The recent OPEC meeting provides an opportunity to understand the mysteries of the global oil market. As expected, OPEC decided not to cut its oil production. Barring unanticipated developments, prices will drop, says oil analyst Larry Goldstein. Potential oil supply, including drawdowns from bloated inventories, exceeds demand. Goldstein rightly cautions, however, that no one knows where prices will settle.
Oil’s dramatic price changes seem baffling. In mid-2014, crude prices averaged around $100 a barrel; now, they’re gyrating between $50 and $60. Over the same period, U.S. gasoline prices have dipped from more than $3.50 a gallon to around $2.50. With the world economy slowly recovering, why have prices collapsed?
The standard explanation comes in two parts.
First, oil demand is what economists call price inelastic. Slight changes in supply and demand can produce large price swings. People and businesses need fuel. If oil is scarce, they still need fuel and will pay dearly to get it. If oil is plentiful, they don’t need much more fuel and, therefore, require huge price discounts before buying more.
This is what’s happened. Supply and demand have unexpectedly expanded the global surplus, reducing prices. The increase in American shale-oil (U.S. oil production is up about 80 percent since 2006) unexpectedly boosted supply. Weaker than predicted global economic growth depressed demand. The world now uses about 93 million barrels daily (mbd) but can produce 95 mbd or a bit more.
Second, Saudi Arabia hasn’t absorbed the surplus. OPEC isn’t a cartel, says Goldstein, because most of its 12 members won’t cut production to prop up prices. In the past, the Saudis have done that. But now they are refusing to play. They’ve flooded the market with oil. Reportedly, they don’t want to lose sales to other producers. They are also said to worry that excessively high prices will blunt the future demand for oil.
All this is fine as far as it goes. It explains the mechanics of lower prices. But it misses a larger story: the retreat from “peak oil.”
Peak oil would occur when new oil discoveries no longer offset annual consumption and provided for future growth. This seems unavoidable. Oil is a finite natural resource. There’s only so much of it. When it’s gone, it’s gone. The trouble is that this compelling logic has yet to play out in the real world.
In 1950, global oil production was about 10 mbd. By 1970, it was nearly five times that, 48 mbd. Now, production and consumption are marching toward 100 mbd. Whenever peak oil seems to threaten, some combination of high prices, technological advances and happenstance expands global supplies.
The upshot is public confusion, as oil analyst Blake Clayton shows in a fascinating new book “Market Madness: A century of oil panics, crises, and crashes.” We repeatedly veer from the psychology and reality of scarcity to the psychology and reality of abundance.
The pattern dates to at least the 1920s, Clayton writes, when the explosion of car ownership inspired much talk of “oil exhaustion” and “gasoline famine.” Little wonder. From 1921 to 1929, the number of gasoline stations mushroomed from 12,000 to 143,000. In 1919, the average car traveled 4,500 miles a year; a decade later, the distance had nearly doubled. But gasoline scarcity was prevented by discoveries in Texas and Oklahoma, advances in drilling (deep wells went from 6,000 feet to 10,000 feet) and improved oil refining.
After World War II, the fear was that the United States, having supplied both its own and its allies’ oil needs, might soon drain its reserves. Never happened. Whenever prices are high, the notion that scarcity is permanent thrives. In 2008, 76 percent of Americans believed “the world is running out of oil.” Similarly, the fear of peak oil was one reason for thinking crude prices, until their recent collapse, would remain stuck in the $100 to $150 range.
The common error, Clayton writes, is that “no one at the time can see where more oil would come from.” There is a silent assumption that “if it has not been found yet, or cannot be extracted with today’s technology or at today’s prices” that it won’t ever exist. History has repeatedly refuted this premise.
All this suggests a deeper significance to the recent price collapse. Oil is not inexorably fading from the world stage. Peak oil remains distant. This, of course, has huge implications. To the extent that oil is a source of geopolitical and economic instability, the dangers remain. To the extent that it feeds global warming, the dangers remain. Unless history changes — and who knows, it might — the Age of Oil endures.
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