Think Again

Think Again: Oil

It protects wealthy autocrats, poisons the environment, and fuels international conflicts. Yet it won't be the false threat of scarcity or the rise of an Asian energy axis that convinces the world to finally kick the oil habit. An auto revolution courtesy of Silicon Valley and Shanghai may deliver an end to the defining addiction of our age.

"The World Is Running Out of Oil"

Hardly. The world has more proven reserves of oil today than it did three decades ago, according to official estimates. Despite years of oil guzzling and countless doomsday predictions, the world is simply not running out of oil. It is running into it. Oil is of course a nonrenewable resource and so, by definition, it will run dry some day. But that day is not upon us, despite the fact that a growing chorus of "depletionists" argue that we’ve already reached the global peak of oil production. Their view, however, imagines the global resource base in oil as fixed, and technology as static. In fact, neither assumption is true. Innovative firms are investing in ever better technologies for oil exploration and production, pushing back the oil peak further and further.

The key is understanding the role of scarcity, price signals, and future technological innovation in bringing the world’s vast remaining hydrocarbon reserves to market. Thanks to advances in technology, the average global oil recovery rate from reservoirs has grown from about 20 percent for much of the 20th century to around 35 percent today. That is an admirable improvement. But it also means that two thirds of the oil known to exist in any given reservoir is still left untapped.

The best rebuttal to the depletionists’ case lies in the world’s immense stores of "unconventional" hydrocarbons. These deposits of shale, tar sands, and heavy oil can be converted to fuel that could power today’s ordinary automobiles. Canada, for example, has deposits of tar sands with greater energy content than all the oil in Saudi Arabia. China, the United States, Venezuela, and others also have large deposits of these energy sources. The problem is that the conversion comes at a much greater environmental and economic cost than conventional crude oil. But the very same high oil prices that doomsters claim are a sign of imminent depletion also provide a powerful incentive for the development of these mucky deposits — and for the technology that will allow us to extract them in a cleaner fashion.

"High Oil Prices Are Here to Stay"

Don’t bet on it. High oil prices are the result of short-term mismatches between supply and demand, a relationship seen in all commodity markets. All it takes is another global economic hiccup like the Asian financial crisis for oil markets to shift out of balance, leading prices to soften or worse, just as they did in 1997.

The key variable to watch is the spare oil production capacity maintained by the Organization of Petroleum Exporting Countries (OPEC) cartel. For much of the past three decades, OPEC has been capable of pumping far more oil than it actually delivered to market, which helped it manage prices. In particular, Saudi Arabia used its cushion to act as a swing producer, flooding the market with its buffer supply when normal global output was disrupted, such as during the Iran-Iraq War and the first Gulf War. The price increases that have occurred with regularity during the past several years are chiefly the result of the Saudis’ allowing their buffer capacity to fall during the 1990s and the global failure to anticipate the growth in Chinese oil imports. To address the increased demand, the Saudis are spending tens of billions of dollars rebuilding their spare capacity, and an unprecedented wave of new oil — the result of investments made a decade ago — is now coming online in Russia, the Caspian, and West Africa.

If supply in Saudi Arabia and elsewhere surges, or if demand, particularly in China, falters, then the new price floor that many investors assume is permanent will look increasingly shaky. OPEC will, of course, seek to stabilize prices if other oil producers (or oil alternatives, for that matter) take off. But history suggests that the cartel cannot maintain perfect production discipline. Inevitably, some greedy members defy the leadership and cheat on their quotas, again undermining the future of sky-high prices.

"Oil Companies Are to Blame For High Prices"

Actually, no. Whenever the cost of a gallon at American gasoline pumps shoots up, politicians and energy activists claim oil companies like ExxonMobil and BP are fixing prices. Big Oil may appear all-powerful to the consumer, but in reality the major private-sector energy companies with the famous brand names are powerless compared with the OPEC goliaths.

The issue again is supply and demand. Unlike during the 1970s oil shocks, when most oil was sold through bilateral contracts, much of the world’s petroleum today is sold through sophisticated and highly liquid futures markets, such as the New York Mercantile Exchange. It is therefore difficult for firms to manipulate prices. And when there are suspicions of back-room dealings, market watchdogs step in.

It is true that the oil market is far from unfettered, distorted as it is by a host of subsidies and handouts. It is also true that a conspiratorial cabal does meet regularly behind closed doors to rig prices and supply. However, that cabal is not Big Oil. It is OPEC. Saudi Aramco, a charter member, holds 20 times the oil reserves of ExxonMobil, the biggest of the private-sector majors. In other words, the Western firms are price takers, not price setters.

In fact, despite the current spate of record profits, Big Oil is in big trouble. Oil-rich countries, such as Venezuela and Russia, are nationalizing their resources, just as Saudi Arabia and Iran once did. That means most of the world’s reserves, and all of the cheap or easily accessed oil sources, are no longer available to the major private companies. The Western oil firms are running out of their primary product, even though the world at large is not. And that is a development that could ultimately hurt consumers, because Big Oil is the only counterweight to OPEC we have.

"Russia’s Pipeline Politics Threatens the West"

Not so. Russia produces some 10 million barrels of oil per day, roughly on par with Saudi Arabia. But it can’t maintain that output forever. Although Russia has indeed eroded OPEC’s global market share since it began quietly increasing its production output in 2000, it simply cannot challenge the Saudis for domination of the world’s oil market. That’s because Russia sits atop about 5 percent of the world’s oil reserves, compared with the Saudis’ 25 percent. Right now, Russia is a free rider, pumping without restraint in order to take advantage of the high prices made possible by global demand.

