Peak Oil: A Pass/Fail Intelligence Test
by Dan Ferris

You know about peak oil.

That's the idea that the world is running out of oil, that the price is going sky high as the global supply of oil shrinks to nothing.

It's going to happen so fast, say true believers, that we won't have time to develop new alternatives. We'll be caught with our pants down, and the world will plunge into chaos.

C. J. Campbell, geologist and author of The Coming Oil Crisis, says, “We have come to the end of the first half of the Oil Age.”

As if the Stone Age ended because we ran out of stones.

Peak oil theory is wrong because it demands a repeal of the laws of economics, the simple dynamics of supply and demand. It also endows prognosticators with the ability to see the future, an ability, unfortunately, which no one actually possesses. Finally, like all Malthusian theories, it ignores the fact that every human mouth comes with one human brain attached (and at no extra charge, I might add).

I recently gained a new respect for the folks at Morningstar, who wrote recently (and correctly),

“The laws of economics have not been repealed... Canada alone has almost 300 billion barrels in its tar sands, economical to process at prices above $30 per barrel and astonishingly profitable at $70. Ratchet prices up to $40 per barrel and coal-to-liquids (gasoline, diesel, etc.) becomes realistic, providing more than 50 years supply alone. 

At $70, oil shale - which could supply the world at current consumption levels for 100 years - becomes realistic. Finally, above $80, biomass-to-liquids, an essentially limitless source, becomes economical.”

Peak oil, like every apocalyptic depletion argument, is one of life's little intelligence tests. If you believe it, you fail. If you know it's crap, you're smart enough to pass. It's like Y2K. If you moved your family to the hinterlands of Arkansas and predicted violence in the streets, you failed that little test. If you ignored it, you passed.

As for your money, you can take the peak-oil test with your portfolio on the line. Accepting peak-oil nonsense requires ignoring the highly cyclical nature of oil (it was near $80 a couple months ago; now it's under $60). That, in turn, could lead you to downplay the role of savvy management, like that of, oh... say... ExxonMobil (XOM).

ExxonMobil's management knows that the company has to make its oil exploration investments work across cycles and in many different pricing environments. That's why its deepwater Gulf leases only go out to 2008. Management knows the company will get a chance to buy in cheaper at some point. Charley Maxwell's recent piece in Barron's is wrong about this. He says they'll miss out... but Maxwell believes in peak oil, so he fails the test.

ExxonMobil's management buys to make money, to earn a return on investment, not to indulge fears about paranoid theories. And ExxonMobil has done a better job of earning shareholder returns than most of the companies that now exist or have ever existed.

Since 1950, when it was known as Standard Oil of New Jersey, ExxonMobil has generated average annual shareholder returns of more than 14% a year. More than 5% of that was from dividends.

ExxonMobil has raised its dividend every year since 1983. Think about how oil prices hovered in the teens from 1983 to 1998, and you'll appreciate that dividend record even more.

In 1999, when hardly anyone made money in the oil business and a barrel cost about $10, ExxonMobil earned 12.1% on capital. That's its worst performance: 12.1%. These days, it exceeds 30%. If ExxonMobil can make money at $10 oil, it's going to be raising its dividend forever.

ExxonMobil's managers have made it clear that the company doesn't buy into the peak-oil nonsense. They pass the test.

Good investing,

Dan Ferris

P.S. My colleague, Matt Badiali – a petroleum geologist with 15 years in the business – just came across a stunning discovery that validates my argument. He guarantees me no one has heard about it. I certainly hadn't. To read Matt's findings, click here.

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