EconomicsPeak Oil

The Future of Oil Prices

As Matt Simmons points out: oil is not just another commodity. For industrial societies oil is as basic as food and water. That’s why the price of oil cannot go up very high after the production of oil peaks. Economic logic suggests that if demand is high and supply is low then prices will skyrocket. However, there are goods for which the prices cannot be set by the interplay of demand and supply, because if they were it would undermine the viability of the whole economy. Oil is one of these goods.

Many analysts suggest that the price of oil will rise sharply after the peak. They predict that one barrel of oil may cost 280 USD, 350 USD or even 600 USD. Speaking strictly from the economic point of view, this is correct. Demand outstrips the supply, so the price goes up. But… there’s something missing from this picture – that being politics. At the moment world leaders are working hard to restore economic growth. It doesn’t matter if it makes sense or not, that’s just what they intend to do. The price of oil directly underpins the livelihoods of millions of people. What would politicians do if the price of oil started to rise again? Would they react or not? Would they allow their economies to crash again under the high price of oil or would they counteract? And what would people do? Would they march on the streets demanding their governments to act or not?

When analyzing the future of oil supply to my home country, Poland, I looked at it from a social perspective, and I just cannot imagine that prices on the gas stations will go up, up and up. If the fuel prices crossed a certain level, let’s say 5 zlotys per 1 liter of petrol (at current exchange rate that would be USD $1.51 per 1 liter or USD $5.71 per gallon) we would have massive social unrest, road blocks and protesters screaming from the top of their lungs right in front of the prime minister’s office. They would wave the “Solidarity” flags, bang pots and blow sirens until the prime minister’s ears would fall off. People would demand the government reduce the fuel duty in the first place. In Poland taxes are a large chunk of the price of petrol, even 53%. Our government would have to react or it would face defeat in the next elections. That’s the political logic. It seems to me that the same situation would be repeated in other EU countries that have high fuel taxes. In 2008 thousands of truck drivers brought Spain to a standstill as they went on strike over rocketing fuel prices. There were also fishermen protests Netherlands, Portugal, Italy and Belgium, and the famous lorry drivers protests in UK in 2000. And Tony Blair’s government eventually had to give ground.

But what would the US government do if the oil prices reached 147 USD per barrel again? Would Barack Obama react or not? Would he allow more foreclosures, more job losses, more families not able to make ends meet? However, one thing that is different in the US than in Europe, is that there is not much room for lowering fuel taxes.… If Obama wanted to have socially acceptable prices at the gas stations he would have to deal with the price of crude oil itself. And he would have the full support of the EU governments for it, because they don’t want to lose the substantial income from fuel taxes at home.

The record oil prices in 2008 sparked a discussion about curbing market speculation. If the price of oil starts to rise again, politicians may call another G20 meeting so and they can take on this issue. They can take the price of oil out of the hands of hedge funds, investment funds and the others. They can even have a regulated price of crude oil. How could it be since OPEC countries may not be willing to cooperate with the USA or the European Union? Well, they don’t have to. The prices are not set by sellers alone. They can be influenced by buyers as well. If oil buyers agree on a common price, how can sellers get around it? This is just a possible future scenario, but it seems very likely to me.

Keeping oil prices at the relatively low level after the peak may mean that fuel rationing will have to be introduced quickly. When I was a kid we had fuel rationing in Poland. It wasn’t that bad. Actually, it was quite normal. With today’s technology it could be e.g. plastic cards zipped at the gas stations. We can certainly live with it.

11 Comments

  1. “If oil buyers agree on a common price, how can sellers get around it?”

    By selling only what is profitable at that price i.e. selling less. Therefore, a reduction in oil production.

  2. Personally, I think that no matter what governments might do to subsidise the real, rapidly rising costs of production (and for searching for new harder-to-get and thus more expensive to develop sources) that will likely become exponential over the coming years as demand once again outstrips supply – the money still has to come from somewhere….

    End users will get stuck with the bill in one way or another, and as an increasing percentage of public funds are diverted to maintain the oil-based economy, priorities for public spending will shift away from other important and semi-important services/projects. Since it can potentially take a tremendous amount of time to transition a society away from oil dependency, most of the world will be caught on-the-hop. Expensive oil will arrive, likely in the midst of a moribund economic condition, just when enormous amounts of funds are needed for transitioning societies towards a low-carbon existence.

    If such realities had not been ignored, and were sensibly considered and tackled during prior economic boom years, when money was flowing freely, then we might have had a hope of avoiding large-scale social disruption. As it stands, if the most recent supply forecasts of the IEA are anything close to reality, then it certainly looks like more than a mammoth task to avoid such disruption. We’ll now be in a situation where we’re ‘reacting’, rather than ‘acting’.

