The good oil

-By Donal Curtin

Tuesday 12th August 2008

Even after the 4-cents-a-litre discount voucher I got from the supermarket, filling up the Ford Fairmont the other day cost me $104. Not that anyone needs a professional economist reminding them of the reality of high prices; for months we all dreaded rolling up to the forecourt to find the $2 a litre signs had gone up.

But maybe people do need an economist's perspective to get a grasp on why petrol prices have got to today's levels - especially as some of the explanations that people are subscribing to are wildly off the mark.

A lot of people think, for example, that one of the big reasons for the surge in prices is that we've reached the finite limit of available oil. Other people argue that surging prices are due to the developed world's gas-guzzling profligacy; if people like me didn't drive 4-litre eco-disasters, we wouldn't be in this pickle.

Wrong on both counts. Let's take the "oil is running out" argument first. The US government agency called the Energy Information Administration (EIA) bills itself as an independent statistical agency within its Energy Department. (I've read its stuff over the years and I can't spot any political agendas being pushed, so it looks a credible description to me.) The EIA produces an International Energy Outlook it calls "an objective, policy-neutral reference case that can be used to analyze international energy markets". The latest full one is last year's.

Looking just at oil (strictly speaking, petroleum and other liquid fuels), on the EIA's central forecast there will be substantially increased production by 2030. To put it in perspective, the world's biggest oil producer is Saudi Arabia, with production of some 9 to10 million barrels of oil a day. By 2030, there will be the equivalent of roughly three new Saudi Arabias on stream, since consumption is forecast to rise by 27 million barrels a day between 2010 and 2030. And while it's true that some oil fields (like the North Sea) are indeed past their peak, in aggregate they're far outweighed by new finds and upgraded reserves in existing fields. As for running out, Saudi Arabia could keep pumping at the current rate for the next 75 years.

Now let's have a look at the demand side. Until recently you could make the case that any problems arising from profligate demand, and from pollution issues such as fuel-related global warming, could be laid fairly and squarely at the rich world's door. But that's changing fast.

Looking at the numbers, and accepting that you probably didn't want to know this in the first place, energy consumption can be measured in "British thermal units" or Btu. On that basis, if you take "the OECD" as shorthand for the rich world, and "non OECD" for the rest, in 2004 energy consumption in the rich world (240 quadrillion Btu a year) was modestly higher than that in the entire developing world (207 quadrillion). But by 2010 the developing world will have pulled level, and by 2030 the developing world's consumption will be 403 quadrillion Btu versus the rich world's 298 quadrillion.

The reason is straightforward. Demand is tied to relatively slow economic growth in the rich world, but rapid and relatively fuel-intensive growth elsewhere. Neither grouping can be said to be on the side of the conservation angels, although, if there's any finger-pointing to be done, you'd probably indicate China's massive expansion of coal-based energy as the most important issue. (It's already quite large, and will roughly have doubled by 2030.)

But, in short, single-villain stories don't explain what's going on. The reality is that you have a demand for oil (and energy in general) that's growing, mostly (but not exclusively) from the developing world. You've got supply relatively fixed in the short-term, but with room to expand over the longer haul, although a lot of the new resources will be more expensive to develop. These shifting patterns can be modelled to see where the oil price ends up, and the EIA has done that, too. It reckons that oil will be about US$113 a barrel in 2030, but with (as you'd expect with a heroic forecasting exercise like this) a high degree of uncertainty around its estimate.

It may feel like bad news that higher energy prices look like being permanent. But it's worth remembering two positive effects. First, it is those high prices that will tickle out the new resources (such as Canada's oil sands) that will keep the lights on. Secondly, high prices are key to conservation on the consumption side. You can devise all the fancy emission schemes you like, but, for sustained impacts on fuel use and energy efficiency, there's nothing like a $104 petrol bill for focussing the mind.

economicsnz@xtra.co.nz

*A free disclosure statement is available on request

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