Oil

The rise of oil production (and oil consumption) has coincided with the industrial revolution. Some go as far as attributing our rapid growth in the last century to easily accessible and cheap oil. Historically, expensive oil has tended to cause or coincide with recessions, and cheap oil has coincided with growth and prosperity. Not quite what one would expect if the oil price were determined mainly by demand variations. No doubt, oil has been and still is very important to the global economy.

Up until the seventies, oil production and consumption tended to increase at a rapid pace. Then came oil sheiks, the oil crises and increasing oil prices. The immediate effect was economic and political turmoil. The longer term effect was increased exploration efforts and energy savings. The oil consumption has gone up somewhat since the seventies, but the peek of oil consumption per capita is far behind us.

One of the results of the oil crises was feeling that oil might run out. Known oil reserves would only last for a few decades into the future. But time passed by and oil did not run out. In fact remaining oil reserves seemed to increase each year rather than deplete. Today the general consensus is that oil will not run out, at least not in the foreseeable future. Anyone who thinks differently is a crackpot or a doomsayer. History has taught us that we will find as much new oil each year as we pump from the ground. Yet, this will not go on forever. Oil is a limited, non-renewable resource. Every time we burn a barrel, there is one less barrel left. Eventually oil will run out, or at least become scarce enough and costly enough so that we won’t burn it all. Before oil runs out, there will be a peek in production. We have not passed that peek yet, but growth in production tends to be slowing.

A lot of facts tell us that we will soon see the peak in oil production. We know a lot more about geology and the forming of oil now than we did in the seventies. The easily accessible potential oil fields have been explored, and the most likely places have been drilled. It is becoming increasingly harder to find new oil. There is also indications that remaining oil reserves are not as large as are officially stated. One reason for exaggerating reserves is the OPEC rule that oil quota are determined based on the size of reserves.

A likely outcome of a future reduction in oil supply would be a rising price to the point where it would not be economical to use oil as energy anymore. Other outcomes are possible as well. One might think that it would be rational for the oil producing countries to restrict production in anticipation of a significantly higher oil price. There are, however, a number of reasons why they don’t.

As mentioned before, world oil consumption per capita has dropped from the peak value. This is mainly due to saving and alternative energy sources. In many countries there have been government efforts to reduce the dependency on oil. The high oil prices in the seventies acted as a catalyst to this process. Many OPEC countries, especially in the Middle East, with decades of oil production still in the ground are afraid that increasing oil prices will speed up this process. Also, a drastic rise in oil prices might throw the world into a recession, and many oil producers have major investments in the world stock markets. A more sinister explanation could also be contrived. Maybe the Middle Eastern oil producers anticipate a drop in world oil supply a few years from now. If oil is allowed to be cheap for a few more years, the rest of the world may not notice that oil supply is drying up. After several years, there would be no competition left, and the world would still be heavily dependent on oil.

There are other explanations as well. Many of the oil producing countries need money now. Either they are poor, in war or have gotten used to steady incomes from oil production. Especially for the democratic countries, there is usually no incentive for the politicians not to maximize oil incomes. These countries tend to call for higher prices and cuts in production and then produce as much oil as possible anyway.

Basically, the key to long term prediction of the oil market is to determine whether oil supply or oil demand will dry up first. A joker might be the environmental movement.

Related Sites

American Petroluem – API