The concerns about Russian bullying make more sense when it comes to natural gas, but even those fears are inflated. Russia has the world’s largest reserve of natural gas — about 25 percent of the world’s total — with Iran a close second at 15 percent. However, geology and simple market forces make it impossible for a successful gas cartel to ever be established between the Kremlin and the mullahs. There is far more gas in the world than oil, and while Russia and Iran have a lot to sell, so do many other countries. No putative cartel could ever enforce enough production discipline to control prices, as OPEC does (and even OPEC has difficulty accomplishing this feat). That is especially true thanks to the rise of liquefied natural gas technology, which is turning gas into a fungible commodity, just like oil. Every cubic meter of liquefied natural gas is identical to every other cubic meter, no matter who produces it.

Although Europe fears a Russian gas embargo, it should rest easy: Pipelines are double-edged swords. Any supplier that cuts off its best pipeline customer will be unable to recoup its lost revenue. After all, piped gas cannot be redirected anywhere beyond where the pipes lead. That’s the reason the Soviet Union never dared cut off German gas pipelines during the height of the Cold War. And occasional saber-rattling aside, it’s the reason that Europe’s gas supplies face no serious danger today.

"China’s Thirst for Oil Is Insatiable"

So what? There’s no arguing that China’s demand for oil has grown dramatically in the past decade and that the major global energy producers failed to anticipate how much upheaval it would cause to oil markets. That increased demand, and the recent frenzy of overseas energy purchases by Chinese firms, has led many forecasters to worry that global energy security will be imperiled as China’s oil needs continue to grow. In the United States, this concern reached a fever pitch in 2005 when one of China’s state-owned oil companies, CNOOC, placed a bid for Unocal, a middling American gas company. The offer was ultimately withdrawn after a vicious political backlash in Washington. But China’s desire for oil does not make the United States — or any other country, for that matter — less secure. What matters most is that oil gets to market, regardless of who owns or produces it. That is why it is very good news for energy consumers that China is overpaying for oil assets around the world. It means the Chinese now have every incentive to invest additional billions of dollars in increasing production so that they can sell those barrels of oil or take them home. Every barrel of oil that China develops in Chad, Ecuador, or Kazakhstan is a barrel that it does not buy on the world market, leaving more for the rest of us, and easing global prices. Contrast what China is doing — investing billions to boost global production — with Venezuela’s tactics — expelling foreign firms and discouraging fresh investment in the oil sector to satisfy Hugo Chávez’s misguided notions of energy patriotism.

Nor should China’s oil consumption be considered a global environmental nightmare. That gloomy view ignores an important development: China’s determination to find alternatives to hydrocarbon fuels. China’s burgeoning green revolution is not driven by concern for the environment, but by growing paranoia among the country’s leadership over dependence on Persian Gulf oil. It is one reason China now has tough fuel economy standards, and why it’s a world leader in developing electric and hydrogen-powered automotive technologies. What’s more, it’s not hard to imagine that some technological leapfrogging, along the lines of what has occurred in telecommunications in the developing world during the past decade, could transform the next generation of Chinese cars into green machines.

"Hybrid Cars Will Save the Planet"

Not quite. Imagine a world in which 100 percent of cars are gasoline-hybrids like the Toyota Prius, and you still have a world that is 100 percent addicted to oil. A partial move toward alternative fuels won’t ever be enough; the future actually calls for a radical shift in both new fuels and engine technologies. Condemning SUVs as environmental menaces misses the central problem: It’s not the size of the car that matters — it’s the fuel it burns. This year, two thirds of U.S. oil consumption — and half of global oil consumption — will be sucked up by cars and trucks. Reinventing the car is the only serious way to wean the world off oil. The advanced electronics found in the Prius are but the first, helpful step in the clean-car revolution now getting under way.

From Silicon Valley to Shanghai, inventors, entrepreneurs, and environmentalists are zooming ahead of Big Oil and Detroit. Today, it’s far easier for new start-ups to challenge the major automakers because key technologies are no longer jealously guarded in-house but outsourced around the world. While the auto dinosaurs dawdle, giants from other industries are investing millions to stake a place in the game. In fact, the car of the future may well be brought to you by Sony, Apple, or Intel. Perhaps it will even come from two teenage whiz kids working tirelessly in their garage on the Next Big Thing. What’s certain is that its day is near.

"A Visionary Leader Can Kick the Oil Habit"

Absolutely not. Beginning in 1961, U.S. President John F. Kennedy successfully pushed the United States to send a man to the moon within a decade. And more recently, China’s obsessive efforts to put a person into orbit, no expense spared, ended in happy accomplishment. But it will be far more difficult to curb the world’s thirst for oil than it has been to shoot a man into space in a tin can. Any substitute for fossil fuels will need to be affordable, reliable, and ubiquitous; and markets and innovators, not political leaders, will be the ones to deliver it. Modern history is littered with failed government schemes to reduce dependence on fossil fuels, such as the effort to develop synthetic petroleum after the 1970s oil shocks or the false dawn of wind and solar energy in the 1980s. Massive government programs are simply not the answer. Of course, there is a legitimate government role in investing in and encouraging long-term energy research of the sort that private firms cannot provide. But when bureaucrats start picking pet technologies, whether they are fuel cells, clean coal, or corn-based ethanol, the real trouble begins.

The far more important, and most often neglected, place for government is leveling the policy playing field. Governments have the power to regulate the forces that can influence energy markets but are not reflected in market prices. Imposing caps on emissions, instituting new taxes, or ending subsidies for fossil fuel industries can get clean-energy innovators off the bench and into the game. Creating an environment in which new technologies can flourish and allowing markets to do what they do best — reward innovation and efficiency — should be government’s purpose. And happily, there is growing evidence of a bottom-up demand, from both citizens and entrepreneurs, for such a market-minded policy revolution. It’s the revolution that will lead us, at long last, to life after oil.

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