Did Doug Casey call me an 'idiot'?...
Closed for Labor Day... Did Doug Casey call me an 'idiot'?... Why M. King Hubbert was dead wrong... And why he'll continue to be wrong forever... The human cycle of abundance... Last chance to get our best price on DailyWealth Trader...
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In today's Friday Digest... a family squabble of sorts. Civil wars are always the worst kind. People reserve a special fury for those most similar to themselves...
My old, dear friend and mentor... a man I refer to as "Uncle Doug"... launched a broad attack against "Peak Oil" critics. He referred to one Peak Oil critic, Peter Glover, as "an idiot," and then accused him of being "intellectually dishonest." (You can read Glover's article, which I highly recommend, here.)
Doug took a pretty hard line. As many of my readers know, I've written many times over the past decade that I consider Peak Oil to be one of the greatest intellectual frauds ever perpetrated. Clearly, Doug and I don't seem to agree. I've gotten several e-mails asking about Doug's view. Many folks even thought Doug was calling me an "idiot." And I suppose we should ask Doug for clarification on that particular point... He might have been talking about me, too.
There are bigger issues at stake here, though... And I believe having a correct understanding of these issues is critical... perhaps the single most important economic issue of the next several decades. This matters because if M. King Hubbert (the original Peak Oil theorist) was right in 1956 when he forecast global oil production would peak around the year 2000... we're facing a major change in the future of the energy industry.
If we're actually about to run out of oil, or if production is inevitably going to decline, we ought to be making major investments in alternative sources of energy, like windmills and solar farms – even if those technologies are terribly expensive. Likewise, if we're really about to run out of oil, spending huge sums of capital to dig up most of Alberta (for oil sands) and mandating electric cars might be sensible policies.
Investors face an even more basic question: If oil production is inevitably doomed to recede, isn't the future price of oil likely to be drastically higher?
On the other hand, if M. King Hubbert is wrong (and I believe he was catastrophically, even laughably, wrong), perhaps we're wasting billions of dollars in capital pursuing energy solutions that aren't practical, economic, or... in the case of photovoltaic semiconductor (PV) solar... physically possible. If the production of oil is more likely to greatly increase over the next 50 years, perhaps investors ought to be cautious about assets that require high oil prices to be economic.
Most important... if we're not really going to run out of oil... perhaps we ought to be leery of corporations and their partners in government that want to tie us to energy products and policies that aren't in our ultimate best interests. We should be on guard for ideas that will handicap us with higher energy costs for the next several decades.
Just imagine how the Germans and the Spanish will feel when they realize the PV solar panels from First Solar that they spent billions of dollars on don't work. Not only that, but the plummeting price of natural gas made them completely unnecessary. That's why M. King Hubbert's theory matters. That's why this is far more important than a simple intellectual disagreement between a handful of pundits. And that's why I'm so passionate about these ideas.
Energy lies at the foundation of our ability to produce wealth and enable the pursuit of happiness. When people talk about us running out of oil (or other energy resources), what they mean is a vast decrease in our ability to produce wealth. These kinds of theories – that man has exceeded some fundamental limit to his ability to progress – are called "Malthusian."
Thomas Malthus was an economist during the industrial revolution of the early 1800s. He believed population gains associated with the rise of machines would cause food shortages and a global famine. Of course, that never happened. Human ingenuity and the free market (whose pricing system communicates across vastly distributed markets) overcame the rise in demand for food.
Any time I hear an idea or theory that claims mankind is about to become poorer in the future, I always assume it is false. Then, I try to figure out how it's likely to be proven wrong. Obviously, some societies do suffer catastrophic declines. But when you study the causes, you will always find some critical disruption to the free market and its price system. Man, when given the liberty to produce more wealth, always does.
So... when I heard about Peak Oil for the first time in the late 1990s and early 2000s, I knew it had to be wrong. But what is the flaw? Isn't oil a physical resource? Wasn't it created millions of years ago? Obviously... if it's not a renewable resource, we'll inevitably run out of it, right? And if we're going to run out of it... yes, sooner or later, the production of oil will peak and begin to decline. How could M. King Hubbert be fundamentally wrong?
That's exactly the conclusion my friend Doug Casey reaches. Doug explained his view in his Wednesday e-letter, Conversations with Casey. (If you don't receive Doug's e-mail, you should sign up. We recommend it highly... and it's free.) And he's smart enough to dismiss the price system as a panacea, too...
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Peak Oil is widely misunderstood, even by economically literate people, oddly enough. Such people rightly point out that the world will basically never run out of anything, as long as the market is free to set prices... That's absolutely true, but irrelevant to Hubbert's point, which was strictly a geological one: The number of conventional deposits of light, sweet crude in the U.S. are finite, and the search for them has been more thorough than anywhere else in the world. [A]nd a documented decline in discoveries had to lead to a documented decline in production of this particular kind of oil. |
In fact, Doug thinks Hubbert's theory explains the current high price of oil:
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Peak Oil is a major reason why, in spite of a rapidly cooling global economy, oil prices are still near historic highs, at over $95 a barrel... clearly evidence of the essential correctness of Hubbert's theory, which accurately predicted the peaking of light, sweet crude-oil production in the U.S. circa 1970. It was not only technically daring, but occupationally and politically dangerous in the '50s for Hubbert to forecast that the U.S., and then world production, would go into decline. And he was right. |
Unfortunately for Doug (and fortunately for the rest of us), he's wrong about Peak Oil. It's clear from reading his comments that Doug has never even bothered to read Hubbert's seminal, 57-page tract, Nuclear Energy and the Fossil Fuels. His 1956 treatise explained Peak Oil theory and predicted a global oil production peak around the year 2000. (You can read it here.)
