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Steve's note: Today's essay is a little longer than usual... But I think you'll find it well worth reading. It's from my good friend and colleague Porter Stansberry. Porter's been dead-on with his predictions on the energy sector, and I think you'll be far ahead of most investors after reading what he has to say today.

One of the Greatest Intellectual Frauds Ever Perpetrated

By Porter Stansberry
Monday, September 10, 2012

I've written many times over the past decade that I consider Peak Oil to be one of the greatest intellectual frauds ever perpetrated.  
 
I believe having a correct understanding of these issues is critical... perhaps the single most important economic issue of the next several decades.  
 
This matters because if M. King Hubbert (the original Peak Oil theorist) was right in 1956 when he forecast global oil production would peak around the year 2000... we're facing a major change in the future of the energy industry.
 
If we're actually about to run out of oil, or if production is inevitably going to decline, we ought to be making major investments in alternative sources of energy, like windmills and solar farms – even if those technologies are terribly expensive. Likewise, if we're really about to run out of oil, spending huge sums of capital to dig up most of Alberta (for oil sands) and mandating electric cars might be sensible policies.
 
Investors face an even more basic question: If oil production is inevitably doomed to recede, isn't the future price of oil likely to be drastically higher? 
 
On the other hand, if M. King Hubbert is wrong (and I believe he was catastrophically, even laughably, wrong), perhaps we're wasting billions of dollars in capital pursuing energy solutions that aren't practical, economic, or... in the case of photovoltaic semiconductor (PV) solar... physically possible.  
 
If the production of oil is more likely to greatly increase over the next 50 years, perhaps investors ought to be cautious about assets that require high oil prices to be economic.
 
Most important... if we're not really going to run out of oil... perhaps we ought to be leery of corporations and their partners in government that want to tie us to energy products and policies that aren't in our ultimate best interests. We should be on guard for ideas that will handicap us with higher energy costs for the next several decades.
 
Just imagine how the Germans and the Spanish will feel when they realize the PV solar panels from First Solar that they spent billions of dollars on don't work. Not only that, but the plummeting price of natural gas made them completely unnecessary.  
 
That's why M. King Hubbert's theory matters. And that's why I'm so passionate about these ideas.
 
Energy lies at the foundation of our ability to produce wealth and enable the pursuit of happiness. When people talk about us running out of oil (or other energy resources), what they mean is a vast decrease in our ability to produce wealth. These kinds of theories – that man has exceeded some fundamental limit to his ability to progress – are called "Malthusian." 
 
Thomas Malthus was an economist during the industrial revolution of the early 1800s. He believed population gains associated with the rise of machines would cause food shortages and a global famine. Of course, that never happened. Human ingenuity and the free market (whose pricing system communicates across vastly distributed markets) overcame the rise in demand for food.
 
Any time I hear an idea or theory that claims mankind is about to become poorer in the future, I always assume it is false. Then I try to figure out how it's likely to be proven wrong. Obviously, some societies do suffer catastrophic declines. But when you study the causes, you will always find some critical disruption to the free market and its price system.  
 
Man, when given the liberty to produce more wealth, always does.
 
So... when I heard about Peak Oil for the first time in the late 1990s and early 2000s, I knew it had to be wrong. But what is the flaw? Isn't oil a physical resource? Wasn't it created millions of years ago? Obviously... if it's not a renewable resource, we'll inevitably run out of it, right? And if we're going to run out of it... yes, sooner or later, the production of oil will peak and begin to decline. How could M. King Hubbert be fundamentally wrong? 
 
Hubbert's theory is simple. He sees the world as a kind of giant oilcan. The can has a limited amount of energy. When it's gone, it's gone. That is very likely true. It's also likely (but not proven) that oil takes millions of years to form, and the Earth isn't producing material amounts of new supply.
 
But... what Hubbert got wrong is just as important as what he got right. And what he got wrong was that by using current demand curves and current estimates of known reserves, he could predict when we'd run out of oil.
 
In Hubbert's seminal, 1956 treatise, Nuclear Energy and the Fossil Fuels, he explains his critical assumption was the size of the total oil reserves...
 
The only a priori information concerning the magnitude of the ultimate cumulative production of which we may be certain is that it will be less than, or at most equal to, the quantity of the resource initially present.  
 
Consequently, if we knew the quantity initially present, we could draw a family of possible production curves, all of which would exhibit the common property of beginning and ending at zero, and encompassing an area equal to or less than the initial quantity.
 
Hubbert was trying to forecast when we'd run out of oil. He didn't understand how the price system would reduce demand and produce alternatives (if supplies did run low). He based his forecast on production curves and the current best estimates of total supplies. For example, his paper cites production curves from Ohio. He argues that Ohio oil production peaked in 1896. He does the same for Illinois, where he says production peaked in 1940.  
 
