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Okay, it’s official. The price of oil has touched $109 and that wipes out once and for all any doubts about whether this is the record inflation-adjusted price. This is it. This is the new record for the price of the world’s most widely consumed and traded commodity, which has surpassed the peaks of the late 70s and early 80s.
So far, mainstream commentary has been that this increase is the work of speculators who are pushing the price up as they flee the U.S. dollar. But is that the whole story? Personally, I think the price of oil has to come down in the months ahead. The U.S. uses one quarter of the oil pumped in the world each day, but it’s sinking into recession and that fact will catch up with the price at some point.
But even if the price of oil drops in the months ahead, let’s not lose the signal in the noise. I’m one of those believers in the collective wisdom embedded in markets. Market prices, though they get away from fundamentals over the short-term, accurately reflect fundamentals over the long-term. And so even if it is the case that there is a lot of speculation built into this price, the fact that oil is still at unprecedented levels (even if it falls to $60 that is still 300% higher than it was through the late 80s and 90s) tells us that there are real issues around supply and demand.
What is going on? Back in the late 70s and early 80s, the last time oil was at these prices, inflation was beginning to pick up (like it is now) and there were all kinds of worries about the future of the West. Luckily North Slope Alaska and North Sea crude came online and provided all kinds of new supply. The Saudis also opened their taps in the early 80s and the vast new flood of crude swept through markets, knocking prices down for a generation and let it float through the 90s on a pool of super cheap crude.
Since then, of course, two of these crucial sources of supply — the North Slope and North — have begun to dry up. The North Slope in Alaska has gone into decline and is now putting the 49th state into a state of fiscal emergency (Alaska recently raised taxes on oil production to stem the tide of falling revenue from declining volumes on exported crude, a move that saw it fall down to the bottom of a list of “stable” energy economies). Over in the North Sea, the cluster of fields found in the cold waters between Scotland and Norway peaked a decade before many expected and volumes there are down 40% from where they were at the peak of 1999.
No wonder we’re at $109 a barrel. But at the same time we’re dealing with these declines, demand continues to rise in China. A recent cover story in Time magazine talked about the trend among middle-class Chinese to flee the smog-ridden urban centres for idyllic car-centric suburbs. It seems the Chinese are repeating that great American migration of the post-WWII years, and that trend is working to create a whole new level of “base demand.” As it is, the U.S. economy uses 25 barrels of oil per capita, China just two. Even if a percentage of the Chinese population increases its use to half of what the U.S. uses, say twelve barrels per capita, this is massive new demand.
That has been enough to affect the price of oil, and the China story was one of the reasons for the increase in price early in this decade. But we’ve run into some new bumps in the last couple of years. It wasn’t long after the North Sea peaked that the U.S. went into Iraq, and according to Alberta Oil (AO) magazine “a military victory in Iraq [that] was supposed to bring additional crude oil to market and provide another generation of inexpensive petroleum — in much the way the Saudis did in the 1980s and 1990s.” That hasn’t happened, of course. Production in Iraq is still only about two million barrels a day, far less than what was supposed to be coming out of there by now. And the problems could get worse. According to Alberta Oil, the Bush administration failed to recognize that the American occupation would send the price of oil up as insurgents began to focus on “destabilization,” which has driven the price up even further. It is also clear now that the Bush administration wasn’t able to install its first choice, Ahmad Chalabi, as leader of the country and that the country could be moving into the sphere of Iran. When Iranian president Mahmoud Ahmadinejad became the first foreign president (after Bush) to visit Iraq, the visit (a week ago) was designed, in the words of one Iraqi politician, "…[to send] a strong message to the Iraqi people that Iran is present in Iraq."
Dick Cheney is in the Middle East this week, presumably to get some of these stray ducks in order. As it is, the Iraq Oil Law — a contentious document that has come to be viewed by many Iraqis as something relegating a national Iraq oil company to the sidelines and handing over command and control of the nation’s oil to Western firms — has yet to be passed by the Iraqi parliament. It’s not widely reported in the West, but the signing of this document is something that has been addressed by the string of U.S. officials who have traveled to Iraq in the last couple of years. We’ll see what kind of reception Cheney gets.
The other big problem in the region, of course, is the Saudis’ recent refusal to up their production beyond current levels. The world has always relied on the Saudis to up their production in times of need, and so when they refused last week to do that. the price of oil began to wander into its current territory. The Saudis suggested they didn’t raise production because the U.S. economy is likely to go into recession (and that is likely true), but the fact that they didn’t raise production only increased speculation among the peak oil crowd that the Saudis are at the limits of their production and simply can’t increase it.
Also playing into the high prices is the fact that Conoco-Philips and Exxon-Mobil (along with Petro-Canada) recently pulled out of Venezuela’s Orinoco tar sands, which would have been another great supply response to rising demand. Canada’s tar sands are often said to be the world’s largest “new” deposit of oil, but there’s a lot of the same stuff in Venezuela. In fact, the Orinoco tar sands may be even more valuable than Canada’s since this deposit (which is at least as big as the Alberta tar sands) is located near the equator, which means you don’t have to burn tons of natural gas to melt the tar for processing. But capital investment there is on hold now that Hugo Chavez has thrown Exxon-Mobil out, and that seems to be adding to price concerns. “Now that they’ve solved the technology problems in Alberta [for extracting oil from tar sands] and they’ve taken them down to Venezuela, this is where we could have expected, over the next 15 years the best supply response to oil demand,” said one industry observer in a recent interview. “But by putting this military dictator in charge, they’ve replaced petroleum engineers and geologists with thugs and the result is that production keeps falling in Venezuela. They haven’t met their OPEC quota in two years. They’ve only skated onside because the oil they are producing is priced so high. From a world standpoint, where Venezuela was a big solution to the problem, they’re now part of the problem.”
No wonder the price of oil is at $109. You’d almost think it should be higher. So, is there any hope for that a new flood of oil from other sources that would complete the cycle and lead to another generation of low prices? This is the key question in oil markets today — and it’s one that takes us to the heart of the debate between the “cornucopians” (those who suggest there’s lots left to find) and the depletionists, the peak oil types who say that we’ve found all there is.
Kenneth Deffeyes, a Princeton petroleum geologist (and a key figure in the peak oil camp) coined the term cornucopian. He uses it to describe those who believe that the dearth of discoveries since the 80s was the result of the lack of investment in new exploration and production that followed on the low prices in the 80s and 90s. With no money to spend on exploration, companies gave up looking for oil, and so we didn’t find any. But now that prices are high again, we’ll begin to find more, and we’ll soon realize a flood of new oil. At least that’s the cornucopians’ take.
Counter to that camp is that of the depletionists, the peak oil types who suggest that the problem is actually simpler than that: we’re not going to find more oil because there is little more to find. According to this school, we’ve already discovered all of the world’s big super-elephants. What we’re finding these days are increasingly smaller, harder-to-access fields (usually in the rougher areas of the world), and this is a key global issue. As it is, of the 40,000 oilfields currently producing oil, over two-thirds of the total flow comes from just 400 of the very largest of these pools, all of them super-elephants found back in the golden age of discovery, the 50s and 60s. If these big ones begin to go into decline, we’re in real trouble, since it’s going to be hard to replace what we’re losing.
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