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Schork Oil Outlook: How Dear Is Oil?

Last week’s WikiLeak’s dump regarding oil production estimates for Saudi Arabia reintroduced the notion of peak oil to the popular discussion. By peak oil we are talking about the high-water mark, as assumed from the Hubbert curve (illustrated in today’s report—request here), of global oil production.

In a paper presented to the American Petroleum Institute (API) in 1956, U.S. geophysicist, M. King Hubbert predicted that U.S. crude oil production would peak in between 1965 and 1970. U.S. oil production actually peaked in November 1970 at 10.04 MMbbl/d.

In that same paper Hubbert predicted global oil production would “… peak at about the year 2000” (see banner p.1). To this effect, present day estimates vary as to when peak oil will be reached. The more enthusiastic adherents to this theory stick with Hubbert’s 1956 forecast, i.e. peak oil is already here. Others suspect we have until the end of this decade before production enters in to a death spiral. Either way, the assumption among both believers and non-believers in peak oil agree that the era of cheap oil is over.

Perhaps it is, but what exactly is “cheap” oil anyway? The upstream cost of oil has risen by around 24% over the last three decades, from $33.86 in 1980 to $75.81 in 2010. Nevertheless, Eminem is paying no more at the pump today to fill up his Chrysler 200 than his mom was in 1980 to top off her Cordoba.

Let’s assume oil averages $100 this year. Based on historical relationships, that should translate in to a retail cost for gasoline of around $3.35. Is that dear?

No, no it is not. After all, how can a commodity which we use more of today than we did thirty years ago, but does not cost anymore, be considered dear?

Passenger car fuel economy has improved from 16 mpg in 1980 to 22.6 mpg. More importantly, thirty years ago 13,380 Btus were required to produce one dollar of real GDP in the U.S. Today it requires 7,352.

Today’s issue of The Schork Reporthighlights that ongoing enhancements in the productivity of both up and downstream operations, along with greater fuel economy and a wealth effect mean that it might be premature to write “cheap” oil’s eulogy.

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Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.