Peak Oil and Oil Prices

Oil prices in recent times rose dizzyingly to all-time highs. In an intuitive way, the experience seemed to many to validate the notion of Peak-Oil. Then along came the credit-crunch and the global-financial-crisis, and oil prices have plunged dramatically. Does that mean Peak Oil is no longer a problem?

Well no. Peak oil is a consequence of geological realities, and oil prices are a manifestation of market forces. In themselves, rising oil prices didn’t ‘prove Peak Oil’ and falling oil prices don’t ‘disprove Peak Oil’.

Peak Oil is a consequence of geological realities. The earth is finite, oil bearing geological formations are finite, and over time, the rate at which oil can be pumped from any given formation declines. Globally, production has outpaced new discoveries for decades. So the question is not if but when and how fast oil will peak. predictions have ranged from ‘happened already’ to 2035, but seem to be converging with increasing confidence on 2010 or shortly after.

Oil prices are a product of market forces. Oil is a product with strongly inelastic consumer demand (at least in the short-term). In plain English, demand for oil won’t necessarily halve overnight just because the price has doubled: if you must use an oil-fuelled car to get to work, then your oil demand is pretty much fixed, unless you give up the job altogether (obviously in the longer term you may have other options like buying a more fuel efficient vehicle, shifting to a job closer to home).

As well as inelastic demand, oil is characterised by the fact that – in relation to how much we consume in any given period – there’s not much pumped and refined product available above ground at any given time. I’ll have to go back and find some better numbers later, but  for the OECD total commercial oil stocks were about 14% of OECD annual consumption  in 2007, which is about seven or eight weeks supply. The point is that it is a small margin when you consider how much we use and how vital oil is to our lives.

Combine price-inelasticity of demand with limited storage of pumped and finished product and you have a situation where prices will rise rapidly if supply does not rise to meet demand (note that for the same reasons, prices will fall rapidly if supply exceeds demand!).

  1. Supply might not rise to meet strong demand  if sufficient below-ground oil reserves are available, but suppliers – for economic or political reasons – are unwilling to pump more oil in response to demand (this is true even if the demand is speculative).
  2. Supply might not rise if sufficient reserves are available, but investment in oil drilling and pumping infrastructure had been inadequate, so suppliers were unable to get the oil out of the ground any faster.
  3. And supply might not rise  if Peak-Oil has arrived, and it is simply becoming physically impossible for suppliers to pump more oil, even if they have the best possible infrastructure in place.

[UPDATE: For a longer but much  better examination of oil pricing mysteries, which extends to long-term prices as well as under and over-pricing, see here]

Don’t be fooled by short-term oil price movements. Peak Oil will happen, it is likely almost upon us, and it will mean a future in which oil becomes more expensive. Expensive oil will make our economic future different. And the challenges of Peak Oil will combine with the challenges of Climate Change. But our inevitably different future doesn’t have to be bleak, if we act now, act wisely, and shape a future economy that is more sustainable, inclusive, and compassionate.

P.S.For an interesting report on some of the implications of Peak Oil for New Zealand, see this report by Simon Tegg, which draws attention to the danger for New Zealand in being an oil importer at a time of Peak Oil – in other words, Peak Oil is a national security rsik for New Zealand – perhaps if politicians and policymakers understood it as such we might be acting more urgently?

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