Peak Oil

Oil Price Declines Due to Falling Demand

By Ryan McGreal
Published August 05, 2008

this blog entry has been updated

After peaking in the high $140s, the price of a barrel of oil has receded below $120. This, naturally, has led to as much knee-jerk bloviating from pundits as the steady rise past $100 that preceded it.

What most of the analysts have missed in stirring such causes out of their tea leaves as US President Bush's decision to lift the moratorium on offshore drilling and the good behaviour of Tropical Storm Edouard is the underlying role of supply and demand.

The very high petroleum prices over the past several months have finally succeeded in stalling growth in global demand - particularly in places like China, which have been driving most of the demand growth over the past several years. This stall has taken pressure off suppliers.

In the developed economies, demand is actually falling. For example, driving is down four and a half percent in the US this year. At the same time, the US is in a full-fledged recession and Europe is in precarious shape.

Canada may not technically be in a recession, but that's mainly because of the huge increase in national revenue from Oilsands exports. The rest of the economy may be in recession already.

So has the decline in oil prices disproven the Hubbert Peak hypothesis and vindicated the naysayers? Hardly.

Peak Oil theory predicts exactly what we are observing: a turbulent yo-yo of price volatility. Growing demand for oil leads to price super-spikes when supply growth can't keep up, followed by economic crisis and falling demand for oil, which leads to falling prices.

Lower prices then trigger a resurgence in demand, which leads in turn to another super-spike when demand again hits the peak in rate of production. (Market signals are effective but clumsy.)

This volatility is the "bumpy plateau" in which oil production hovers around a global peak - around 85 million barrels a day, it turns out - and demand strains against the upper limit of production as prices spike and fall off, spike and fall off.

The analysts poring too closely over each putative trigger - a hurricane develops or disperses, blustering over Iran intensifies or eases, the US dollar rising or falling against a basket of other currencies, offshore drilling in the US is approved or vetoed - will surely miss this larger picture of global demand repeatedly banging off a rate of production that has reached its zenith and must rachet back bit by painful bit through each mini-crisis from here on out.

Update: added to the description of the bumpy plateau for clarity. -Ed.

Ryan McGreal, the editor of Raise the Hammer, lives in Hamilton with his family and works as a programmer, writer and consultant. Ryan volunteers with Hamilton Light Rail, a citizen group dedicated to bringing light rail transit to Hamilton. Ryan writes a city affairs column in Hamilton Magazine, and several of his articles have been published in the Hamilton Spectator. He also maintains a personal website and has been known to post passing thoughts on Twitter @RyanMcGreal. Recently, he took the plunge and finally joined Facebook.

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By Capitalist (anonymous) | Posted August 05, 2008 at 12:33:45

Ryan sounds like you want to have things both ways:

Oil prices go up = Peak Oil
Oil prices go down = Peak Oil

Peak oil is a sham just like global warming (or should I be calling it climate change)

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By Ryan (registered) - website | Posted August 05, 2008 at 12:43:41

I'm surprised that with a screen name like "Capitalist" you would object reflexively to an explanation based on market price signals and supply/demand relationships.

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By jason (registered) | Posted August 05, 2008 at 12:53:04

thanks to TV and media in general, some people have a very short attention span. They think peak oil should come and go in about 3 weeks. It's a long, drawn out, complicated process that will see several more spikes and drops like this current one. 20 years from now (I know it sounds like a long time in the world of braindead TV programming and false, electronic stimulus to keep us entertained for more than 30 seconds) you'll be able to look back and see the 'peak'. By then we may be in the backside of the plateau, or perhaps just finishing the peak. Nobody knows for sure, not even the talking heads. But the peak is upon us and won't go away by pretending that cheap oil can last forever.

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By Reason (anonymous) | Posted August 05, 2008 at 14:43:16

Ryan et al...whatever...regardless of the reason, it is good that prices have fallen. Now, that doesn't mean we squander the resource, but at least we wont' go broke driving the kids to school.

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By Ryan (registered) - website | Posted August 05, 2008 at 14:48:11

Reason wrote:

at least we won't go broke driving the kids to school.

If "driving the kids to school" puts you at risk of bankruptcy, perhaps it's time to reconsider either your means of getting the kids to school or your choice to live so far from school that you need to drive them.

High oil prices are unpleasant, but people respond to price signals - as evidenced by the continued existence of European civilization despite fuel prices at least double what we pay.

In any case, the falling prices are only a temporary reprieve. When prices fall enough to restore consumer demand, the cycle of volatility will just repeat itself.

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By jason (registered) | Posted August 05, 2008 at 14:54:04

you'll go broke driving the kids to school eventually. Now would be a good time to make decisions to help insulate yourself from 2,3 or 4 dollar/litre gas in the future. The government sure ain't going to do anything to prepare for the future, but individuals can.

