We humans can't produce crude oil any more than we can produce sunlight or mountaintops. We will continue to pump the finite amount of oil that nature made many millennia ago, and when there is no more readily-accessible oil to extract, we will stop pumping and go home.

Are we really going to live to see this day? Is there any way to significantly delay it? What alternative forms of energy can we develop to replace oil? And as investors, what will all this mean for our portfolios? Is there any way to turn the world's energy chaos into opportunity? By the end of this article you'll know the answers.

The End of Easy Oil

Please don't misunderstand; the world will not run out of oil any time soon. There are still small oceans of petroleum waiting beneath Middle Eastern sands, Siberian ice pack, Venezuelan jungles and Alaskan tundra. Indeed, right here in the Lower 48, there are yet-undiscovered lakes of oil patiently awaiting the driller's bit. Many billions of dollars will be made by those fortunate enough to discover this oil and bring it to market. We may be entering the Autumn of the Oil Age, but it isn't December 31 st quite yet.

The question for investors is this: What price will tomorrow's oil command? We have recently seen crude sold for over $42 per barrel. Is this a temporary price spike, or part of a major, more or less permanent, upward price trend?

That question hinges on three major factors: Surging worldwide demand, war and terrorism, and a third, not-so-well-known phenomenon: Peak Oil.

What is Peak Oil? It is the name geologists have given to a proven fact of oil exploration and development: when half of an oil field's reserves have been extracted, the field will begin to yield progressively less oil with every passing year, until it yields zero.

Imagine you have a loaf of bread, and you decide to eat half of that loaf with every meal. With the first meal, you enjoy half of the entire loaf. With the second, you get half of the half that remained after the first meal. With the third meal, half of that, and so on, until eventually you're splitting tiny morsels and crumbs, at which point it just isn't worth bothering with anymore.

That's what peak oil is like. With any given field, the big payday is up front, in the field's first half of production. Now, you still get paid as you extract the second half, but it is in progressively smaller amounts, until the paydays are negligible.

Now, before the discovery of the Peak Oil phenomenon, many assumed that rates of oil extraction in any given field could or would plateau at high levels, until there remained no more oil to extract, at which time the well would simply quit producing. Full throttle until the gas tank runs dry, as it were.

All that began to change after Dr. Marion King Hubbert, one of the most respected geophysicists of his time, stunned the world geological community with his audacious and counter-intuitive prediction in 1956 that U.S. crude oil production would peak sometime between 1966 and 1972.

Many of his fellow geologists were both shocked and dismayed. Here was this eminent scientist, holding multiple advanced degrees from the University of Chicago, himself a Columbia University professor, the Director of the Shell Oil Research Laboratory no less —proclaiming a kind of wild-eyed doomsday scenario, at a time when U.S. fields were spurting oil nearly everywhere one bothered to poke a hole. It was almost scandalous.

Well, here's the amazing thing: it all came true. U.S. crude production peaked in 1970 at just over 11 million barrels per day—right on schedule—and never reached anywhere near those levels again, introducing the oil shocks of the 1970's. (Since 1970 U.S. production has steadily declined to its current level of around 7.5 million barrels per day, despite the construction of the Alaska Pipiline).

Obviously. Dr. Hubbert understood something about the behavior of oil fields that his contemporaries did not. What was it? Richard Heinberg, author of The Party's Over: Oil, War and the Fate of Industrial Societies explains:

“During this early phase, production increases rapidly as the easiest-accessed oil is drained first. However, at a certain point, whatever remains is harder to get at. Production begins to decline, even if more wells are still being drilled .

“Typically, the production peak will occur when almost exactly half of the total oil in the reservoir has been extracted. Even after production has tapered off, some oil will still be left in the ground ; it is economically impractical—and physically impossible—to remove every last drop. Indeed, for some reservoirs only a few percent of the existing oil may be recoverable ( the average is between 30 and 45 percent )” (pp. 88, 89, emphasis ours).

This is what we mean by “The End of Easy Oil.” It's not that there will be no more oil in the ground. There will always be oil in the ground. For producers the questions will be, how hard will it be (and thus how much will it cost) to get it out? And, how high will the going rate per barrel have to be to make it worth my while?

Now, as investors our concern in this discussion is simply this: as peak is approached, what is left in the major fields is becoming harder to extract , reducing the growth of oil supply, thus increasing its price .

