Although oil has experienced an extraordinary price increase over the past few decades, a turning point has now been reached where scarcity, uncertain supply and high prices will be replaced by abundance, undisturbed availability and suppressed price levels in the decades to come, write Roberto F. Aguilera of Curtin University in Australia and Marian Radetzki of LuleĂĄ University of Technology in Sweden. In this article they provide a synopsis of their new book, The Price of Oil, which is to be published by Cambridge University Press in October 2015. They explain why we are in a new oil price world and examine the implications of this turnaround for the world economy, as well as for politics, diplomacy, military interventions and the efforts to stabilize climate.
Part I. Oil’s extraordinary price history: how can it be explained?
Oil price developments over the past 40 years have been truly spectacular. In constant money, prices rose by almost 900% between 1970-72 and 2011-13 (Figure 1). This can be compared with a 68% real increase for a metals and minerals price index, comprising a commodity group which like oil belongs to the exhaustible category. The objective of this part is to explain the price exceptionality of oil.
We do not share the widespread opinion, held by a majority of market specialists, that OPEC’s interventions since the early 1970s have had a major influence on the price behavior of oil. While OPEC cooperation has undoubtedly had short term impacts on the oil market, its interventions are completely inadequate for explaining the longer run price performance. Underlying our position is a number of academic studies pointing to the short run and insubstantial nature of the oil group’s supply-restraining actions. However, it needs mentioning that actions of Saudi Arabia in isolation to limit output, and even more, the country’s cautious approach to capacity expansion, have clearly contributed to the oil price evolution.
In our view, a number of political rather than economic forces have shaped the inadequate growth of upstream production capacity, the dominant factor behind the long run upward price push. This is particularly, but not exclusively, true in OPEC, the country group with a leading share of global oil reserves.
Widespread nationalizations of the oil sector in the 1970s replaced private multinationals with state owned enterprises. The latter did not invest much in capacity expansion because of a persevering lack of technical proficiency in many cases and a tendency of their government owners to use the surpluses generated by oil production in support of the state budget, so leaving insufficient resources for investment. A variety of goals apart from profit were often imposed on the state owned firms, resulting in high costs and inefficiencies that further reduced investments in new capacity.
Private multinationals had been deprived of a sizable proportion of conventional oil reserves in the nationalization wave, so they could not easily compensate for the state owned deficiencies in capacity expansion. Furthermore, as prices and profits rose in consequence of rising demand and stagnant production capacity, virtually all producing governments, inside and outside OPEC, sharply raised taxes and other impositions, further reducing the willingness to invest. In this way, a vicious circle was put in place, and its operation was made viable by the very low price elasticity of demand (i.e. unresponsive demand to even significant price changes) in the short- and medium-term.
While some believe that depletion and thus rising costs can explain price developments, the continuous rise of global oil reserves along with the high level of pre-tax profits in the industry are clear indicators that depletion has not been a factor behind the observed oil price evolution.
Another related revolution is beginning to see the light of the day, but news about it has barely reached the media
The resource curse, represented by domestic and international conflicts over the oil rent, is probably the most important explanation to the extraordinary oil price developments. We have looked at only six countries – Iran, Iraq, Libya, Nigeria, Sudan and Venezuela, all richly endowed with oil resources – to conclude that the resource curse had suppressed their recent production levels below peaks attained decades ago by a total of 7 million barrels per day, corresponding to no less than 55% of overall annual oil consumption in the European Union. In the absence of such suppression, oil prices would clearly have been far below the heights seen between the end of 2010 and autumn 2014.
Part II. The shale and conventional oil revolutions: low prices ahead
The shale oil revolution has unexpectedly and forcefully begun to transform the energy landscape in the United States. Beginning less than ten years ago, the revolution – employing technological innovations in horizontal drilling and hydraulic fracturing – has turned the long run declining oil production trends in the US into rises of 73% between 2008 and 2014 (Figure 2). The shale oil costs become broadly competitive at oil prices of $50 per barrel, lower than the costs of Canadian oil sands and Brazilian deep offshore pre-salts. An exceedingly high rate of productivity improvements in this relatively new industry promises to strengthen the competitiveness of shale output even further. The revolution has had a number of positive effects for the US economy in terms of, for example, investments, employment, fiscal revenue and a strengthening trade balance.
The US lead in the shale revolution has many explanations, including large-scale and long-lasting conventional oil exploitation, a well-developed fossil fuel infrastructure, established production of inputs, many small adventurous prospecting and production enterprises, a relatively sympathetic public approach to the new industry, and the incentive to the landholder of underground resources ownership.
