Commodity price, Energy crisis, Market research, Oil market

3/5: Revisiting the peak oil hypothesis

As we discussed in part 1 and part 2 of this series, the world is facing a dire energy predicament; world oil reserves are fast dwindling and new extraction technologies won’t be able to reverse global production declines. By all accounts, it appears that we are past the point of peak oil and today we take another look at the peak oil hypothesis. One of the key thoughts in this report is that, as oil production becomes more expensive in real terms, it must also become more expensive in nominal, or dollar terms. That it has recently become cheaper in dollar terms can only be a temporary aberration.

In the aftermath of the 2008 financial crisis, oil prices collapsed from over $140/bbl to below $40 in a few short months. Although they subsequently recovered, they haven’t regained the 2008 peaks, capped perhaps by the ongoing weakness in the global economy and the growing optimism about fracking. As a result, concerns about peak oil faded from the narrative and from the minds of market participants. Still, the reality of peak oil has not faded, and it will seep back into the narrative in the near future.

As a reminder, peak oil refers to the point in time when the worldwide oil production irreversibly passes its maximum point, followed by an unstoppable decline. Again, note the terminology: we are talking about declining production, not the “resources,” or even “reserves” which have mushroomed over the years as calculation methods and definitions of oil changed. Conventional oil production peaked between 2005 and 2009[i] with at least 37 oil producing countries already experiencing significant declines in production. A chart prepared by the EIA for a U.S. Department of Energy conference [ii] in 2009 shows the agency’s projected global output decline through 2030 against projected demand []:


Today, oil production is declining at a rate of between 4% and 9% per year, depending on whom you ask. But even at the low end of these decline estimates[iii] [15], it turns out that to keep oil production from falling, we would need to develop and put into production the equivalent of Saudi Arabia’s entire output every 3 years! It is now clear that fracking can’t fill the 43-million-barrel-per-day gap marked in the above chart as “unidentified projects.” It might buy us a bit of extra time – but only if oil prices rebound significantly and remain at much higher levels than today.

EROEI and the diminishing returns on energy investment

The world’s energy predicament appears graver still when we analyze it in terms of the energy return on energy invested, or EROEI. International Energy Agency’s 2014 special report “World Energy Investment Outlook” asserts that meeting world’s energy needs will require investing $48 trillion through 2035. That sounds like a lot, but framing that investment in dollar terms is deceptive. Dollars can be printed in any amount as needed, but producing oil requires investment of real capital including materials, equipment and highly skilled labor. It also requires energy, and in many cases plenty of it.

In the 1930s and 1940s, oil producers obtained a return on energy invested of about 100:1 at the well-head. In other words, for the investment of 1 barrel of energy they obtained 100 barrels from the ground. This is what “cheap,” easily extractable oil was. Today, the world average is down to 15:1 and in the U.S. it is 11:1. Best shale oil basins yield an EROEI of 6:1 while deeper shale wells and tar sands yield 4:1 or less. Biofuels like ethanol from Corn yield 1.5:1 or less.

The energy we must invest to obtain new energy cannot be conjured up out of thin air and our declining EROEI numbers reflect the diminishing returns from investment in energy production. As more and more resources are required to generate the same amount of liquid fuels, energy production is becoming ever more expensive to society in real terms. And as it becomes more expensive in real terms, it must also become more expensive in nominal or dollar terms. That it has recently become cheaper in dollar terms can only be a temporary aberration.

Alex Krainer is an author and hedge fund manager based in Monaco. Recently he has published the book “Mastering Uncertainty in Commodities Trading“.


[i] In its 2010 edition of International Energy Outlook, U.S. Energy Information Administration (EIA) proclaimed that oil production from conventional sources probably peaked in 2006.

[ii] “Meeting the World’s Demand for Liquid Fuels – A Roundtable Discussion” – U.S. EIA, April 7, 2009 –

[iii] Production decline of 4% translates into about 3.4 mb/d each year – 10.2 mpbd shortfall every 3 years! Saudi Arabia’s output is now just over 10 mb/d.


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