THE world is running out of oil. That much is self-evident, since oil is a nonrenewable resource and mankind has been pumping it out of the ground in ever-increasing volumes for more than 150 years.
However, contrary to popular perception the inevitable eventual depletion of the world’s oil reserves is not the reason oil prices have almost quadrupled over the past four years. The total recoverable resource base has in fact grown, largely due to technological advances. A little more than a third of the oil in a reservoir is recoverable using today’s technologies, for example, considerably more than the 20% that could be extracted a couple of decades ago.
Such technological development and the changed geopolitical environment will almost certainly result in more new discoveries, too. There are parts of the world that remain underexplored, largely as a result of the Cold War, while others in known oil-producing areas will benefit from advances in 3D seismic imaging and other recent innovations. Perhaps most importantly, higher oil prices have revived investment in research and development, which all but came to a halt when crude was at $10 a barrel in 1999.
Where there have been genuine supply concerns over the past few years, these have resulted from relatively short-term phenomena, such as wars and political strife in oil-producing countries and extreme weather conditions like the hurricanes that battered the US Gulf Coast recently. Such supply shocks cause prices to spike, but markets inevitably cool when the threat to supply disappears or production is restored.
This has not happened of late; prices remain close to record levels in real terms because they are being driven by demand, rather than a lack of supply. Last year’s increase in global oil consumption was the biggest for almost three decades, due mainly to robust economic growth in China, the rest of Asia and the US. It follows, then, that upward pressure on oil prices would dissipate if world economic growth was to slow. With global inflation starting to stir and higher interest rates on the cards, this may be the course events will follow.
The danger, especially in the US, is that interest-rate hikes intended to kill inflation could do more harm than good. If they result in the bursting of the asset-price bubble that has developed in the housing market, for instance, the resulting recession could have us all looking back at high oil prices with nostalgia.