Watch for falling comsumption worldwide and an oil-price correction soon, says Henry Groppe Jr., founder or Groppe, Land & Littell.

For more than 50 years, Henry Groppe Jr. and his firm, Groppe, Long & Littell, have studied the minutia of global oil supply and demand. More than once, they have gained notoriety for calling a new direction in oil prices that flew in the face of the consensus. For that, they have gained the loyalty of long-time clients that include major oil and gas companies, independents, chemical and refining companies, financial institutions and governments.

Groppe thinks there may be an oil-price correction in the third quarter that “is likely to be abrupt, with the price rising again over time.”

Groppe (rhymes with copy) is in his 62nd year in the business and by all accounts, is going strong, thanks to a lifestyle based on the work of best-selling medical author Dr. Dean Ornish, whose research Groppe has supported for years.

After graduating from the University of Texas with a degree in chemical engineering, he served in the U.S. Navy. Next, he worked for Dow Chemical, Texaco and the Arabian American Oil Co. (Aramco) in Saudi Arabia for three years, where he began a decades-long friendship with fellow UT alum Abdullah Tariki, the first Saudi oil minister and a co-founder of OPEC, before forming his own firm in 1955.

It still has only six employees because Groppe prefers to keep it small, nimble and simple. He’d rather spend time on intricate data analysis and with clients, instead of managing people.

Groppe was formerly a director of Tom Brown Inc., working with that company’s chief executive at the time, former Commerce Secretary Don Evans. And, he has been on the board of UT’s engineering school for nearly 30 years.

Now with Evans, ExxonMobil chief Rex Tillerson and other energy and utility luminaries, he has helped form a new kind of energy think-tank that will spend millions of dollars during the next 10 years. The Energy Institute at UT’s mission is to help develop sustainable energy supplies for the U.S. It will study world consumption patterns, energy efficiency and distribution, and identify where new research is needed.

He strongly believes the U.S. should be and can be the world leader in new energy technologies. His preferred long-term energy source? Fusion.

With oil prices topping $130, it was time for Oil and Gas Investor to ask Groppe for his outlook, getting that and more in a wide-ranging, four-hour conversation that touched on declining Russian oil output, peak oil, OPEC’s big mistake, Chinese demand, the state of U.S. education and neuro-biofeedback.

Investor What do you make of $130-plus oil?

Groppe The world’s never seen anything like this. But there’s no way oil is going to rise to and stay at $150 or $200—consumption is responding all over the world.

With inventory changes and OPEC adding about 1.5 million barrels a day in the past few months, if I had to guess, I’d say we’ll see a correction in the third quarter this year. These kinds of bubbles—their timing and magnitude are hard to predict. My guess is, the correction will likely be abrupt, with the price then rising again long term. Oil is in short and declining supply, and prices have to be at a level where you can produce as much as you can.

Given enough time, the fundamentals always express themselves. Something’s got to give and industrial demand always goes first—consumer behavior takes longer

Investor You say OPEC has made a mistake?

Groppe OPEC cut production in late 2006 because they thought there would be a 1.3-million-barrel increase in daily non-OPEC production in 2007. That would have been the highest non-OPEC increase since 1984, by the way. What actually happened was, there was no increase in non-OPEC oil production in 2007, and demand was fairly steady.

But OPEC cut production by about 1.2 million barrels a day, and we drew down world inventories by about 800,000 barrels a day. Then in January and February this year, we had extra cold weather and we needed oil that wasn’t there, so we drew down inventories again. That’s why oil prices are where they are.

Investor You are a big believer in peak oil.

Groppe Peak oil has arrived and, of course, everyone is confused by it. It’s clear to us that total non-OPEC and most of OPEC’s production is peaking. And Saudi Arabia—the only country with significant unused capacity—is continuing its policy of limiting production, to postpone the day that their oil runs out. Oil prices must maintain levels required to reduce consumption, to match these irreversible declines in total future supply. We’ve been anticipating this for a long time.

Investor What about Saudi Arabia’s ability to do more?

Groppe They have launched a long-term program to raise their productive capacity to 12.5 million barrels a day. They’ll get there in a couple years. They also plan to create jobs by building more refineries and petrochemical plants in the kingdom. That is probably misplaced because those are so capital-intensive, and they employ not as many jobs as you’d think. But that is al Naimi’s plan, to create manufacturing jobs eventually.

There is little correlation between production and the resource base around the world, says Groppe, But he says production clearly is peaking for most OPEC and non-OPEC countries.

I admire him for being so dedicated to wanting to do whatever it takes for an ongoing, viable economy for the Saudis.

Investor When did you start sounding the alarm about the peak?

Groppe About 10 years ago, we concluded the peak would happen at roughly this time. I still don’t know exactly when the peak year occurred—that is less meaningful than the fact that it is happening. We did pinpoint almost to the year that the Soviet Union would begin to decline now.

Investor Why?

Groppe The FSU (former Soviet Union) peaked in the 1980s at more than 12 million barrels a day. But with the political collapse in 1989, the economy fell apart and internal consumption fell by 6 million barrels a day.

