It has become fashionable lately to talk about the world being awash in oil due to increased production from such disparate places as North Dakota, Iraq, and Saudi Arabia. Analysts have been crowing about the coming oil boom (which you can see here, here, here, here and here). Over the long-term, increased production from unconventionals (tar sands and tight oil), and newly produced offshore oil from the Arctic, Brazil and Africa promise to usher in an age of abundant oil. U.S. oil production will continue to climb until we achieve the ultimate goal of energy independence, at which point, maybe even become an energy exporter.

Maybe. But, even if that were possible, it would not mean that the U.S. would become immune to the price volatility that has long characterized the oil industry. Oil history is a history of booms and busts that are accompanied by the associated price spikes and crashes. World oil markets have seen three such spikes since 2008.

Despite the recent uptick in production, global spare capacity is still rather tight. Oil markets get nervous when spare capacity is low because an unexpected supply shock means oil producers may struggle to meet demand. Saudi Arabia remains pretty much the only country with a significant capability to ramp up production in the short-term, and because they are currently maintaining elevated levels of production to keep prices down, their spare capacity has been eroded. The result is the lowest level of spare capacity since the financial crisis (see chart).

The recent decline in oil prices from a high in March of $128 per barrel for Brent crude to $90 in late June belie the fact that the oil markets are tight. Prices dropped precipitously because of the ongoing Eurozone crisis and high Saudi output, as noted before. But, as the economy rebounds, demand will rise, bumping up against low spare capacity. This means prices will remain volatile.

By definition, oil is a finite resource, and as the easiest oil wells dry up, drilling companies have to move on to oil that is more difficult to reach and more expensive to produce. This shift to offshore oil and unconventionals means that the cost of production is rising, as a recent IHS report described.

But, perhaps the most pernicious conclusion from the “abundant oil supply” crowd is that we no longer need to worry about finding alternatives to oil. Higher production (and lower prices) allows us to become complacent. Investment in biofuels, electric vehicles, energy efficiency and other forms of clean energy will suffer.

The result? Well, the recent wildfires, drought, floods and broken heat records are examples of what the future may look like in a world awash in oil.

Share on Facebook

Tweet