End of the Oil Economy?

In a recent issue, The Economist boldly announced on the front cover the end of the oil age. This would certainly be welcome news to the oil dependent U.S. economy. Hydrogen powered fuel cells are here and we can thumb our noses at OPEC for once and for all. We could breath a collective sigh of relief if this were true. Given OPEC’s recent attempt to cut production and increase prices, the timing of the end of the oil age could not be much better.

According to economists at Economy.com, the only problem is that it isn't going to happen. Real prices for oil have indeed swung wildly in response to short-term perturbations in supply and demand. These short term fluctuations have hurt the economies of both oil consuming nations and oil producing nations. It would be good news for everyone if oil prices exhibited more stability. For the past 30 years the real price has tended to converge around $30 barrel. Price movements above this mark, however engineered or market driven, have been followed by periods of lower prices

In the long-run, tightening by OPEC is counterproductive by three mechanisms. Positive price movements encourage the reduction of oil demand through simple gains in efficiency, conservation and curtailment. A barrel saved is a barrel earned. As oil prices climb towards the production costs of alternative energy sources new ideas are developed and brought online. We are now seeing the emergence fuel cells and hybrid automobiles into the real world. As oil prices climb, areas of higher production costs become profitable to explore and enhance.

What is likely to happen? Oil prices will maintin their long-term trend at about $30 per barrel real. Alternative sources of energy will continue to emerge and diffuse into the market. Siberian oil will come online. U.S. energy consumption per dollar of GDP will continue to fall, soon reaching half the 1973 mark. Books will continue to be made of paper.

With the cost of extraction of Middle Eastern oil at about $1 per barrel there is plenty of room for the price to fall before anyone loses money producing it. The importance of oil will gradually diminish but not disappear for a long long time.

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