    Governments may ‘patch’ the problem in the short term, but it still has to come out of taxpayer dollars. The true costs (even if not counting the externalised environmental costs – considerations that will take a back seat to the urgent need to stop widespread and immediate economic/social breakdown) will always have to get passed along. It’s either that, or governments will just print more money, and ensure that the economic predictions of many will be even more likely to come true – that we’ll head into a period of hyperinflation.

    Also, like climate change, I think the mechanics of how Peak Oil will play out will be a lot more dynamic (less linear) than many suppose. We look at supply forecasts for a particular country (like Russia for example), and consider depletion rates, and then conclude that supplies to countries dependent on Russian oil will diminish at that same percentage rate – whereas we need to consider the very real possibility that as a country like Russia realises the true value of its energy resources to help it through a very expensive transitional period, it will make its own internal needs priority, and start to pull the plug on exporting. Mexico is another good example of this. It is the USA’s second biggest supplier, and is now experiencing a very rapid decline in production. At what point will it decide they no longer want to supply the US? What will that mean for relations between these countries? etc….

  3. First a rising Oil Price simply reduces demand. There are some easy means to reduce demand e.g. in heating and driving – up to a point.

    Once you reach the point where it requires significant investment to reduce demand even further (buying better heaters/cars/etc., investing in alternate energy sources) and demand is still higher than supply, then things will get serious. Prices will go up again until some people simply can’t afford to buy oil any more while others still can. Look at what happened in Pakistan and other poor countries during > 100$ Oil.

    The next stage happens when there isn’t even enough oil/gas to cover the basic needs of the rich, developed countries. Then the fighting will start and physical control of pipelines, tankers and oilfields will become important. At this stage, the future becomes impossible to predict but it will not be nice.

  4. In the current economic paradigm it will be unlikely that high oil prices causes recessions, until the next collapse or the one after. This recession will take some years to play out and oil will NOT be the focus during this time – when things pick up and oil heads back over the $100 mark things begin to unfold again there is a < 50/50 of a concensus that oil is the problem, the time after will be different – that is when we are living the lifestyle of the 1940’s!!

  5. Craig, I agree that on the supply side we may experience very soon an oil crunch due to lack of new investments. My point is that if the prices start to rise again, politicians will intervene and the price of oil will no longer be set by market speculators. This alone may be enough, and if not then perhaps politicians will come up with some sort of a mechanism for setting the international price of oil.

    Regulating the prices doesn’t necessarily mean subsidizing them. Currently in Poland the price of energy which is sold to households is regulated by government. Companies sell energy at profit, but this price cannot go above a certain level which is set by the government. It’s very convenient, because Enron-style tricks with rising energy prices, like they did in California, are not possible here :) And it’s still a free market, only a regulated one.

    It seems to me that oil prices can be a subject to negotiations between countries or on the international forum. Poland and other EU countries may be dependent today on oil imported from Russia. However, Russian economy is also dependent on receiving income from sales of this very oil. Cutting down on oil exports may be very difficult for them. Russia and Venezuela already have problems with less revenue to their budgets. But certainly I agree, at some point they will have to choose to pump oil for local consumptions. For the US dependence oil imports from Mexico, fuel rationing could solve this problem.

    Getting ready for the oil crunch is a whole different story. It would mean restructuring the whole economies, before the problem appears. I agree that it’s a good idea to use money from economic boom to finanse the transition. However, very often politicians are willing to act only after the problem appears. In Poland building highways is a no. 1 political priority. There is absolutely no way of explaining the government that it doesn’t make sense because for them… it does. It helps them to win elections.

  6. This article was very unimpressive. A few reasons:

    1) price of oil has nothing to do with taxes. If taxes are high, that is a problem with government, and has nothing to do with peak oil.

    2) Saying that “oil prices cannot go up” because…paraphrasing, we need it too much, is silly. Considering the net energy, crude oil is amazingly valuable. Price controls would simply keep oil off the market and drilling/exploration would stop.

    3) the question of what the US govt would do if crude hits $150/bbl was already answered last summer…NOTHING will be DONE. Politicians will complain (only because the people they theoretically represent are complaining), and oil companies will make huge profits. Nobody cared about the oil companies when crude was at $18/bbl, so why is it different when they are MAKING money?