Growth in crude oil production is slowing, and prices are moving steadily higher. When worldwide growth actually stops, we'll know we're at peak. Then the long decline in net crude production will set in, and the real price fireworks will have been underway. It's anyone's guess how high the price of crude will eventually go, but triple digits per barrel certainly does not seem out of the question.

But we're getting ahead of ourselves. Even if the U.S. has peaked in production, do we know for a fact we're approaching peak worldwide? That's the key question.

Will We Really See Worldwide Peak Anytime Soon?

Granted, Hubbert's Law pinpointed U.S. peak production, but does it apply to the worldwide situation as well?

Yes, it does. Hubbert's Law is a function of the scientifically-observable behavior and characteristics of oil wells. It has been observed over and over again in the field, and exceptions are rare indeed. By aggregating the major oil-producing countries' production curves into a single matrix, analysts would be able to estimate worldwide peak, plus or minus a few years.

However, in order to make that estimate, analysts need to have at their disposal hard numbers of the reserves of each major oil-producing nation.

As you might imagine, given the uncertainty about reserves there are more optimistic forecasts and more pessimistic ones. As a potential oil investor you should be aware of the range of opinions and estimates.

By far the most optimistic forecast comes from the U.S. Geological Survey (USGS). They estimate proven worldwide reserves (oil in discovered fields, not yet pumped out) at 1.7 trillion barrels, and undiscovered reserves (oil not yet discovered but suspected to exist due to geological markers) at 900 billion barrels, for a total worldwide reserve of 2.6 trillion barrels.

Assuming that current worldwide demand of 80 million barrels per day grows two percent each year, worldwide peak would then occur around 2030.

The pessimists, on the other hand, point out two weaknesses in the USGS calculations. First, their proven reserves figure relies in large part upon the public reporting of reserves by OPEC nations. The problem is, in OPEC, production quotas are determined by production capacity, which in turn is directly related to reserves. They have a built-in incentive to overstate reserves in order to justify higher production quotas, and thus, greater oil revenues. As a result, some dramatic restatements of OPEC nation reserves have occurred over the years.

A good example is the period of 1988-1990, when Iran and Iraq both doubled their estimated reserves within months of each other, despite a decade-long war during which no significant exploration was performed. Not to be outdone, Saudi Arabia followed suit in 1990, reporting their reserves had grown some 90 billion barrels, virtually overnight—the rough equivalent to three North Sea oil deposits . Again, no major finds were cited to explain this sudden expansion of oil reserves.

These are the kinds of numbers the USGS have relied upon to make their 2030 peak estimate, and critics have understandably called this out-of-hand acceptance of dubious reserve claims unjustifiably naïve.

The second reason the USGS peak estimate is doubted is because of its assumption of only two percent yearly worldwide consumption growth. China alone has increased its oil imports over 6,000 percent since 1993, and if its current consumption growth continues, in about five years China will be consuming nine million barrels of oil per day, exceeding the entire daily output of Saudi Arabia , the world's largest producer. The rest of the Far East, and India as well, are not far behind.

These facts have led others to different conclusions concerning the date of worldwide peak. Two of the more prominent geologists studying peak oil are Princeton professor Kenneth S. Deffeyes, author of Hubbert's Peak: The Impending World Oil Shortage , and Dr. Colin Campbell, a former Amoco oil geologist, founder of the Association for the Study of Peak Oil (ASPO) and author of the book The Coming Oil Crisis .

Deffeyes declines to state an unequivocal peak date, but believes Hubbert's methods paired with realistic reserve and consumption estimates would place worldwide peak no later than 2009. Campbell has consistently estimated the year of peak production to be 2010. If their estimates are correct, the world does not have much time before oil production begins declining and prices undergo their inevitable vertical climb.

Paul Roberts, author of The End of Oil , in 2003 interviewed Joe Romm, former acting assistant energy secretary for the Clinton administration, who told him, “The point to remember about production isn't that it peaks, but that it declines rapidly afterward , at a time when the world demand would be moving rapidly in the opposite direction .”

When considering these facts, keep this last one in mind: it is widely known that markets do not merely react to current supply-demand pressures; as discounting mechanisms they anticipate them. Is it possible that this year's surge in oil prices is but the first preliminary phase of a decade-long oil-price moonshot?

Perhaps you're wondering now, can't new discoveries and improved drilling technology take up the slack, or at least delay the inevitable? What if we open up the Alaskan National Wildlife Refuge and unconventional oil resources, won't that help? There are those who answer yes to all these questions. Are they likely to be right?

