low sulfur, and the Maya crude, which is a heavy sour crude. Whereas that spread used to be something like 5$ a barrel a few years ago, recently it's been on the order of $15 a barrel. So I think that's pretty clear evidence that yeah, we are in a sense running out of the light sweet crude and more and more of the stuff we're using is less favorable.

Another question you might have asked, all the news about the hurricanes in the Gulf. This is the thunder horse that got a lot of publicity, but of course there was a lot of damage at various places. You might wonder why the heck are we getting oil out of such a difficult place? Why are we getting our oil from deep parts of the ocean when the hurricanes come through on a regular basis and zap out what's there? Well the answer to that is very simple. The reason we're trying to get oil in such difficult places is there isn't any more in the easy to get places. So there's no question, if you have your choice, put a nice little derrick in Texas where there's a nice capitalist economy and hurricanes aren't blowing you down and you get this nice light sweet crude. That's the place to go. But the oil isn't there anymore. We took it out of those fields in Texas and so we've got to go places like the Texas Gulf where it's a whole lot trickier.

Or for that matter why are we getting all of this oil out of the Middle East? And you go back to that graph of the production. This is a very unstable part of the world, all kinds of consequences. Why aren't we getting oil from Texas? Again, the same answer. We used up the oil in Texas. In fact the U.S. produced more oil than Saudi Arabia did, but ours is gone now. So we have to turn there. And as time goes on I think we're turning more and more to parts of the world that are less and less attractive in terms of stability of investments, for example Nigeria. My guess is that that's a country we'll be hearing a lot more about geopolitically in the next 10 years because that's going to prove to be a very important country in world production. And people will come to be as familiar with the political parties and conflicts there as we have with some of the other regions. It might not be your first choice of what you're going to hang your economy on, but we don't really have an alternative. And so there's a general principle here. The most reliable sources of oil are used up first. I think in a lot of different dimensions you're seeing we are turning to less and less reliable sources of oil precisely because the best sources are gone. And that is one aspect unambiguously of peak oil that I would say is here now, it's not something in the future.

So what should we expect to see from here? Well I'm persuaded we're going to see the price of oil rise over time. I think that this trend we've seen over the last couple years is the beginning of that long run reality that I think is unavoidable. That the industrialization of China and India and other parts of the world is for real. That's adding a very significant kick to world demand. And even if it's true that we do have the resources to produce some more oil for the next five years, the next 10 years, I can't imagine it being extrapolated at these rates that far into the future. So I think that what we've seen of the last couple of years is not just a temporary imbalance between supply and demand, it's a fundamental response to the fact that this was a major source of demand. And we really have to learn to live with it. So I expect to see the price of oil rise over time, rise relative to inflation. I don't know for sure that's going to happen over the next couple of years. We could see a retraction in response to these demand adjustments, but I see a long run trend as up because the man has to be contained.

A second thing that I think we can probably count on is that these temporary disruptions are going to become more severe. We have to worry more about hurricanes now because that's the place we have to look for oil. And we're more vulnerable to supply disruptions now than we were when all the oil came out of Texas because the places we're getting oil from are inherently more hazardous and more subject to disruptions than Texas.

And a third prediction I'm comfortable offering for you is that while all of this is going on who is the public going to blame? Well the public is going to blame the greedy oil companies, doesn't have anything to do is apply, doesn't have anything to do with demand, doesn't have anything to do with geography or geopolitics or weather. That's something I think we can count on.

So in a nutshell, what is the peak oil going to look like? I think it's going to look like our sources of oil are less and less attractive. We're more and more vulnerable to disruptions. We pay a higher and higher price. In other words I think peak oil is going to look a whole lot like where we are right now.

[End of Audio]



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