Peak Oil

$16 Billion Gamble

By Ryan McGreal
Published April 13, 2005

The San Francisco Chronicle has published an interesting column by David Lazarus, who reports that ChevronTexaco is shelling out $16.4 billion for Unocal and its oil reserves.

What sets this apart from a typical merger/aquisition story is the fact that oil shares are historically high right now. Unocal's stock is up 75 percent over last year. Assuming this is just a temporary spike in stock prices due to a temporary spike in oil prices, ChevronTexaco is making a big mistake. If and when Unocal's stock falls back to its previous value, ChevronTexaco will be sitting on a mountain of debt.

But Lazarus points out that ChevronTexaco CEO David O'Reilly "knows more than most people about world oil markets" and is still prepared to gamble over $16 billion on oil prices staying high. According to Lazarus, O'Reilly would only make this gamble if he believes firmly that oil prices are not going down.

Historically, oil prices, like most commodity prices, cycle up and down in predictable patterns. Demand goes up, and supply growth falls behind, driving prices up. Eventually, the price gets high enough that demand falls back, just in time for all that new supply to hit the market, driving prices down. Low prices spur new demand, which starts the cycle over again.

We're at the "top" of the cycle right now, with strong demand and high prices, but O'Reilly seems to believe the cycle is going to remain stuck here for some time. The only way oil prices won't fall is if there is no additional supply to bring to the market.

In other words, peak oil. This is consistent with oil companies vying furiously to gain control over existing oil reserves instead of investing in the search for more oil. Lazarus quotes Amos Nur, a geophysics professor at Stanford who says, "Oil prices are not coming back down."

He also quotes the U.S. Energy Department, which insists oil won't peak until 2037. However, the U.S. Energy Information Agency has admitted it sets reserve volumes "based on non-technical considerations that support domestic supply growth to the levels necessary to meet projected demand levels."

That is, the U.S. government sets its reserve volumes based on what will maintain domestic demand for more oil, not on how much oil is actually ing the ground!

Oil markets seem to have caught on to the fact that global oil production is running at close to 100 percent capacity while demand continues to increase (another 2.2 percent this year). The recent spike in oil prices is a reflection of investors' fears that supply cannot continue to meet this growing demand.

Commodities analysts at Goldman-Sachs recently warned that the world is entering a "super spike" period where oil prices pass $100 per barrel and keep climbing until exorbitant prices finally strangle demand.

Lazarus finishes his column with a prescient statement:

History shows that when others are panicking, it's the ones who keep a cool head that end up profiting.

ChevronTexaco's O'Reilly is spending a lot of money on Unocal.

He's keeping a very cool head indeed.

See also:

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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