A series of environmental problems related to shale exploitation have been identified, most of which are likely to be successfully handled as the infant, “wild west” industry matures and as environmental regulation is introduced and sharpened.
We firmly believe that the combined impact of the two revolutions will have an overwhelming impact on oil, by far the economically most important primary commodity in human use
Geologically, the US does not stand out in terms of shale resources. A very incomplete global mapping suggests a US shale oil share of no more than 17% of a huge geological wealth widely geographically spread, with lead positions held by countries like Argentina, Australia, Mexico, China, Libya and Russia. Given the mainly non-proprietary shale technology and the many advantages accruing to the producing nations, it is inevitable that the revolution will spread beyond the US.
We have assessed the prospects of non-US shale oil output in 2035, positing that the rest of the world will by then exploit its shale resources as successfully as the US has done in the revolution’s first ten years – implying that the global revolution will occur with a substantial delay and at a much slower pace than the one achieved by the US. With roughly a 17% share of global shale resources, the US in 10 years expanded its output by 3.9 mbd. Assume, then, that the rest of the world is equally as successful as the US was between 2004-2014 in exploiting its share of the resources between 2015-2035. This would yield rest of world output of 19.5 mbd  in 2035 (Table 1), which is similar to the global rise of all oil production in the preceding twenty years – a stunning deduction with far-reaching implications in many fields.
Another related revolution is beginning to see the light of the day, but news about it has barely reached the media. It is being gradually realized that the advancements in horizontal drilling and fracking can also be applied to traditional oil extraction, thereby substantially improving the productivity of conventional, mature and declining oilfields worldwide. This is yet another method to achieve enhanced recovery, in addition to the usual enhanced oil recovery technologies involving the injection of steam, chemicals or gas into formations. Several basins in the United States and other countries are already experiencing this new phenomenon, which we call the conventional oil revolution.
In a similar fashion to the output projections for shale oil, we assume that conventional oil in the rest of the world is able to benefit from the application of shale oil extraction methods just as US conventional oil did. Since 2008, the shale technologies have led to a US conventional oil rise of around 0.5 mbd. Imagine now that the ROW is correspondingly successful by 2035 in applying the related technologies to its share of conventional oil reserves as the US has been until now. This would yield a further addition of conventional oil amounting to 19.7 mbd by 2035 (Table 2).
The combination of the two revolutions sum up to a spectacular total output rise of 39 mbd. This equals almost half of global oil output in 2014, is nearly twice as much as the global increase in all oil production in the 20-year period 1994–2014, and is close to one-third greater than OPEC’s output in 2014.
The pace of the shale and conventional oil revolutions is likely to be slowed somewhat if the price levels observed in the first half of 2015, averaging some $57 per barrel (Brent spot), persevere for several years, and the ultimate price fall caused by the revolutions will be less dramatic. In a five year time perspective, we believe there is a likelihood that prices will recover a bit from the 2015 quotes, pending the shale revolution’s international spread. However that will be, it is our view that the major long-term conclusions from our analysis remain unaltered even with oil prices persevering for many years at the 2015 levels. The main reasons are that shale oil is likely to remain broadly economic at those lower market prices, and that many producers will thrive in a low price environment as they are incentivized to slash costs and increase operational efficiencies.
The efforts to develop renewables for the purpose of climate stabilization will become more costly, requiring greater subsidies, in consequence of lower fossil prices
We firmly believe that the combined impact of the two revolutions will have an overwhelming impact on oil, by far the economically most important primary commodity in human use. The oil output increases alluded to above are bound to have a strong price-depressing impact, either by preventing price rises from the first-half 2015 levels, or by pushing them back to these levels if an early upward reaction takes place. Our reference case conclusion on prices envisages a level of about $60 in 2035, while a more optimistic scenario which appears increasingly likely, sees a price of $40 by then. The price implications of the revolutions will in turn influence many other conditions that shape human life, be they economic, political, diplomatic or military. This, however, is the subject of the book’s third part.
Part III. Global implications for the macroeconomy, the environment and for politics
The global spread of the revolutions and the ensuing price weakness that we envisage for the coming two decades will, on balance, provide a great advantage both to the oil industry and to the world economy at large. Successful shale and conventional oil developers could reap benefits similar to those bestowed on the US in its progress in recent years.
