NOTE: May 2009 — For further updates on the oil price, see also:

The price of oil: 3 — energy economics and the financial crisis;

The price of oil: 4 – a rising road ahead.

It was a chilly evening in early February when the Managing Director called us all together. He paused a moment, glanced at the expectant faces all around him, and then he started.

Business is tough, he said, and we’re doing what we can. But finally, we’ve reached that moment when we’ve got to let some of you go.

A hundred of us stood there then, looking at each other, at the floor, and at the winter’s dusk outside.

There was silence. Some more explanation was required, and some more honesty was needed. And, to his credit, Mitch provided it. As ‘this company is going down the toilet’ talks go, it was pretty fairly done.

We’d had problems with one of our installations in the North Sea, he told us. We all knew that already. In the big money business of finding oil and gas and getting them to the beach, failing on either of those priorities was never good.

An asset team would miss its targets, and there’d be no bonuses or payrises for anyone ahead. Such is business, in any organisation. But this time, it was worse.

It’s the oil price, he said. February, 1999.

On that day nine years ago, the price of Brent Crude Oil from the North Sea stood at $9.80 a barrel, having fallen off a cliff to $9.20 in the December before.

Even then, it cost more than $12 a barrel to produce, and we were losing money on every barrel we delivered. It’s getting worse, he said, and we can’t see how it’s going to end. And no one could.

An analyst’s report in The Economist in the spring of 1999 said that with $10 oil a reality, there was nothing to stop a fall to $5. The market had changed, and changed for ever. There was a world glut of oil, with no resolution in sight.

Surely there are two sentences which should strike fear into the heart of any speculator, or anyone who has ever bought a house. ‘A structural change in the market’ – that’s one. And, ‘It’s different this time’ – that’s another.

It wasn’t then. But it is now.

In 1999, world oil production was at 75 million barrels of oil a day, and the Asian and Russian financial crises had removed enough demand, temporarily, to send the oil price plummeting.

Less than a decade later, the world is consuming 85 million barrels of oil a day, and produces almost exactly that much.

Within five years from that evening in 1999, the price of oil had more than tripled to $34 a barrel. It doubled again to $70 by the summer of 2005. And a few weeks ago, in January 2008, a barrel of Brent Crude Oil was trading at $98. In the space of just nine years, the price of oil had risen by exactly ten times.

In 1999, the North Sea was at its peak. UK oil production averaged 2.7 million barrels of oil per day that year. Further afield, Girassol, the first of a series of giant fields offshore Angola, had recently been discovered by Elf, and a string of new international successes followed. For a while.

By 2008, only nine years later, the UK’s production is down by almost half, at 1.4 million barrels of oil per day.

This country is still a world-class oil and gas producer, and the North Sea will yield petroleum for another three decades to come. But not at the same rate. The basin has passed its peak, and production is declining by around 4% each year.

The North Sea is just one hydrocarbon basin amongst many all around the world. But they all follow the same trend. Every dog has its day, and every oil and gas province ever found is eventually drained. For as long as we don’t invest massively in alternative energy, then we’ll have to keep finding new reserves.

But what if we can’t? With highly memorable exceptions in 1973 and 1979, world petroleum supply has always risen to meet demand. Maybe not much longer, since production looks remarkably flat, these days.

In 2007, the Bush administration and Gordon Brown each called on the Middle East to boost production and stem the rise in oil prices.

But the OPEC states can’t manage that trick any more. Petroleum supply in 2006 was slightly lower than in 2005. Early data for 2007 suggest that supply was static, or falling slightly further still.

So here’s the paradox. We’re not running out of oil – and we won’t, for years to come. But right now we can’t pump oil and gas faster to meet new growth in world demand. Oil and gas production is virtually at its peak.

That’s why it really is different this time.

It was in December that I bought petrol at over £1 a litre for the first time (that’s $7.60 a US gallon, by the way). That might seem a high price to pay, until you realise that the UK’s petrol costs just about the same as milk. That’s remarkable, when you consider the technology and effort required to bring it to the pumps.

Petrol costs in Europe are largely sheltered from escalating oil prices because taxes on fuel are so high. Until recently, we’ve also been protected by the falling dollar. But prices are still rising – and petrol is at 104.9p a litre in London as I write today.

The North American consumer is not so protected. I can remember the outcry when gasoline first rose to $1 a gallon. And then $2, and $3 at one time, too. But that’s just the start – and even a recession in North America may not make much difference now. Because what will a recession do? A drop in GDP of 1 or 2%, for a year or two, with a slow recovery to follow?

That’s just not going to cut it. Even if the phenomenal economic growth in India and China grinds to a total standstill, which seems unlikely, then static world demand can’t change the fundamentals of depletion. The North Sea shows that the decline from peak production in any basin can be swift – by 4% a year, remember, or as much as 50% within a decade.

With so many hydrocarbon-producing basins around the world, we can hope that the decline will be more gentle than that, when it comes. But make no mistake, a decline is coming, and it’s not that far away.

In January 2008, the oil price touched $100. It’s slipped to $87 today. That’s not surprising, since the value of any commodity is always subject to the direction of the market – that weight of speculation which can add or subtract 30% from the fundamentals, at any given time. The oil price may fall further in the next few months – perhaps to as low as $60, or a little less.

But let’s not get too excited about $60 – that’s just the level of twelve months ago. Prices will rise again, eventually, and we won’t have long to wait – since the economics of falling supply and rising demand make that a rising certainty.

Let’s be clear. This isn’t about $100 oil. In the near future you can add another 50%, or even double that figure, and just keep on going.

What’s the world going to look like with oil at $200, $300, $400 a barrel ? That’s a crazy notion – it sounds like madness. And if you think so, then just go back and read this post again.

So, let me reiterate. The price of oil has risen 900% within the last nine years. It rose 50%, year-on-year inside the last twelve months to reach that $100 peak. Maybe not tomorrow, but before too long, you can double that again. And after that, you can just keep on going.

This world of ours is going to look very different, very soon. Peak oil is happening, and it’s happening today.

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UPDATE 30.04.2008

When this article appeared in February 2008, the oil price stood at $87, down from $100 in January. Less than three months later, the oil price is hovering close to $120. The graph below from The Independent illustrates that rise.

Today’s oil price is at around 400% of the January 2004 level, and close to 250% of the figure for January 2007. Will the curve level off, or will it continue to extrapolate upwards? That’s the subject for a fascinating debate.