    4) fuel rationing…will only effect the countries who choose to/have to do it. Crude oil is a WORLD market. Rationing will only be a local phenomenon. Buyers will pay up, and the rest will simply have less oil. Rationing will not keep prices low. And of course the oil that is left is just the NET EXPORTS..an issue not mentioned in the article.

    I get the feeling that this article must have been written by a European, as nothing else could explain such basic ignorance of economics and energy.

  7. Dboy, while the price of crude oil has little to do with taxes, the price of fuel has a lot to do with fuel duty and VAT. As I’ve mentioned in Poland taxes can constitute even 53% of the price of petrol and in UK in 2000 taxes accounted for 81.5% of the total cost of unleaded petrol.

    You also write that: “Price controls would simply keep oil off the market and drilling/exploration would stop.” I’m sorry but I disagree with you. If the internationally regulated price would be e.g. 85 USD, then I don’t see why most of current drilling would not be profitable. Please note that extracting oil from tar sands in Canada is currently profitable at 50 USD per barrel.

    You are certainly right that there was no government intervention in US in 2008 when prices reached 147 USD per barrel. But: at that time George W. Bush was a president and it was before the financial crisis. In the summer 2008 who would have thought that just in couple of months many banks will be nationalized :) It seems to me that if prices go sharply up, the reaction of Obama’s administration will be different.

    Fuel rationing may be a local phenomenon, but it may be an international agreement as well (such as the Oil Depletion Protocol). In the scenario that I presented early fuel rationing is the effect of keeping low prices when demand is high.

    Daniel, I agree that at first the higher oil prices will reduce demand. But I think that while the developing countries don’t have enough political power to change anything when prices are too high for them, the US and EU countries do. And it’s the US that will be most interested in dealing with the high price of crude oil, so many things are possible, I think.

  8. I think what is being forgotten here is that there is a great deal more to oil than just ‘fuel’. Oil and natural gas translate to all the industrial agricultural chemicals that grow the food that feeds the majority of the world’s population, for example. The ratio typically accepted is ten calories of fossil fuels to produce one calorie of food. This will be arguably the most critical aspect of peak oil – in that the necessary transitioning to low-carbon, more manual agriculture, if done in a hurry, will cause massive social unrest and displacement. It means potentially arbitrary siezure and dividing of lands, etc. Cuba’s ‘special period’ is worth studying in this regard.

    Beyond food is a host of other interdependencies, exacerbated by the national specialisations born of ‘free trade’ and globalisation.

    Our oil dependency is far more entrenched than just transport fuel we buy at the pump, taxed or otherwise.

  9. Mr. Gerwin,

    the lifestyle that China and India aspire to (= the american way of life), will definitely outstrip the global capacity of oil production. At that point, governments have no rea

  10. Peak oil is a major problem that can and probably signal the beginning of the end for globalisation, and industrial civilisation in general. The only way we are going to transition from fossil fuels to alternatives is with a lot of sacrifice, and a lot of pain and even when when/if we actually carry out a transition, per capita energy consumption will have to remain a hell of a lot less then currently………sorry all you people that think that wind, solar, hydro, geothermal can mean business as usual if ramped up enough….they can’t, they can mean survival and maintainaing the most important bits of our modern world….and thats it….like keeping your lights……and refrigeration…….but not your giant flat screen……air con….or loads of other luxury appliances. What got us into this mess in the first place is that we use energy to make life luxurious….we should use it for needs and limit severly the amount a person can use for making life more comfy…….regardless of the amount of money they have to spend on it. I say strict rationing……20 liters per car per day max….if it’s not enough…..rearrange your life so it is…….period. Do away with all throw away plastic items…..make it illegal to put plastic in rubbish…..all has to be recycled by law….and do away with plastic bags……plastic bottles……and a million other measures. Make is so that all petrolieum products need a license for businesses to use….and all uses are judged on a need basis and knocked on the head if they are not needed……that means only essential items could be made out of plastic……no junk. I bet we could get the world down to using less then half the oil we do now. Then use all the saved energy and materials to ramp up alternatives and limit per captia energy use by growth of alternatives only……in other words….limit electricity consumption per house to enough to run the lights and friges/freezers plus a little bit of entertainment based on number of people living in the house, you use your limit…it cuts off until the next day, and no amount of money can buy you more……if you want more…you install solar panels…..wind turbines or heat pumps or sterling engines or something…..but you can not get more power off the grid for all the money in the world….period……..do the same with fuel..watch the sale of super economical cars go through the roof…..and bikes……scooters……motorbikes…..public transport…..and walking. Lets face it…..we are fuel and energy pigs…….and we do not “need” to use so much……we are just pigs.

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