Sunset on the Age of Oil
The American Dream of suburbia and the post-WWII global economy were built on cheap oil. Although the price of oil is down by over 40-50% from the $100 level of recent years, they are still higher than during the formative post-war period or even that of the 90s ($10-$30).
Oil and gas are now in a lose/lose situation. When prices are high for a sustained period, it will spur production (supply) but put a drag on world economic growth (demand), leading to a surplus and then a price collapse. When prices are low for a sustained period, while not helpful for alternatives, oil and gas companies will suffer more and production will eventually be cut back while demand rises, leading prices to go back up. Over time, technology improvements in extraction and production will be more than offset by rapid depletion rates. The low-hanging fruit has been picked.
Meanwhile, the economics of solar and wind will continually improve and are now close to competitive, even without subsidies.
Nominal and Inflation Adjusted (Real) Price of Crude Oil
MacroTrends.net, EIA, BLS
A Brief History of Oil Prices
When oil was easy
- The industrial economy of the 20th century is built on cheap and easy oil
- The birth of OPEC and its actions in the mid to late seventies cause a spike in the price of oil, leading to inflation, down-sizing of cars, and talk of alternative energy
- OPEC realizes that they would be better off in the long run with a growing world economy addicted to cheap oil
- At the start of the 21st Century, globalization has really kicked in, China is growing at 10+% and the price of oil starts a steady march upward as rapidly rising demand leads the depleting supply of conventional oil
- Rising oil prices and a U.S. housing and credit crisis infects the world economy, crashing economic demand and oil prices
- As the economy recovers, economic demand and high oil prices return
- Saudi Arabia, as the swing producer in OPEC, stabilizes prices at around $100/barrel by increasing or decreasing production as needed
- On the Supply Side, with consistently high oil prices at or above $80-100/barrel, unconventional sources are developed and come online (deep water, American shale from fracking, Canadian tar sands, and soon, Arctic)
- On the Demand Side, with consistently high oil prices, world economic growth is slowed and there are incentives to economize with higher gas mileage cars and other energy efficiencies (demand destruction)
- The result: with supply up and demand down (slowed), oil prices weaken and then crash, fueled by speculation on the down side.
- This time, Saudi Arabia decides not to intervene in hopes of putting unconventional sources, primarily U.S. shale, out of business by driving prices below the cost of production (also hurting Iran and Russia as a bonus).
- Venezuela’s economy is virtually destroyed as the country had become too dependent on oil export revenues and failed to maintain their oil industry infrastructure under Chavez.
- Saudi Arabia’s plan is not entirely successful. Shale production does back off some at lower prices, but much production continues as producers need the cash flow.
- After losing market share long enough, OPEC, led by Saudi Arabia, finally agrees in November 2016 to make some production cuts in order to bring oil prices up from the $40s to the $50s.
- For now, US sale production is operating somewhat as a swing producer, able to shut down and start up drilling relatively quickly in response to prices.
- For the time being, it appears that prices will stabilize in the $50-60 range.
- When oil prices were lower and US gasoline hovered just above $2.00/gallon, Americans returned to buying larger SUVs and pick-up trucks. With prices now settling slightly higher at closer to $2.50/gallon, we shall see if this enthusiasm continues.
Why Oil Prices May Be Volatile
“The best cure for low prices is low prices. The best cure for high prices is high prices.”
Here is the key to it all:
- On the supply side, low oil prices will disincentivize further development of North American shale (from fracking) and then deep water and tar sands
- On the demand side, low oil prices are already sending Americans back to pick-up trucks and SUVs and providing a stimulus to the economy
- Eventually (6 months to 2 years), supply will be down, demand will be up, and prices will rise again
- When prices rise again, production (supply) will increase but economic growth (demand) will slow and the vicious cycle will repeat
- Meanwhile, economic and geopolitical wildcards could come into play at any time for better or worse
- Financial speculation can drive prices up and down quickly and excessively but fundamentals will eventually prevail to some extent since oil storage can serve as a buffer but is not unlimited
Why Unconventional Oil is So Costly
Much of the low-hanging fruit (cheap oil) has been picked.
Deep Water
1 mile down to the sea floor, 2 miles further down to the oil seam. When something goes wrong… 
Fracking for Shale Oil and Gas
See my full post on fracking for more on the environmental and economic costs. 
Canadian Tar Sands
Imagine the energy, water, and expense of steaming oil out of this. 
Think these unconventional sources will continue to be produced with low oil prices? Think again. Low oil prices will wreck havoc on the debt-laden unconventional oil producers and oil service providers. This could be the next financial crisis and is already leading to whispers that there may be a need for bailouts.
For Further Exploration
Beyond Economics 