Not surprisingly, there would be important negative repercussions on public income from oil in producing/exporting nations that fail to compensate for the effects of the oil price decline by expanding output with the help of the revolutions. Juxtaposed against this conclusion is our supposition that the effects of the resource curse will be ameliorated as prices decline.
Geologically, the US does not stand out in terms of shale resources
The two revolutions will apparently cement and prolong the global fossil fuel dependence, with implications for climate policy. At the same time, the expansion and cheapening of natural gas in consequence of the revolutions will make it possible to shrink coal use in power production, thereby reducing CO2-emissions, as is already evident from the US experience since some years. The efforts to develop renewables for the purpose of climate stabilization, however, will become more costly, requiring greater subsidies, in consequence of lower fossil prices.
The abundance caused by the revolutions will lead to hard to fathom changes in international political relations. We assert that much of the oil importers’ urge for political intervention and control will dissipate as the criticality of access becomes less urgent with normalization of profit levels and more ample and diversified oil availability. For instance, the heavy diplomatic and military presence of the United States in the Middle East is likely to be questioned when the country’s dependence on oil from the region is further reduced. The growth and geographical diversification of supply would not only suppress prices, but would also promote competition among suppliers and make it more difficult for producers to influence the market to their advantage or for their governments to use energy sales in pursuit of political ends.
There is no doubt that successful shale and conventional revolutions will bring about exciting changes in many fields. Our book aims to explain what they are and where they will occur. However preliminary, we believe our findings will be highly useful as a starting point for discussions and analyses to follow in many coming years.
Editor’s Note
Roberto F. Aguilera is Adjunct research fellow at Curtin University, Australia. Marian Radetzki is Professor of Economics at LuleĂĄ University of Technology, Sweden.
Mike Parr says
Use. The article does not discuss use. Oil is, at least in Western Europe (& the USA) mostly used for transport, not power generation. So at the user end, how is all this errr… “cheap” oil working out? I notice the Brussels ring was solid today (@ 1510hrs) (ditto, M25, Paris inner & outer, motorways around Dusseldorf etc etc). Increasing numbers of cities have day round gridlock (Bangkok anybody? “One Night in Bangkok” =- you would need to spend a day just getting to the place where you could stay “one night”). Pollution & apologies for saying the VW word in polite company. NOx, UK (and other cities) totally failing to address transport related pollution – which is killing their citizens, which is ironic when you think about it – super high prices for houses (which the rich buy) in one of the most polluted cities on the planet.
So yeah, lots of oil around (just remind me how much it costs to get it out?) – but it’s poisoning us. & 26% of CO2 emissions in Europe come from … transport & these emissions continue to grow (maritime, air and road). Oil $10 a barrel? (I picked a number) – so what? – what does this mean when the planet is starting to fry (or die of boredom in a bloody traffic jam).
Aster says
“The efforts to develop renewables for the purpose of climate stabilization, however, will become more costly, requiring greater subsidies, in consequence of lower fossil prices.”
Wind and solar have gone through a price revolution over the last decade and are expected to improve significantly over the next… The revolution in the renewable space is every bit as impressive as the shale revolution… In terms of energy content the growth of Wind/Solar over the last decade is equivalent to ~1.6 mbd. This may not be as large as the 3.9 mbd increase that’s been driven by shale but it’s certainly respectable.
Cheaper natural gas could translate to higher subsidies for renewables if you assume the decrease in the price of NG is greater than the decrease in the price of wind/solar. If the price trajectories of wind/solar continue down as expected this assumption won’t hold up.
Mark T says
Many of the points made about oil supply apply equally to natural gas. Natural gas is likely to be a far more abundant resource than many predicted 10 years ago. This has particular implications for climate change policy. Natural gas produces significantly lower co2 (some say 50% lower) and lower micro-particle emissions. The US shale gas revolution has allowed the USA to lower its overall co2 emissions in the last 5 years as natural gas has replaced coal in electricity generation. Greenpeace reported recently that China has reduced it’s co2 emissions this year by over 5% (equivalent to the WHOLE of UK emissions) again by replacing coal with gas. At the same time, Germany, the international champion of renewables, through abandoning nuclear, has barely changed it’s level of emissions in the last 5 years, yet has the highest electricity prices in Europe. When considering a low carbon future over the next 50 years , low carbon should not be confused with renewables. Natural gas is considered by many to be a bridge low-carbon fuel which will allow time for renewables, and perhaps carbon capture and energy storage to improve and become economically viable. At the Paris climate summit in December it is likely that many countries will move to meet their new emission targets by a mixture of increased use of renewables combined with an increased use of gas (and perhaps nuclear) whilst moving towards an almost complete abandonment of coal in electricity generation.
