Peak oil entered our lexicon in 1956 and has since framed countless discussions regarding the finite nature of our Earth’s hydrocarbons. In the energy world, no other phenomenon has more frequently traversed the ground between relevance and obsolescence. However, the idea itself has several interpretations. Peak oil is relatively independent of the volume of total reserves, which have in fact been growing. Instead, M. King Hubbert, the American geologist who coined the term, concerned himself with production rates, which are also under the influence of political, technological, and economic constraints. While Hubbert’s exact predictions are outdated, his primary contribution (i.e. the Hubbert curve) remains significant today. The curve assumes that regional and/or global fossil fuel production follows a bell curve over time. More specifically, following a discovery, production increases exponentially eventually reaching a peak, after which production experiences a similarly exponential decline. Hubbert correctly predicted peak production in the United States, which occurred at the beginning of the 1970’s. However, technological advances have paved the way for a second US peak and opened the door for a delayed global peak. The shale revolution in the United States has restored widespread belief in the longevity of hydrocarbons and stunted the growth of the renewable energy sector. US crude oil production has risen every year since 2008 and some industry players have pipe dreams of a Saudi Arabia West. Nevertheless, such resurgence is likely an exception and not the rule.

Figure 1: US Crude Oil Production

Globally, crude oil production is declining at a rate of approximately 3.5 millions barrels a day per year. Amongst the 34 high-income economies who comprise the Organization for Economic Cooperation and Development (OECD), production experienced modest growth, mostly thanks to the United States and Canada. However, minus the Americas, production is down in both OECD Asia Oceania and OECD Europe 18.1% and 7.4% respectively when compared to the previous year. To date, the shale revolution has yet to take off across the Atlantic, but it’s certainly not for a lack of want. Energy giants found potential suitors in countries like Poland, France, and the UK, but the people, and thus far the governments as well, have voiced their preference for greener development in the face of hydraulic fracturing’s less than clean reputation. In any case, a shale-powered Europe offers little in the way of a global production boost. Compared to conventional wells, fractured wells decline hyperbolically. The initial return is high, but the flow rapidly declines before leveling off. Wells can be refractured several times throughout their lifespan. However, the results, both in terms of flow and environmental impact, are highly variable and each presents a unique case.

Decline rates aside, we have not seen the level of exploration and development required to offset production declines from conventional sources. Speaking more to the financial considerations, current global economic conditions simply do not support intensified development of both conventional and unconventional sources. Many parts of the globe are still in the grips of recession and as a result demand for high-priced fossil fuels has flattened. Sustained prices of approximately $110/bbl will likely keep such demand relatively flat for the foreseeable future. Additionally, these prices, and any lower prices, almost guarantee companies will operate in the red once all the low hanging fruit is harvested. Prices approaching $150/bbl would certainly support new development and, in time, production growth. However, national economies would struggle to bear the costs.

An examination of the energy return on investment (EROI) further explains the relationship between energy and economic growth. EROI refers to the amount of energy produced versus the amount of energy expended to extract, transport, and make use of that energy. EROI is expressed as a ratio. As that ratio approaches 1, the net energy gain decreases. Globally, EROI is approximately 15; EROI for unconventional sources is lower at around 10. As the EROI of an energy source declines, the energy source itself becomes more valuable; the resource is more difficult to obtain and the strain on the economy to obtain it is greater as well. The dependence of global economic growth on cheap oil is no secret and, in the absence of an accessible alternative fuel, long-term economic growth will be increasingly more difficult to realize. In this regard, considering the economic and demand constraints, global crude oil production has likely reached its peak.

Figure 2: Energy and GDP

In the post-peak world there are still plays to make and profits to be had. A host of these lay within the Russian Federation, who, despite facing declines in their giant Western Siberian brownfields, have recently pushed past Saudi Arabia as the number one producer of crude oil in the world. To maintain Putin’s ambitious production goals, Russia will face steeper and steeper development costs as they test the Arctic and perhaps try their hand at unconventionals. While not particularly open to foreign partnerships, Putin and Russia will need foreign help if they are to maintain their leading pace in both oil and gas. The International Energy Agency estimates investments totaling $730 billion will be required from Russian gas producers to sustain the current production of ~655 billion cubic meters. The situation regarding liquids replacement is perhaps more dire as approximately 50 percent of Russia’s federal budget is balanced with oil revenues. Additionally, Russia remains a price taker, subject to its inherent volatility. Unable to afford a slip in price, Russia must lean on its production to ensure stability.

Enter the recent and somewhat unexpected release of former oil magnate and Russia’s one-time richest man, Mikhail Khodorkovsky. Khodorkovsky spent the last decade behind bars for a list of crimes easily attributable to almost every one of his oligarch brethren. Unlike the others, however, Khodorkovsky seemingly forgot, or rather challenged the rules of the game. In a system of soft legal constraints, property rights lose their mettle and, at best, reflect a privilege granted by those with the control rights. After placing his feet squarely in the political ring, violating an unwritten agreement between Putin and the oligarchs, Khodorkovsky was abruptly incarcerated in 2003 and his multi-billion dollar oil business was stripped from his control, later forming the backbone of national oil giant, Rosneft. The ramifications were immediate as capital flight quadrupled the following year. In 2010, Khodorkovsky was convicted on additional charges of embezzlement and money laundering, pushing back his release until 2014.

On December 19, 2013, Putin surprised all parties involved when he announced that he intended to pardon Khodorkovsky; he followed through with the act the following day. The sudden change of attitude begs many questions, the answers to which only speculation serves. The pardon follows in the wake of heavy human rights criticism as the World anticipates the opening of the Sochi winter Olympics. Still, the release carries financial implications, which are likely not missed by President Putin. To foreign, and perhaps more importantly, domestic investors, Khodorkovsky’s imprisonment served as constant reminder of the financial and contractual insecurities that characterize Russia’s current institutional trap. Foreign direct investment is growing, having risen each of the last three years, but meaningful international partnerships have been slow to materialize. Domestic investors lack confidence and wealth is still rapidly flowing out of the country. As part of his release, Khodorkovsky has allegedly agreed to stay away from everyday politics and not seek to recover his lost Yukos assets. Shunning his business savvy and perhaps fearful of his political potential, Putin believes the symbolism, his mere freedom represents, also carries benefits.

Any impending global peak is the product of production peaks on a national level. While the exact arrival of global and/or national peaks are heavily subject to the economic conditions of extraction, the World can be sure the era of cheap oil is a thing of the past. Among the nations who will find it difficult to replace, let alone raise production, the United States and Russia rank near the top. Moreover, Russia continues to be a land filled with red tape where efficiency is anything but the norm. When coupled with already high replacement costs and growing research and exploration expenditures, Russia is squarely in the corner. In this context, the recent amnesty and specifically the release of Khodorkovsky is not altogether surprising, but instead a well calculated step towards a new image and perhaps the subtlest of admissions that, after years of posturing, Russia, just maybe, might not be able to go it alone.

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