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By highwater (registered) | Posted August 05, 2008 at 15:59:20

Some school districts in the States are already responding to expensive oil by going to a 4 day school week, and increasing the distances from school that qualify kids for bussing, with the result that more kids will be walking farther, or more likely being driven by their parents, at least until they go broke.

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By Steer (anonymous) | Posted August 05, 2008 at 16:03:43

Damn, Merulla may be on to something.

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By gullchasedship (registered) - website | Posted August 05, 2008 at 21:10:49

Peak oil sure sounds like global warming.

When the price rises, it's peak oil.

When the price falls, it's peak oil.

What was it in the 70s when oil prices were so high?

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By adam1 (anonymous) | Posted August 06, 2008 at 00:56:51

Gullchasedship, to answer your question, here are some researched facts that should help you in your quest to understand the oil situation:

Oil prices skyrocketed in the 70's in North America because US production reached its peak. It took a while for North America to shift its oil supply to overseas sources (namely the middle east). This resulted in the spike you see if you look at historic oil prices.

So, the price spike in the 70's was due to a national oil peak, but the price spike we see today is due to the oil peak on a worldwide scale. If I am correct, the stats say a new oil rig hasn't been installed in the US for over 40 years. Only now, Bush has lifted restrictions on rig installations offshore near highly populated coastal areas. A lot of people are upset at this as you can imagine.

Canada isn't due to peak for another 20 years. The tarsands in Alberta are booming... but unfortunately most of that oil is very hard to extract. Now that price per barrel is high enough, it has become profitable to extract the tarsands oil as well. Our increased oil production from the tarsands is also why Canada has been cushioned from the recession in the past few months.

I hope this clears things up. Feel free to do your own research and let me know of any inaccuracies in my post.

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By Ryan (registered) - website | Posted August 06, 2008 at 08:08:37

gullchasedship wrote:

What was it in the 70s when oil prices were so high?

Further to adam1's informative comment, politics played an important role in the panics that surrounded the 1970s oil crises. US production peaked in about 1971 but global production still had plenty of room for expansion.

The 1973 crisis started when OPEC stopped exports to countries that supported Israel in the Yom Kippur War. The total oil production declined only modestly, but as adam1 noted, it took time to adjust distribution channels to get the oil into North American markets.

The 1979 oil crisis started when the Iranian revolution replaced Shah Reza with the Ayatollah and Iran's oil production was disrupted. Then Iranian oil production was curtailed further in 1980 when Iraq invaded.

This time around, the cause of the shortfall is mainly geological, not mainly political. Every oil producing country is producing at full capacity - with the exception of Iraq, which has at least restored its prewar production rates - but supply can't keep up with demand.

As a result, the market price has undergone what CIBC World Markets and Goldman Sachs are calling a "super spike", which is finally starting to curb demand growth. As demand falters, pressure on oil prices is easing.

This is basic supply and demand, folks, and there really isn't any serious debate among geologists, economists and oil industry analysts over what's going on.

The only debate is over whether the adjustment to falling oil production rates is going to be relatively easy, relatively difficult, or catastrophic.

I don't think anyone knows the answer to that question, but it seems clear that the sooner we start planning and preparing for declining oil production, the more success we will have in managing the transition.

Hence: take the hint and start figuring out how to stop driving your kids to school. :)

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By adam1 (anonymous) | Posted August 06, 2008 at 09:01:42

Just reading the first comment again by Capitalist... its important for people to understand no system exists in a vacuum. Supply is influenced by many variables and demand is influenced by many other variables. I feel like I'm teaching a 1st year economics course here. I'll stop.

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By lipsync (anonymous) | Posted August 07, 2008 at 00:37:00

It has been said that what is the difference to our children if the peak is now or 5 years from now. Our society should have prepared for this in the 1970's when we had the chance.

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By tt3 (anonymous) | Posted August 07, 2008 at 11:44:34

It's simple.

Oil production was at 85 mbd when oil was $140 and production is still at 85 mbd and oil is $118.

Supply increase did not bring down the price. A slowing economy did. The demand is down which made oil cheaper. Demand will increase (because it's cheaper) again and then bring the price up again, and so on, repeating this cycle until we are in a post-peak decline.

Buy oil now, because after several yo-yo corrections we will eventually see $200/barrel in about 12-18 months.

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By David (anonymous) | Posted August 09, 2008 at 04:03:47

Ryan's article is right-on point. He might have also indicated that the price decline is additionally because the US Dollar has risen from the doldrums recently, partially because of the Euro falling, as well as some PPT intervention. But his continued "peak oil" comment is well advised - we are finding only 2 units for every 5 in decline. Just because there have been some slight declines in demand due to price, the stage is set for a rekindling of prices soon, especially if Iran is attacked. We could see the previous high-price of oil as the "good ole days".

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