In 1994, they privatized their oil companies and the companies contracted and brought in thousands of engineers from Halliburton and Schlumberger. They just did the easy things to bring production back up to 12 million barrels a day—at which point the decline has kicked in again.

The irony is that, when President Gorbachev diverted money away from the provinces (satellite countries like Kazakhstan and Azerbaijan), they could not increase their oil production—and now, of course, they are exploiting those reserves for themselves. There is also still huge potential in eastern Siberia.

Investor Why is the world in trouble as far as production goes?

Groppe There is little correlation between production and resource base around the world. Look at Alberta—it has the second-largest amount of oil reserves in the world and yet it is only producing just over 2 million barrels a day—and with great difficulty. But it’s important because it can, actually grow production in the future.

There are two things at work in all this. First is depletion. The second thing is equally or more important, and that is, exploration is a rational process: everybody looks for the biggest deposits first and develops them. From 1945 to 1970, the U.S. doubled its production with big new finds and then peaked.

But in the 38 years since, oil prices have increased 50-fold, the technology is obviously much better, we’ve had a large number of competitors—and none of that has offset our decline. The latest example of this trend is the North Sea and Mexico. One country after another, it is happening.

Last year, for the first time in many years, the U.K. was a net importer of oil. They exploited their reserves rapidly, sold their oil for $20, and now they are buying it back for $120.

Investor What about all the untapped resource base in the world?

Groppe You never run out of oil, but we ran out of $10 oil 35 years ago, and we have now run out of $50 oil. There will be an oil industry 100 years from now, just like there has been in Appalachia for 100 years. They have third- and fourth-generation oil people there, using new technology.

Total world consumption has bee leveling off since 2004. Growing consumption in China and India will not offset declining oil use in the OECD countries, Groppe says.

The conventional forecasts from the likes of ExxonMobil and the Department of Energy say that the resource base keeps improving and technology keeps improving, so they assume oil production can continue going up. We disagree completely.

We find that most forecasts—no matter who is doing it and what has been forecast—are usually a straight-line extrapolation of what’s been happening recently. But our work has been focused on forecasting major discontinuities because that’s how the world really operates. The world doesn’t operate in a straight line.

Investor Explain how you do that.

Groppe We try to do very detailed, bottoms-up work. Activity in the world is so diverse and discontinuous. Every place has unique reserves and a unique cost structure. If we could do a thousand studies, the more accurate the composite answer would be.

The next big set of surprises will be on the consumption side.

Investor How so?

Groppe You’d need to do thousands of studies on each type of use in each part of the world to really understand it. We’ve been working on that for more than a year.

There are only about 400 or 500 refining-company oil buyers in the world who buy raw crude. The one thing we’ve found is accurate is oil-import data, because generally each country’s importer pays an import duty on every barrel and would not lie about that. We look at each country’s production, what they import or export and what they net out for their own consumption and we learn where the mistakes are in the data, and try to get closer to the truth.

Investor What have you found out?

Groppe We don’t agree that new demand in China and India will overwhelm consumption declines in the OECD (the Organization of Economic Cooperation and Development) countries. Total world consumption growth has actually been leveling since oil passed $40 in 2004.Yes, from 2000 to 2004, the average annual increase in Chinese oil consumption was about 8% per year. But since then, the average annual increase in China has been more like 3% per year—less than half the rate that it was.

The universal explanation for inexorable growth in demand is China, but that has to be examined more closely. Everybody talks about cars there, but two-thirds of their oil use is for power generation, industrial and other consumption. They are trying to cut back on their need for imported oil by using more coal, which they have plenty of—last year they brought on the equivalent of a new 1,000-megawatt coal-fired power plant every five days! The world has never seen anything like it.

So, there doesn’t have to be any increase in total oil demand in China for years—as internal use of coal displaces oil used for power and other uses, and makes that oil available for transportation uses.

In the past three years, they only increased their oil demand an average 200,000 barrels a day annually—I’m sure consumption in the U.S. will drop by more than that this year.

This is the kind of detailed study we do of world oil consumption.

Investor What about other data, like from the International Energy Agency?

Groppe The IEA data is the worst. It’s almost fiction. Their problem is structural—they are a classic bureaucracy and most of the employees are mathematicians, economists or computer programmers, not oil-industry people. They have no leverage on anybody reporting data except the member OECD countries.

In the past, OPEC has exaggerated its production by as much as 1.2- to 2 million barrels a day. That’s a huge error in an 84-million-barrel-a day market. We’ve looked at this over time and a 100,000-barrel change in production or consumption moves the price by about a dollar a barrel. We’ve tested this through many cycles and it always works. So that could change the price by $12 to $20 a barrel!

Investor What do you think of alternative fuels?

Groppe As we exploit lower- and lower-grade resources, we’ll be doing more work on alternatives. In a free political system like ours, you can’t get anything done until there is a crisis. In an emergency, you do 25 things at once and usually, they are all wrong. Ethanol from corn is one example.

Ultimately I think it’s likely to be something like fusion energy. That’s got a lot of problems, but if you accelerate the research now, maybe in 50 years when oil is a less prominent part of the supply we use, we’ll be able to phase it in.