Investing in Peak Oil

Investing in Peak Oil: Blade Runner and the Future of Oil Profits

A Taipan Publishing Group Strategy Report
by Irwin Greenstein, Senior Research Analyst, Taipan Publishing Group

The theory of “peak oil” -- that supplies will peak and decline into exhaustion -- ranks as a top economic argument for energy investors.

Peak oil advocates say that we have passed the point of no return, and from now on we can expect the world’s crude supply to run dry. That scenario implies that prices for a barrel of oil could run up into infinity as we approach oil Armageddon.

Peak oil opponents argue that technology will save the day -- that new software, powerful supercomputers and drill-bit alloys will let us tap reserves that today are out of reach. If peak oil opponents are right, oil will continue to flow and investors’ profits will be more modest.

While peak oil theorists pore over graphs, tables and pie charts with the fervor of religious scholars, our view is that the peak oil argument is an open-and-shut case. And the proof is right in front of us -- big as day.

Investing in Peak Oil: It Comes Down to Two Words

We believe that peak oil is here to stay, that we are indeed on a slippery slope into zero oil. And we believe in peak oil simply because the oil sheiks are preparing for the day when their wells run dry. For us, that reduces a very complex argument to two easy words: BUY OIL.

For undeniable proof that peak oil is more of a prediction than a theory, look at the historic building boom underway in the Persian Gulf. It is the clearest sign of all that the oil sheiks believe their reserves are finite -- and are building their way into a future where oil becomes as scarce as water in the desert.

Saudi Arabia has committed $500 billion over the next decade to transportation infrastructure, petrochemicals, water, electricity and waste management as they shift economic priorities into shipping, trade, tourism and banking. Qatar, the United Arab Emirates (UAE) and Dubai are also deep into a construction orgy that sets the stage for economic diversification.

Investing in Peak Oil: Aluminum Smelters in the Desert

Saudi Arabia has plans to build 10 energy-sucking aluminum smelters as they map a course away from oil. Other plans include building four refineries, two petrochemical plants and a modern graduate-level university with an endowment of $10 billion.

The driving vision of the Saudis is to turn the Persian Gulf into a major industrial power. For example, Saudi Arabia is intent on becoming one of the top three chemical producers in the world, requiring billions of dollars to build modern refineries and factories.

In Riyadh, Saudi Arabia, a new urban sprawl teems with malls, luxury hotels and upscale boutiques. With oil hitting $115 per barrel, the Persian Gulf is in an all-out race against the clock to create new sources of wealth to attract and keep the younger generations who will shape the region’s economic future.

Saudi Monarch King Abdullah is committed to the construction of six new cities, including the King Abdullah Economic City, the Knowledge Economic City and the Prince Abdulaziz bin Mousaed Economic City.

The six new Saudi cities together will occupy four times the land mass of Hong Kong, become home to a population three times bigger than Dubai, and generate an economic output equal to Singapore's, according to SABB, an arm of the giant HSBC Group, one of the world’s largest banking and financial service companies.

Investing in Peak Oil: The Saudis Industrialize

Today’s soaring oil prices have given Saudi Arabia’s industrialization strategy new impetus. And this plan is already producing results.

The country’s private sector now accounts for 45% of the economy, compared with just 20% about 20 years ago. That shift coincides with the Saudis’ commitment of investing at home, which started in earnest in the 1990s.

For Dubai, the clock is ticking even louder. A UAE government report categorically states, “Dubai’s oil reserves have reduced over the past decade and are now expected to be exhausted within 20 years.”

Following our own premise of a peak-oil construction boom in the Middle East, Dubai is the new Mecca for Middle East mega cities.

Investing in Peak Oil: Blade Runner Architecture

With its Blade Runner-style architecture and over-the-top opulence, it’s no surprise that Dubai hosts the Persian Gulf's first indoor ski resort -- in addition to the world's tallest building, a seven-star hotel in the shape of a giant sail, its first underwater hotel, and a family of dredged-up, man-made islands where condos sell for $14 million.

The Persian Gulf's version of Disneyland, called Dubailand, dwarfs the country of Monaco. It should, with a price tag of $4.5 billion. Dubailand will employ 300,000 people and attract an estimated 15 million visitors.

Dubai’s new urban railway, with 37 stops, will soon begin construction. Dubai will build its own Silicon Oasis for computer companies to the tune of $1.7 billion. And a $6 billion mixed development called Dubai Waterfront / Arabian Canal will house more people than Paris!

Investing in Peak Oil: A Sea of Liquidity

Visit Dubai and you’ll see the largest man-made harbor in the world. Dredged out of the desert sands in 1979, the 1.5-mile quays have been described as fading into the desert haze.

