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What Peak Oil theory can teach you about all-too-neat theories.

peak oil theory

Peak Oil theory believers thought we were in danger of running out of oil

From time to time a novel investment idea comes along. It may or may not have any lasting value, but it may still attract a following and gradually rise to its height of popularity. Often, it seems to hit that popularity peak just when it can do the most harm to its believers.

One example: Peak Oil theory. This theory, which got its start in the 1950s, is based on observations of the cycle of production and depletion of existing oilfields. It says that global oil production will inevitably hit a peak (if it hasn’t already), then head relentlessly downward until the world runs out of oil.

Peak Oil theory became widely known and commonplace in the first decade of this millennium, along with rising acceptance of predictions that the world was running out of oil. Best-selling authors trumpeted the idea that we were headed for oil prices of $250 a barrel or higher. This was supposed to have all sorts of terrible repercussions, from the collapse of the intercontinental air travel industry, to the end of New Zealand’s exports of frozen lamb.

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However, Peak Oil theory failed to allow for the fact that science and technology might come to the rescue. That started to happen near the end of the last decade. Fracking and other new technology made it possible to produce oil and natural gas in larger quantities than ever before, in all sorts of places that had never produced a drop of the stuff.

Beginning investors often start their portfolio investing with these types of ideas. Some aim to stumble upon an investment that provides a 1,000-to-1 return, or find a course or guru that promises instant riches.

In early 2008, many investors’ portfolio investing strategy consisted of loading up on oil and gas stocks. Many made these investments in response to such notions as Peak Oil theory.

In the summer of 2008, some investors feared we were reaching this peak, and that was why oil prices soared to a record of $147.27 U.S. a barrel while numerous best-selling books were predicting that oil was headed for $250 a barrel or more.

Instead, oil prices fell below $40 in late 2008. The drop was partly caused by falling demand during the recession. As well, rising prices spurred oil exploration and production in places that were previously dismissed as too costly—like the oil-shale deposits in the western U.S. and elsewhere in the world.

Oil’s sharp rise and fall proved yet another old investment adage: The cure for high prices is high prices.

Peak Oil theory is still being used to invest

Peak Oil believers haven’t given up, however. They just re-did their calculations. Now they think they simply sounded the alarm about 50 years too early.

This is old news, of course. I bring it up here because something like this may happen to another novel investment idea that’s becoming commonplace. I’m referring to the Shiller price-to-earnings ratio or “Shiller p/e”.

The conventional per-share price-to-earnings ratio compares a stock’s price to its per-share earnings in a given year. It comes in two broad types.

One concerns earnings estimates—this kind of p/e compares the current stock price to an estimate of future earnings—usually the current fiscal year, or the one after that.

The other kind compares the current price to historical earnings—usually the last fiscal year, or the sum of the latest four fiscal quarters.

The Schiller p/e is an extreme version of the historical type of p/e. It compares the current stock price to the average earnings of the previous 10 years.

But It’s always a bad idea to base your investment outlook on any one indicator or tool. It’s a particularly bad idea to base your outlook on a single idea that is in fashion with investors, but out of tune with the current investment situation.

We see well-established oil stocks as a sound addition to a conservative portfolio, up to a limit of perhaps 10% to 15% of portfolio value. But we advise against excess exposure to oils, especially junior or aggressive oil stocks. The future of oil prices is far less certain than Peak Oil theorists make it out to be.

If you ask investors who have a few decades of successful investing behind them, few if any will credit their portfolio investing success to one big idea. That’s especially true if the technique involves predicting the future, or trying to speculate on the price movements of volatile commodities like oil. Instead, most will talk about everyday qualities like patience, consistency and a healthy sense of skepticism—the kind of qualities that bring success in all aspects of life, not just investing.

These qualities help you apply our three-part formula for portfolio investing success: mainly invest in well-established, high-quality companies; spread your money out across the five main economic sectors; and downplay or stay out of companies that are in the broker/media limelight. These are our guiding principles when we manage the portfolios of Successful Investor Wealth Management clients.

Have you followed Peak Oil theory? Are there other market predictions that you think will be debunked by time? Share your experience with us.



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