Given the stakes involved, it's no surprise that a number of theorists and economists have come forward in recent years to assure policy-makers and the general public that we are decades from worldwide peak oil production—indeed, some suggest, we may never reach worldwide peak in the lifetimes of anyone living today.

The arguments are based, for the most part, upon faith in certain precepts of human nature and general human experience. We should give each argument close consideration.

#1: Past predictions of oil depletion have been consistently wrong. Predictions of immanent oil depletion by government analysts in 1914, 1939 and 1951 were proven later to be wildly off the mark. There is no reason to believe today's doomsayers are any smarter.

It is true that predictions of oil shortages were made by government bureaus and others in the first half of the 20th century, and that they were flat-out wrong. However, the idea that past oil-depletion forecasts were incorrect, therefore every

forecast in the future must be incorrect, is a faulty assumption. Each forecast needs to be assessed on its own merits, according to the facts and science available at the time.

The 1950s were the best years for oil discovery worldwide, and those discoveries have formed the basis of our worldwide oil economy ever since. However, worldwide discovery peaked in the 1960s. Each decade since, we have found less and less oil, no matter where we look around the globe. Today we pump and burn between three and four barrels of oil for each new barrel discovered. To get the graph lines of production and consumption moving in the same direction again, major new sources of oil are going to need to be discovered—which brings us to our next argument.

#2: We have always been able to discover new sources of oil when we needed to. Whenever mankind has been faced with a critical challenge such as this, he has always found a way, and this instance will be no different. Oil will come not only from areas we now know, but from places we do not yet know of. Higher prices will stimulate more investment to find more oil.

Geologists who have been scouring the earth for new sources of oil over the past four decades would no doubt appreciate being told where exactly these alleged hidden oceans of oil are. The last major finds were the North Sea and Prudhoe Bay in Alaska over thirty years ago, and they are now well past peak production. There have been no major finds in Iran, Iraq or Saudi Arabia since the 1970s, despite billions of dollars of investment in exploration every year. New discoveries are made, but they have consistently been in the small-to-medium-sized range, and to reverse the current trend of worldwide reserve depletion, the world must find elephants, not squirrels.

Les Magoon is a USGS geologist who has mapped world petroleum fields for the past thirty years and who does not share his employer's sunny optimism concerning worldwide peak. He told a researcher recently, “We've been drilling holes all over the world since the early 1900s. Statistically, it's unlikely that there is all this ‘hidden resource' waiting to be found. It is pretty hard to support scientifically.”

As for higher oil prices stimulating more investment in exploration, it is worth noting that a barrel of crude was priced at $3 per barrel in the early 1970's and that price has risen to an average price nearly ten times that level since, with little notable improvement in U.S. oil discovery or production. Domestic oil production peaked when oil was $3 and has fallen, not risen, despite dramatically higher prices.

This fact holds true not just for the U.S. but for 20 of the 25 largest oil producing nations worldwide. Higher prices have indeed stimulated more exploration, but decades of effort by the best-equipped, best-educated geologists in the world have not turned the tide of reserve depletion. As a result, nations whose peak production lies yet ahead number just five: Kazakhstan, Iraq, Kuwait, Abu Dhabi and Saudi Arabia. Coincidentally, all of these are located in the most politically troubled region of the world.

Why are large deposits of oil so hard to find? The reason lies in the fact that oil is something of a freak of nature, a happy accident resulting from the convergence of several geological phenomena which must serendipitously work together. Paul Roberts explains:

“Oil is not…something that can occur just anywhere. It is the product of complex geological processes that take place only in certain quite specific conditions…you must first have source rock—the deeply buried sediments rich in organic matter. It is also necessary to have a migration pathway— cracks or porous rock through which the newly formed petroleum can escape toward the surface. Finally, a layer of impermeable stone or clay or salt is required, to trap petroleum and create a reservoir, or field…

“The source rocks…must contain enough organic material to generate usable volumes of oil and gas. The migration rock must be sufficiently permeable, or the oil won't flow freely through it. The cap rock must be sufficiently impermeable, or the oil will simply leak away.

“Above all the timing must be perfect. To become oil, the organic material in the source rock must be heated to a certain temperature for a certain period of time…between ten thousand and thirteen thousand feet below sea level…Source rock that isn't pushed low enough will not be cooked, whereas source rock that is pushed to far…will become too hot, and the petroleum is either ‘cracked' into gas or simply destroyed. There is no halfway: the conditions for oil either exist or they don't” ( The End of Oil , p. 50).