These predictions were simply wrong. They are also laughably naïve because they didn't account for further discoveries of additional reserves or changes to technology that could extend the life of the wells.
 
Today, Hubbert's supporters argue his theories simply didn't include "unconventional" sources of oil. But that's not true. Hubbert discusses all of the known oil reservoirs. The same goes for new methods of oil extraction.
 
Hubbert's supporters say you can't count oil production using new methods – which makes no sense if you're actually trying to figure out production curves. And once again, that's simply not an accurate description of Hubbert's work. He mentions innovative methods of oil extraction by name. See page 18, where he calculates production in Illinois by both "primary methods of production and... by water flooding." 
 
"All right," you might argue. "So maybe Hubbert was wrong about the particulars, but that doesn't mean he was wrong fundamentally. We're still running out of oil. And it's only a matter of time before all hell breaks loose because there's no more..." 
 
I will happily concede that there may be some fundamental limit to the amount of energy man can profitably extract from the Earth. But I don't believe the risk that we might one day run low on supplies of crude oil or other hydrocarbons is a threat to human happiness.
 
Other supplies of energy will surely be discovered. Many already have been, like nuclear energy. On the other hand, the ways in which Hubbert was wrong are very important to the decisions we make today about energy.
 
Hubbert was basing his forecast on a specific number – the existing known supplies (as of 1956) of crude oil, in all its forms and from all types of basins. As he says: "Assuming the ultimate potential oil reserves of the United States to be 150 billion barrels, of which 52.5 [billion] had been produced by January 1, 1956, leaves 97.5 billion barrels still to be produced." 
 
His estimate for the world's total reserve was only 1.2 trillion. We know today that estimate was woefully wrong. Today, the proven world reserves are more than 1.6 trillion barrels, despite 56 years of increasing production. Just one example of the supplies Hubbert didn't foresee: The average estimate of the Orinoco heavy oil reserve in Venezuela is more than 500 billion barrels.
 
Why Hubbert was (and still is) wrong has nothing to do with the price system – although that explains why we will never actually run out of oil. Hubbert was wrong because he didn't understand how technology would greatly increase the size of the total reserves. As Hubbert's own calculations would show you, increasing the size of the known reserves has the impact of pushing off Peak Oil.
 
Today, known reserves are larger than they were in 1956, when he first published his theory. Thus, Peak Oil is, at the very least, decades away.  
 
But the reality is, our ability to discover new reserves continues to increase. That means it's much more likely the risk of Peak Oil will continue to recede.
 
There's a cycle here I hope you'll notice... As long as the oil industry has been tracking known reserves, we've seen that reserves tend to keep pace with, or slightly exceed, production. That's counterintuitive. You'd think that as production increases rapidly, reserves would get consumed and the total amounts would fall. But that's simply not what's happened. That's why we have more reserves now than we did 56 years ago, despite the huge increases to production. How is that possible? 
 
Look around. Observe that the same kind of abundance tends to manifest itself in almost every area of human endeavor.  
 
The simple fact is, the more energy we use, the more we discover. Likewise, the more computers we make, the better they get. The more food we grow, the more efficiently we can grow it. This so-called experience curve is the result of the application of the human mind.  
 
That's the one thing none of the experts ever seems to figure out. This is the real reason Malthus was wrong. It is the real underlying reason Hubbert is wrong.  
 
Be glad... It explains much of the wealth we enjoy.
 
Regards, 
 
Porter Stansberry




Further Reading:

Oil production is booming. And Porter predicts America is on its way to being the largest energy producer and one of the largest energy exporters in the world. "Nobody expects this," he says. "But it will absolutely happen." 
 
In a two-part series last month, Porter talks in-depth about new investments in energy production as well as two irrefutable signs of America's energy dominance. Get the details here and here.

Market Notes


ANOTHER SIGN THAT THE U.S. HOUSING MARKET IS RECOVERING

Today's chart provides more evidence that the U.S. housing market is recovering.
 
Over the past year, Steve Sjuggerud has been "pounding the table" about the massive opportunities in American real estate. Whether it's owning single-family homes, buying bank-owned properties, or riding the uptrend in homebuilders, there's been no shortage of investment ideas for DailyWealth readers.
 
The recent action in Wells Fargo (WFC), America's largest home lender, is the latest sign that things are getting better. Wells Fargo's mortgage business is booming, thanks to low interest rates and improving sales of existing homes. In its latest quarter, the bank said it saw a 90% increase in the number of mortgage applications over the same period last year.
 
Last week, WFC shares broke out to their highest level in nearly four years. Investors should take note: The uptrend in housing is here.
 
– Larsen Kusick
 

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