Peak Oil And Runaway China: A Dangerous Combination Of Memes

By | March 30, 2016

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By Ron Rimkus, CFA Back in 2005, investors heard an endless chorus in the financial media around two memes: the end of oil, and the growth of China. Oil production was supposedly hitting its upper limits. In 2005, the US Department of Energy published a study on the peaking of world oil production (.PDF) that stated: Because oil prices have been relatively high for the past decade, oil companies have conducted extensive exploration over that period, but their results have been disappointing [….] This is but one of a number of trends that suggest the world is fast approaching the inevitable peaking of conventional world oil production [….] The world has never faced a problem like this [….] Previous energy transitions (wood to coal and coal to oil) were gradual and evolutionary; oil peaking will be abrupt and revolutionary. The peak oil narrative was reaching a fever pitch around the same time as China’s “runaway growth” meme. A BBC report on ” 2004: China’s Coming Out Party ” highlighted how China’s increasing appetite for oil was affecting global prices. Other articles made eye-popping comparisons of China’s cities before and after the country’s economic changes (decades apart). For instance, Shenzhen transformed from a sleepy fishing village in 1980 to a bustling urban empire by 2006 . Shenzhen had grown at an annual pace of 28% per year during this 26-year period. Yes, you read that right. The pair of memes led some investors to embrace the notion that oil supply was peaking just at the moment that oil demand was accelerating- a recipe for higher and higher oil prices. Then, we all marveled as the price of oil rose from $30 per barrel in 2003 to well over $100 by 2008 . In subsequent years, both memes were proven wrong. There was no “abrupt and revolutionary” oil peaking, and China’s energy demands would not keep growing forever . But higher oil prices created an umbrella of opportunity for capital formation, and much of that capital flowed into US shale oil projects. Between 2009 and 2015, total US oil production nearly doubled from 5,000 barrels per day to just under 10,000 barrels per day , thanks largely to shale oil. The shale revolution, which took place because high prices stimulated investment and innovation, blew apart the notion that the world had reached peak oil. By the end of 2014, it became apparent that oil output would satisfactorily meet demand growth. Blindly following popular investment memes is a recipe for disaster, and investors who convinced themselves that oil prices would remain above $100 per barrel were blindsided by the return of oil priced under $40 per barrel – even though it was a function of price signals directing capital investment as a normal part of the business cycle. One person who correctly identified the business cycle as it played out was Amy Myers Jaffe , executive director for energy and sustainability at the University of California, Davis. “When I would talk about this boom and bust cycle in 2005 and 2007,” Jaffe said in a 2013 issue of The Planning Report , “people would heckle me off the stage because it looked like the price of oil was going to be high forever.” But time has a way of vindicating truth, and now her perspective looks quite prescient. Jaffe will be sharing her views on current events in global energy markets at the 69th CFA Institute Annual conference in Montréal. All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer. Scalper1 News

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