One of the themes of this site is that resources are finite in quantity, hence, once they are gone, they are gone. They will not be replaced on a human time scale. The normal laws of supply and demand do not work because there is new supply available. The logic of the economics for a resource such as crude oil goes as follows.
- We extract the easy pickings, the low-hanging fruit first. So the first oil wells were drilled in places such as East Texas. The oil was easy to find and extract, and it could be moved to the refineries quickly and at low cost. (The picture shows one of these wells. The plume of oil is from a blowout — representing a serious loss of control and the potential for a major fire.)
- As the first wells are depleted they are replaced with sources that are more difficult and expensive to develop. (In technical terms there is a decline in ERoEI, Energy Returned on Energy Invested. Companies have to spend more and more of energy simply finding and extracting new sources of energy.) We go from an easily-drilled field in East Texas to the phenomenally expensive offshore platforms that are being built now.
- Based on the laws of supply and demand, the price of oil should steadily increase — the demand remains the same but the cost of getting the crude oil to the refineries has gone up substantially.
- If the price goes high enough, demand will fall, so the price will also fall. But the price trend will always be upward because it is always going to cost more to find and extract the next barrel of oil. There is no new supply of low-cost oil available to us.
But over the course of the last six years or so that’s not how things have actually worked out.
Consider the following article, which is representative of many others like it.
Oil plunges 7% to lowest level in more than a year
Oil prices slumped on Friday to their lowest levels in more than a year, deepening a rapid seven-week sell-off that has plunged crude futures deep into a bear market.
For background, here is a chart showing the price of West Texas Crude over the last ten years.
The chart shows that,
- There was a steady and rapid increase in price up to the year 2008 — the year of economic recession.
- The price fell, but soon recovered.
- In 2013/14 the price crashed.
- Since then it has increased, but is still not at as high as it has been.
In other words, there are ups and downs, but there does not appear to be any systemic move upwards. What happened?
The standard response to this question is that the development of tight oil prospects in the United States increased the amount of oil on the market, and so the price went down.
This new supply can be seen in the following chart. The red line is production in the United States of conventional oil. It peaked around the year 1970 and has been falling steadily ever since. The green line shows the amount of tight oil produced. It can be seen that this new supply has been sufficient to return overall U.S. production to 1970 levels.
Actually, it’s more complicated than this.
The following additional factors need to be considered.
- The Kingdom of Saudi Arabia was very concerned about the potential dominance of the United States in the world’s oil markets, so they intentionally reduced the price of their crude so as to drive the tight oil projects out of business. This was a purely political move.
- At these prices, tight oil production is not profitable. In fact, it relies on the continued investment of speculative capital — people who wish to get in on the ground floor of this new business area.
- High oil prices tend to discourage general economic activity. So the prices go down in response.
Some analysts predict that by the year 2020 the tight oil business will have to show it can be profitable. Otherwise the investors will move out. But the only way that the industry can be profitable is to have prices that are well north of $100 per barrel.
If this analysis is correct then, looking back on what happened, it may be concluded that the tight oil business was no more than a temporary interruption on the trend toward higher oil prices, or a slower economy at current prices.