Some of the world's top-producing fields appear to be running dry. What happens when they do? A top money manager says we'd better be ready.

Imagine a world in which oil sells for more than $200 a barrel and the price of gas is pushing $2.50 a litre. It’s a world in which global economies have been devastated and competition for increasingly scarce petroleum resources has become heated.

Improbable? Not at all says Eric Sprott, the chairman and CEO of Sprott Asset Management. He thinks it could happen sooner than we expect and that we’d better prepare for it.

Sprott has developed a reputation on Bay Street for two things. First, his gloomy economic forecasts have become almost legendary – he even joked about it at a breakfast meeting with financial advisors in Toronto on Thursday. Second, he’s usually right and that has translated into huge profits for investors in his funds. Over the decade to Sept. 30, the Sprott Canadian Equity Fund generated an average annual compound rate of return of 27.3 per cent. Anyone who invested $10,000 in the fund back in 1997 and left it there would have seen their money grow to more than $111,000 over that period. So if his ideas sound a little kooky at times, just take another look at the numbers.

Right now, oil is both a huge worry and an opportunity in his view. He believes world oil production has either peaked or is about to. As an example, he points to the Mexico’s Cantarell oil field. Few Canadians outside the petroleum industry know much about it, perhaps because we’re so focused on the Oil Sands. We need to pay attention. Cantarell is the second-largest conventional oil field in the world, behind only the Ghawar field in Saudi Arabia. And it appears Cantarell is running dry! Production from the field, which was pumping over two million barrels a day as recently as 2004, is likely to average less than 1.5 million barrels this year and the decline is expected to continue. The word “collapsing” is now being used increasingly in conjunction with Cantarell.

Although we have not seen numbers to confirm it, Sprott believes production from the Ghawar field has also peaked. Saudi Arabia treats its oil numbers as if they were military secrets but petro-physicists who watch these things closely believe that a number of signs indicate a gradual decline in production. Russia, which Sprott says has been a “saviour” in keeping world oil production high, may also be peaking out. Meantime, Abu Dhabi is shutting in 600,000 barrels a day of production in November.

“The price of oil is talking to us,” Sprott told his audience. “It’s telling us that we have a problem.”

That’s why he believes that economists who predict $100 a barrel oil are being optimistic. He thinks the price will blow right by that level and that the time will come when $200 “is going to seem cheap”. He adds: “There is going to be a real fight for oil.” He appeared to mean that in bidding terms, but if the situation gets as tight as he predicts, the “fight” could be a real one.

But what about alternative energy sources? He feels that as the price of oil rises, more expensive options like solar and geothermal power will start to become economically viable. But it will take time to bring them on-stream.

If events play out in this way – and Sprott is by no means alone in his warnings – these are two of the likely consequences over time.

1. The Canadian dollar will continue to rise. There are several reasons why the loonie is so strong and one of them is our emergence as a petroleum superpower. As the oil price rises, therefore, it will pull our dollar along with it, all else being equal.

2. Oil stocks will go through the roof. Oil has always been seen as a cyclical commodity and if there is a world recession the price could fall again. But recessions don’t last forever – in fact, the average one in the U.S. is only 10 months. As the economy recovers, oil prices will rise again, topping their previous highs on the way up. Traders can try to time the dips but for most people the best strategy is to invest in some rock-solid oil companies with long reserve life indexes and stick with them. Currently, 22 per cent of the Sprott Canadian Equity Fund is invested in the energy sector.

Here are a few other quotes from Sprott’s presentation that I found particularly interesting.

On the U.S. housing market: “To my mind, they should have zero housing starts in the U.S. next year. They don’t need a single new house.”

On China: “It’s more important to watch the Chinese economy than anything else in the investment business.”

On stocks and commodities: “When a price goes up by 20 per cent, something unusual is happening.”

On U.S. currency: “The U.S. dollar is in peril for many reasons. Oil is their Achilles heel. Also, they’re still a militaristic country and it costs them dearly.”

On the financial system: “Grossly overleveraged…a farce!”

As you can see, Eric Sprott does not pull any punches. That’s why it was worth rolling out of bed at 6 a.m. to listen to him.