Why is it so tricky to define ‘peak oil’?

at 03:21 PM ET, 10/06/2011

The debate over peak oil can get pretty slippery at times. Geologists will point out the (obvious, banal) truth that there’s a finite amount of oil out there beneath the rocks and, at some point, we have to reach maximum production. Economists and other peak-oil skeptics, for their part, will say that markets can always adjust. If current supplies dwindle and oil gets pricier, then companies will find it profitable to drill for harder-to-extract oil in the Arctic and Canada’s tar sands and elsewhere. No big deal. Yet often it seems like the two sides are talking past each other.

(Nabil al-Jurani/AP)
Perhaps a clearer way of looking at matters comes from petroleum economist Chris Skrebrowski, who argues that peak oil is best defined as the point at which “the cost of incremental supply exceeds the price economies can pay without destroying growth.” In other words, eventually the world will max out on production of the cheap, easy oil — the stuff that comes from Saudi Arabia and other OPEC countries. At that point, as long as demand for crude keeps growing, prices will rise and we’ll have to resort to more expensive oil from the Arctic and tar sands and so forth. And those higher oil prices could cripple the global economy. On this view, then, “peak oil” means the point at which the price of crude acts as a hard ceiling on growth.

In Harvard Business Review, Chris Nelder and Gregor Macdonald concur with this view, arguing that we’ve likely already reached this impasse. Production of “conventional” crude, the easy-to-drill stuff, seems to have hit its peak in 2004, maxing out at about 74 million barrels per day. And, since oil demand — fed by growing countries like China and India — isn’t letting up, that means the slack has been taken up by unconventional sources like natural gas, heavy oil, and tar sands from places like Canada.

One big problem with these new sources is that they’re costly, possibly too costly for comfort. “We have ample historical evidence that when petroleum expenditures reach 5% of GDP, recession typically follows,” Nelder and Macdonald write. “Annual energy expenditures rose from 6.2% of U.S. GDP in 2002 to a painful 9.8% in 2008, which was immediately followed by an economic crash. And now oil is sending energy expenditures back above 9% of GDP, just as we see fresh indications that the recession persists. This is not a coincidence.”

Does that mean we’ve finally hit the point where oil is seriously constraining our ability to grow? Perhaps, though here’s another twist. Michael Levi counters that expensive oil, in and of itself, isn’t necessarily a hindrance to growth. After all, the United States has had quite a few years where petroleum expenditures exceeded 5 percent without whacking the economy (in the early 1980s, for instance). The real killer, Levi argues, is volatility. “What does appear to play a large role, particularly in the 1970s [recessions], is a rapid increase in oil costs that temporarily overwhelms the economy’s ability to adjust.”

And it appears we’ve reached the point where rapid swings in price is a persistent problem. In the old days, Saudi Arabia had plenty of spare capacity and could always flood the market with extra oil if supplies got pinched. But that's no longer the case. Global demand is growing too quickly, and the Saudis are running out of spare capacity. Nor will new, unconventional sources alleviate the problem entirely. That’s why, Levi and Robert McNally recently argued in Foreign Affairs, “Wild fluctuations in global oil prices are here to stay.” However you want to define peak oil, it looks like we’re in for an uncomfortable ride.

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