Oil At $150?
March 2, 2011
Alvaro Vargas Llosa
Washington Post Writers Group
WASHINGTON—Oil has a funny way of concentrating people’s minds when it starts hovering around $100 per barrel, as it has of late due to the turbulence in the Middle East and North Africa, where six out of every 10 barrels of known reserves are located. Suddenly, the specter of mid-2008, when oil reached $145, is back and everybody, from drivers to analysts to presidents, is panicking—and offering solutions. NATO’s possible intervention in the troubled area, massive new investments (and subsidies) in alternative fuels, entreaties to the OPEC cartel and other desperate responses are being discussed.
There is a basic reason why oil will continue to be expensive. Any political or social eruption where oil is produced will make things worse, but the era of expensive oil began long before the Arab ferment. What this and other crises do is simply reinforce the fundamentals of supply and demand.
Which is not to say the consequences of short-term upheavals are insignificant. Libya is a key provider of light, sweet crude to Europe, particularly Italy, France and Spain. While it is true that Saudi Arabia has spare capacity that could put another 4 millions barrels of oil a day into the market, it is not light, sweet crude. If those European countries were forced to buy from Nigeria or Algeria, which is where the United States obtains some of its own light, sweet crude, prices would still go up because of the bidding war.
But the real problem is this: A spare capacity of about 4 million barrels a day is hardly enough to resolve a growing world imbalance between demand and supply, as Charley Maxwell, probably the most respected oil analyst anywhere, has been saying for some years. According to the International Energy Agency, daily world demand grew by 2.7 million barrels last year alone, mostly due to emerging markets such as China and India. For some years, demand has been growing at a greater pace than supply, something that—unless the emerging giants suddenly shrink—is likely to continue. While discoveries continue to be made, they have been dropping heavily since as far back as the 1960s. Except for a brief spike a decade later, the number of known reserves has steadily declined since then. And Russia’s and Venezuela’s incompetent state-owned oil giants ensure that even in places with large reserves, production falls off.
Precisely because of all this, as well as for ecological reasons, the world has heavily subsidized alternative sources of energy. So far, they either have proved too costly for mass production (electric cars) or have triggered food shortages and skyrocketing food prices (corn-based ethanol). Moreover, the surge in oil prices has also encouraged private capital to increase its investments in the oil industry, offsetting the effect that those very prices had in encouraging the search for alternatives. Would you rather try to strike oil if you could sell it at $100 a barrel, or, say, natural gas at $4?
Before the uprisings in the Middle East and the Maghreb, the Arab tyrants had announced plans to encourage about $100 billion in oil investments in the next five years, about two-thirds of what is apparently needed just to keep up with demand.
But even if those plans were to go ahead, the demand pressure will continue to grow. All of which means two things. First, oil, the source of almost all transportation fuel in the world, will continue to be dominant. Second, because the discoveries and investments are insufficient to keep up with the explosion in demand, oil will be ever-more expensive. This will one day change—when the market fundamentals dictate that they do, not when governments, cartels, non-governmental organizations or pundits decide so.
Yes, there will be consequences. If oil supplies to Europe are affected substantially, the region will have to rely even more on Russia, something it has desperately tried to avoid given the strong-arm tactics Moscow employs with its supply of natural gas channeled through Ukraine. If gas at the pump reaches $4.50 or $5 per gallon in the United States, Barack Obama will probably be in big trouble in 2012. And so on. But, beyond these effects, we simply have to become used to the idea of very expensive oil for a very long time. No political theatrics will change that.
Alvaro Vargas Llosais Senior Fellow of The Center on Global Prosperity at The Independent Institute. He is a native of Peru and received his B.S.C. in international history from the London School of Economics. His weekly column is syndicated worldwide by the Washington Post Writers Group, and his Independent Institute books include Lessons From the Poor: Triumph of the Entrepreneurial Spirit, The Che Guevara Myth and the Future of Liberty, and Liberty for Latin America.
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