Why Metals Stocks Haven't Peaked

But I find the mechanisms that Peak Oil theory has developed to explain the direction of oil prices and the operation of the oil market immediately applicable to the metals sector.

Here's how those mechanisms work for oil: As oil production moves toward the peak, oil also becomes harder to find. Discoveries are smaller and in less-accessible regions or geologic formations. And it costs more to produce the crude from these discoveries.

Producing oil from existing fields also gets more expensive: It's never possible to recover 100% of all the oil in a field, and recovering the last barrel of oil also requires more technology, more equipment and more dollars than recovering the first barrel. Peak Oil theory also notes that extracting oil from a field damages the field by allowing water to infiltrate the oil pools, by leading to the collapse of rock or sand formations and the like. That happens even if the oil producer has put adequate capital into the infrastructure of the field, which most oil producers haven't done over the last decade or two.

The price of oil rises as the peak approaches for both reasons.

It's at this stage that opponents of Peak Oil theory often object that Peak Oil doesn't take into account the effect of those higher prices on oil production. As oil prices go up, it becomes profitable to exploit oil deposits, such as Canada's huge oil sands reserves. And it becomes profitable to find substitutes for oil -- such as ethanol or biodiesel. This postpones the day of Peak Oil, perhaps indefinitely.

But this counterargument, ironically, actually validates the key insight of Peak Oil. As the production peak approaches, the price of oil rises -- even as unconventional sources of oil and substitutions come to market -- because these new sources and substitutes are more expensive to produce than oil used to be. If they weren't, they would have been put into production during the days of cheap oil. In effect, the rise of oil prices in Peak Oil theory creates a price floor for these new sources. As the floor moves up -- to $40 oil from $30 oil, for example, and then to $60 oil -- new sources and substitutes become profitable. That slows the price rise predicted by Peak Oil. But it doesn't reverse it.