Despite being in the desert, Dubai is a sea of liquidity.

Dubai, and the six other sister states that make up the UAE, saw their economy bolt 7.4% in 2007 on expansion of manufacturing and construction (as well as oil and gas).

Non-oil sectors accounted for 65% of the UAE’s GDP economy in 2007. As ArabBusiness.com reports, “The UAE, the world's fifth-largest oil exporter, has been striving to diversify its economy away from a dependence on energy exports by pouring oil revenues into real estate, financial services and infrastructure.”

Of the $1 trillion in construction projects under way in the Persian Gulf, the UAE and Saudi Arabia made up 29% and 20%, respectively, of all the work -- meaning that these two countries account for nearly half of all the construction in the region.

In our estimation, the Persian Gulf boom in construction is a flat-out admission that the region’s oil reserves may be drastically lower than officially reported -- as documented in Matthew R. Simmons’ world-shattering book, Twilight in the Desert.

Investing in Peak Oil: Dramatic Declines

Simmons created a compelling case that Saudi Arabia production will soon peak, exposing the world to a catastrophic oil shortage. He asserts that dramatic declines in oil production could happen at any moment.

In his most optimistic scenario, he suggests that Saudi Arabia might maintain current rates of production for several more years, but even then the kingdom could not boost production to satisfy the impending surge in demand for oil around the world.

The International Energy Agency (IEA) bears this out. It reported a steep loss of oil production during the last few years. After climbing from 82.90 million barrels per day (bpd) in 2004 to 84.15 million bpd in 2005, output only increased to 84.80 million bpd in 2006 and then declined to 84.62 million bpd during the first 10 months of 2007.

Saudi oil production for the first eight months of 2007 showed output of 8.62 million bpd, a decline of 6% from the 9.15 million bpd of 2006.

In October 2007, the Energy Watch Group published a study that concluded global oil production peaked in 2006 -- much earlier than most experts had expected. The report predicts that production will drop by several percent per year. At the time of the study’s release, global oil production was approximately about 81 million bpd. EWG predicts it will plunge to 39 million bpd by 2030 -- a frightening decline of 51.8%.

Investing in Peak Oil: A New Global Prosperity

But the issue goes deeper than dwindling supplies. The global commodities boom is giving rise to a new age of prosperity in emerging economies. More people will drive cars, have fully stocked kitchens and travel the world. Yes, they will spend more money -- and consume more oil along the way.

China and the Middle East are expected to remain the main sources of higher world oil consumption through 2008, according to the EIA’s Short-Term Energy Outlook. World oil consumption in the fourth quarter of 2007 should hit 1.7 million bpd, exceeding Q4 2006 levels.

The global thirst for oil will continue unabated, with consumption in 2008 projected at 1.4 million bpd above 2007. Although China accounts for 400,000 bpd of this growth, the remaining growth is concentrated in developing countries such as the United Arab Emirates and Saudi Arabia.

Investing in Peak Oil: The Middle East Burns Its Own

Bottom line: As the Middle East diversifies away from oil revenues, it becomes a major oil consumer. The difference is they get it wholesale, while the rest of the world pays full retail.

The EIA indicates that Saudi Arabia has increased its oil consumption from 1.4 million bpd in 1997 to 2.14 million bpd in 2006, an increase of nearly 55%. During the same period, production increased by only 10% from 8.4 million bpd to 9.2 million bpd.

As with the entire Middle East, growing oil consumption could cause a form of hoarding, where exports drop to satisfy domestic needs. In fact, shift is already underway.

Saudi Arabia is now the world’s largest oil consumer per capita, consuming more than 32 barrels per person each year. That per capita usage is 28% higher than the U.S., which uses 25 barrels per person each year. Bahrain, Kuwait, Qatar and the UAE are all on track to surpass the U.S. in per-capita oil consumption, which has actually flattened between 2004-2007 at 20.7 million bpd.

Investing in Peak Oil: 42 Years and Counting

Count up all the barrels of oil left to drill, and the Energy Watch Group estimates that, based on current consumption, the world has approximately 42 years worth of oil left -- or some 1.255 gigabarrels (“giga” is equal to 1 billion).

That means higher oil prices are here -- permanently. Is $300 oil feasible in the next three years? Definitely.

You may keep hearing about some company that has the silver bullet to wean us off Middle East oil. It might be tar sands, coal liquefaction or biofuels, or alternative sources of energy, such as solar, wind or geothermal.

And while these new forms of energy could contribute to the world’s energy sustainability, we expect megacities to continue rising in the desert because the oil sheiks know that nothing can truly replace oil.

Originally published June 9, 2008.

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