Karel Beckman says
Mike, I think you make a profound point. Yet in a way this only reinforces the argument of the authors. The implication of what you are saying is: peak demand. China, India and other emerging economies are not going to copy western automobility habits. It would wreck their countries. So all projections of ever rising oil demand can go in the dustbin. But this then means: more oil abundance. In many ways it will mean the End of the Oil Age. The financial and political power of oil states and international oil companies will wane. To be replaced by? That’s the question.
Mike Parr says
Thanks Karel. It is a bright sunny day in Bx : just passed by the Leuvensesteenweg (@0800hrs) by Tervuren – the traffic “park” stretches from half way to Leuven – through to Quatre Bras (approx 10kms) moving at 4 – 5kph & very much one-person-one-car. Solutions to this (work from home/work from local-commue tele-centres for 1, 2, 3 days/week) have been around for +/-10 years – Cisco did a very successful one by Amsterdam. Action by Euro body politic – zero. Oil has many uses, transport into & out of cities ain’t one of them (neither is power generation). Which begs the question: lots of oil – so what.
one.second says
Well, “cheap” oil at 40$ a barrel just won’t be competitive in the transportation sector anymore, as it isn’t tody in the electricity generation sector. As Saudi’s energy minister put it some years ago: “There will be a lot of oil and no buyers.” So probably oil prices will be lower than predicted in this article, but not due to an increase of supply, which by the way would wreck the earth’s ecosystem and cause human civilisation to collapse, but rather a tremendous decrease in demand. There are simply far better, efficient and cheaper ways to do things than burning oil.
Erich J. Knight says
“The financial and political power of oil states and international oil companies will wane.”
Praise the lord and pass the Renewable ammunition!
The political power of oil has fed the “resource Curse” and if we wish to starve the “resource Curse” out completely, while feeding renewables, a carbon tax & dividend is necessary. Short of that, at least a stable oil price will not under cut long term renewable investments and innovations bringing down renewable costs.
The political & economic power of oil was born by Winston Churchill in 1911, converting the admiralty to oil.
Sure that won us a couple of World Wars & a cold one, but the Hot World War now needs to be fought tooth & nail, Manhattan Project style, Climate Bonds, a civilian Carbon Conservation Corps, Victory Gardens & Farms,… EVs not tanks & airplanes, An Arsenal for Sustainability.
By the way the French are leading this fight, (and will probably save our collective bacon this time), at COP21 they will make us all look like “Appeasers” in this Hot World War, committing to raise their Soil Carbon 0.40% per year!
“To be replaced by? ”
Several forms of Bioenergy which conserve the photosynthesized carbon. Pyrolysis & Gasification, old hat technology used in a new way to build Soil Carbon and achieve 1/3 Carbon Negativity.
Restorative ecological Agriculture, as the Ag minister in France envisions, world wide has the potential to sequester;
Ag BMPs, (Best Management Practices) ; 1 Billion Tons Carbon, (GtC)
New Forest & BMPs; 1 GtC
Holistic Grazing; 3.5 tons carbon/acre/year
(Emerging land use practices rapidly increase soil organic matter
http://www.nature.com/ncomms/2015/150430/ncomms7995/abs/ncomms7995.html )
World wide Holistic Grazing; 2+ GtC
Pyrolitic Bioenergy, Clean Cooking Stoves; 0.83 MtCO2e
Industrial Pyrolitic & Gasifcation Bioenergy; 2 GtC
Over 6 GtC,
So soils & biota can do more than half the 10 GtC reduction & continuing CO2 drawn down job.
Japan plans 50 Terra watts of Bioenergy by 2030, if 1/2 of that could be thermal conversion verses complete combustion, Japan could be France.
Ronal says
Although I am quite surprised that we probably will not see , because of directional drilling and fraccing, a return to $100 oil and #15 gas – I believe (and hope) we will see a continuing price climb due to carbon taxes. $40 per tonne CO2 with 0.4 tonnes CO2 per barrel adds $16 in the first year. Adding $10 per tonne CO2 each year, as in some tax (or fee) plans will double the $16 in only 4 years. Oil (and gas?) companies say they welcome a tax. Prof. Wm Nordhaus says that his Carbon Club plan (including a tariff) will be desired by all countries. So I’d appreciate hearing how different it is whether the costs of extraction stay low – if and when (maybe COP21?) countries realize we have to get off all fossil fuels – and soon.