Posted: January 21, 2008

Unless you read The Oil Drum, a web site dedicated to the discussion of “peak oil” – which is the point at which global production can only go down because it has reached its physical limits – you probably didn’t hear what President Bush told an American television correspondent last week.

While in Saudi Arabia, President Bush was asked by a correspondent for the U.S.’s ABC network program “Nightline” about whether he should be taking a tougher approach in jawboning Saudi Arabia to raise its oil production. Before you hear what the American president said, a little background is necessary.

Of all the world’s oil producers, only Saudi Arabia is considered to have significant spare production capacity. Indeed, a top Iranian Oil Ministry official reportedly said the other day that most OPEC producers are currently going flat out, meaning they can’t further raise their production to meet ever-rising demand.

An important distinction must be drawn between what oil optimists and pessimists say. Optimists emphasize reserves, how much oil is still in the ground. Pessimists emphasize production capacity, how fast those reserves can be brought to the surface. When you think about it, production capacity is what really matters, especially to a global economy whose growth remains totally dependent on increasing supplies of oil (such as for those 25 new car models about to be sold to India’s emerging middle class).

Peak oil often is misinterpreted as being a function only of the amount of oil still in the ground. It is partly that. But it is also a function of the number of engineers and of equipment availability. The world has shortages of both that are likely to continue for years, causing new projects to be delayed. It all contributes to what some say is an imminent “peak” in the amount of oil the world can produce.

This argument is rebutted by those who emphasize continuing improvements in oil drilling technology, the steadily-growing amount of oil coming from tar sands and, before long, from coal (synthetic oil), plus also the sharply-rising amounts of biofuel that are being blended into gasoline.

Ultimately, whether the world has or will soon hit a production peak may be as much a political as a geological question. Current biofuel and tar sands production methods are environmentally destructive, and a growing chorus of voices says it must stop.

Whatever happens ultimately, President Bush’s statement has immediate implications for every investor. The president said, “If they (Saudi Arabia) don’t have a lot of additional oil to put on the market, it is hard to ask somebody to do something they may not be able to do.” Left unclear was whether the president thinks the Saudis don’t have the oil, whether the Kingdom may be suffering from equipment and engineering constraints, or both.

Intentional or not, it sounds as if President Bush thinks peak oil is a clear and present danger, the effect of which is raise the chances of a “peak shock” hitting Wall Street in 2008. If this happens, it will likely start with a headline-grabbing report from a big investment banking firm, probably one that is already forecasting that oil will soon shoot through $100 a barrel. Goldman Sachs, CIBC World Markets and Raymond James & Associates are the most likely candidates.

Given that the spot oil market is now dominated by financial institutions, if and when peak shock hits, crude will spike as high as these momentum players can take it. As the shock sinks in, there will be a sickening realization that, as if the markets don’t have enough to worry about, they’ve now got to factor in peak oil. Simultaneously, there should be a big push into anything that’s alternative energy, both the good and the bad. Investors will need to be able to separate the wheat from the chaff.