For example, Doug says: "To my knowledge, Hubbert never said anything about oil sands, shale oil, oil from coal, heavy oil from Venezuela, or deep-ocean drilling off the coast of Brazil or other places. He did not say, and Peak Oil does not mean, that the world is going to run out of oil."
Both claims are exactly wrong. First, Hubbert not only discusses shale oil, tar sands, and the heavy oil of Venezuela, he includes offshore reserves and specifically mentions the shale oil reserves of South America, too. Hubbert was also interested in coal reserves and natural gas reserves. As he explains on p. 4 of his report, he was trying to determine the world's total energy reserve: "a map of the whole world, which, despite its inherent imperfections, is still necessary if we are to have even an approximate idea of where we are now, and where we are going..."
Hubbert's theory is simple. He sees the world as a kind of giant oilcan. The can has a limited amount of energy. When it's gone, it's gone. That is very likely true. It's also likely (but not proven) that oil takes millions of years to form and the Earth isn't producing material amounts of new supply.
But... what Hubbert got wrong is just as important as what he got right. And what he got wrong was that by using current demand curves and current estimates of known reserves, he could predict when we'd run out of oil.
In his paper, he explains his critical assumption was the size of the total oil reserves...
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The only a priori information concerning the magnitude of the ultimate cumulative production of which we may be certain is that it will be less than, or at most equal to, the quantity of the resource initially present. Consequently, if we knew the quantity initially present, we could draw a family of possible production curves, all of which would exhibit the common property of beginning and ending at zero, and encompassing an area equal to or less than the initial quantity. |
Make no mistake, Hubbert was absolutely trying to forecast when we'd run out of oil. He didn't understand how the price system would reduce demand and produce alternatives (if supplies did run low). He based his forecast on production curves and the current best estimates of total supplies. For example, his paper cites production curves from Ohio. He argues that Ohio oil production peaked in 1896. He does the same for Illinois, where he says production peaked in 1940. These predictions were simply wrong. They are also laughably naïve because they didn't account for further discoveries of additional reserves or changes to technology that could extend the life of the wells.
Today, Hubbert's supporters argue his theories simply didn't include "unconventional" sources of oil. But that's not true. Hubbert discusses all of the known oil reservoirs. The same goes for new methods of oil extraction.
Hubbert's supporters say you can't count oil production using new methods – which makes no sense if you're actually trying to figure out production curves. And once again, that's simply not an accurate description of Hubbert's work. He mentions innovative methods of oil extraction by name. See p. 18, where he calculates production in Illinois by both "primary methods of production and... by water flooding."
"All right," you might argue. "So maybe Hubbert was wrong about the particulars, but that doesn't mean he was wrong fundamentally. We're still running out of oil. And it's only a matter of time before all hell breaks loose because there's no more..."
I will happily concede that there may be some fundamental limit to the amount of energy man can profitably extract from the Earth. But I don't believe the risk that we might one day run low on supplies of crude oil or other hydrocarbons is a threat to human happiness.
Other supplies of energy will surely be discovered. Many already have been, like nuclear energy. On the other hand, the ways in which Hubbert was wrong are very important to the decisions we make today about energy.
Hubbert was basing his forecast on a specific number – the existing known supplies (as of 1956) of crude oil, in all its forms and from all types of basins. As he says: "Assuming the ultimate potential oil reserves of the United States to be 150 billion barrels, of which 52.5 [billion] had been produced by January 1, 1956, leaves 97.5 billion barrels still to be produced."
His estimate for the world's total reserve was only 1.2 trillion. We know today that estimate was woefully wrong. Today, the proven world reserves are more than 1.6 trillion barrels, despite 56 years of increasing production. Just one example of the supplies Hubbert didn't foresee: The average estimate of the Orinoco heavy oil reserve in Venezuela is more than 500 billion barrels.
Why Hubbert was (and still is) wrong has nothing to do with the price system – although that explains why we will never actually run out of oil. Hubbert was wrong because he didn't understand how technology would greatly increase the size of the total reserves. As Hubbert's own calculations would show you, increasing the size of the known reserves has the impact of pushing off Peak Oil.
Today, known reserves are larger than they were in 1956 when he first published his theory. Thus, Peak Oil is, at the very least, decades away. But the reality is, our ability to discover new reserves continues to increase. That means it's much more likely the risk of Peak Oil will continue to recede.
There's a cycle here I hope you'll notice... as long as the oil industry has been tracking known reserves, we've seen that reserves tend to keep pace with, or slightly exceed, production. That's counterintuitive. You'd think that as production increases rapidly, reserves would get consumed and the total amounts would fall. But that's simply not what's happened. That's why we have more reserves now than we did 56 years ago, despite the huge increases to production. How is that possible?
Look around. Observe that the same kind of abundance tends to manifest itself in almost every area of human endeavor. The simple fact is, the more energy we use, the more we discover. Likewise, the more computers we make, the better they get. The more food we grow, the more efficiently we can grow it. This so-called experience curve is the result of the application of the human mind. That's the one thing none of the experts ever seems to figure out. This is the real reason Malthus was wrong. It is the real underlying reason Hubbert is wrong. Be glad... It explains much of the wealth we enjoy.
I'd very much enjoy reading your thoughts on today's Digest. I firmly believe that one of the main reasons why people are fundamentally pessimistic is that they don't really understand the feedback loop (the experience curve) that allows us to create wealth through innovation. History is the long story of human progress. Why so many people expect that to end during their lifetimes is a mystery to me. Send your notes to feedback@stansberryresearch.com.
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