Monday, October 10, 2005

Oil Bubble?

A notable editorial from this weekend's Wall Street Journal argues that current high oil prices are unsustainable and a combination of new technologies, new discoveries (or willingness to use existing ones) will bring energy prices back to a virtuous cycle of long term decline. I am not an expert on energy markets but some of the WSJ themes bear some examination:

The cost of energy per unit has gotten cheaper and cheaper

First, the crisis begins with a spike in energy prices as a result of a short-term supply shock. Next, higher prices bring doomsday claims of energy shortages, which in turn prompts government to intervene ineffectually into the marketplace. In the end, the advent of new technologies and new energy discoveries--all inspired by the profit motive--brings the crisis to an abrupt end, enabling oil and electricity markets to resume their virtuous long-term downward price trend.

Chicken Little?

The limits-to-growth crowd has predicted the end of oil since the days when this black gold was first discovered as an energy source in the mid-19th century. In the 1860s the U.S. Geological Survey forecast that there was "little or no chance" that oil would be found in Texas or California. In 1914 the Interior Department forecast that there was only a 10-year supply of oil left; in 1939 it calculated there was only a 13-year supply left, and in 1951 Interior warned that by the mid-1960s the oil wells would certainly run dry. In the 1970s, Jimmy Carter somberly told the nation that "we could use up all of the proven reserves of oil in the entire world by the end of the next decade."

Technological Progress

Fifty years ago people would have laughed out loud at the idea of drilling for oil at the bottom of the ocean or getting fuel from sand, both of which were technologically infeasible. The first deep-sea oil rig went on line in 1965 and drilled 500 feet down. Now these rigs drill two miles into the ground--and miraculously, the price of extracting oil from 10,000 feet deep in the sea bed today is approaching the cost of drilling 100 feet down from the richest fields in Texas or Saudi Arabia 40 years ago.

This spectacular pace of technological progress explains why over time the amount of recoverable reserves of oil has increased, not fallen. Between 1980 and 2002 the amount of known global oil reserves increased by 300 billion barrels, according to a survey by British Petroleum. Rather than the oil fields running dry, just the opposite has been happening. In 1970 Saudi Arabia had 88 billion barrels of known oil. Thirty-five years later, nearly 100 billion barrels have been extracted and yet the latest forecast is that there are still 264 billion barrels left--although the Saudis have never allowed independent auditors to verify these numbers.

Short on Supply? Perhaps not.

In this industry, alas, bad news tends to crowd out the good. When Shell announced earlier this year that its oil and gas reserves were down by 30%, there was a global outcry. But when Canada announced in 2004 that it has more recoverable oil from tar sands than there is oil in Saudi Arabia, the world yawned. There is estimated to be about as much oil recoverable from the shale rocks in Colorado and other western states as in all the oil fields of OPEC nations. Yes, the cost of getting that oil is still prohibitively expensive, but the combination of today's high fuel prices and improved extraction techniques means that the break-even point for exploiting it is getting ever closer.

The energy Malthusians counter that China, India and other nations will satisfy their growing appetite for oil by driving demand and prices ever higher. In the short term, yes. But over the longer term, as the Chinese become more prosperous through free markets, China will become vastly more fuel efficient and also help discover new sources of energy.

America produces twice as much output per unit of energy consumed as it did 50 years ago. Liberals who say we need government to intervene in the energy markets, to patch the alleged failings of the free market, fail to comprehend that the command-and-control economies of the last 50 years have been far and away the biggest wasters of energy (and the biggest polluters). South Korea produces about three times as much output per kilowatt of electricity as North Korea does.

How to get the environmentalists on-board

In the U.S., environmentalists have erected myriad barriers to drilling for new sources of oil. The American Petroleum Institute estimates that there are at least 100 billion barrels that are fairly easily recoverable in Alaska and offshore that oil companies are not permitted to exploit. Once, we could afford the luxury of not drilling it's an economic and national security imperative that we do.

Here's one simple idea to increase the domestic supply of oil: Have Uncle Sam share its oil-drilling royalties with the California government. If Californians realized they could go a long way to solving their deficit and overtaxation problems by raising billions of these petro-dollars, the aversion on the left coast toward offshore drilling might well begin to subside.

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