When we think about oil, most of us think petrol to fill the car. But our economy is far more dependent on oil than we commonly recognise. The infrastructure which has been built around our oil-based economy is scary. Imagine if we were to switch to solar power tomorrow. We would need to re-tool every car manufacturing plant in the world, replace every petrol station with a battery switching station and put in a whole lot of new ones to cater for the shorter range of cars. We would also need to allow for significantly longer travel times, as the speed of these vehicles is well below current cars.
But that’s all fairly obvious stuff. The real hidden costs would be how the flow-on impacts to the oil by-products we use every day. Plastics for wrapping the kids’ lunch in, the toys they play with, putting our shopping in, throwing our rubbish in. Because all this is a spinoff from the core use of oil (a fuel for transport), it is relatively cheap and the related industries make economic sense. Would they in the brave new solar world? One thing is for certain, these bi-products would be a lot more expensive.
All this and I haven’t even mentioned the tragedy which would befall motor sports, car chases in action movies and classic TV dramas like Dallas. It’s hard to imagine old JR Ewing getting excited about a deal to corner sunlight in Texas. Worse still, imagine classic car chases like Steve McQueen in Bullitt or Matt Damon in The Bourne Identity being played out in solar-powered vehicles.
While the need to act on global warming will inevitably drive change, the need for a long transition phase over one or two decades, combined with the geopolitical nature of oil and the stark supply/demand challenges, mean we are potentially entering a structural bull market.
Oil demand, for the most part, is relatively inelastic. Even in the face of higher prices, people generally still fill their cars rather than resort to the bus. Therefore, for countries that are net importers of oil, such as the United States, a higher oil price acts much like a tax on consumers, and ultimately a tax on economic growth.
President Obama, in a recent speech on national energy security, outlined the need for the US to lessen its reliance on foreign oil. Whilst the notion is undoubtedly well intentioned, it is simplistic. At its core, is a transport fuel. Currently, 69 per cent of all oil usage in the United States is used for transport purposes (note 1), for which there are no realistic substitutes in the near to medium term. Hence it is important to understand the driving factors behind the oil price.
A geopolitical asset
First and foremost, oil is a geopolitical asset. Approximately two-thirds of the world’s oil reserves are located in northern Africa and the Middle East. Not your most politically stable regions of the world. From the Arab-oil embargo in the late 1970s to a number of conflicts including the Gulf and Iraq wars, the western world has gone through numerous periods where the supply of oil has been severely disrupted and its price has reacted sharply.
Supply and Demand Challenges
“Worse still, imagine classic car chases like Steve McQueen in Bullitt or Matt Damon in The Bourne Identity being played out in solar-powered vehicles”
We are currently in a state of relative equilibrium in the global oil market. Our production capacity is actually in a small surplus relative to the amount of oil we demand globally. Unfortunately, this is not set to last. We are seeing natural production declines from existing wells, whilst simultaneously seeing growth in demand from the emerging world. In order to bridge this looming supply deficit, we can either seek to find more oil or increase the use of unconventional sources.
Find more oil?
Unfortunately, world oil discoveries peaked in 1965 and in fact we have been consuming more oil than we have found every year since 1980 (note 2). Given how well geologists understand the required conditions for the formation of oil reservoirs, it is becoming far less likely that there are game-changing undiscovered reserves that we are just simply yet to stumble across.
Unconventional reserves?
Whilst unconventional reserves such as oil sands and oil shale are growing sources of production, they are by no means a silver bullet. Both processes bring with them a raft of unwanted environmental side effects, due partly to the very high levels of energy intensity required in their production and refining process. Importantly, unconventional sources, in particular the shale industry, involve expensive extraction processes and require a high oil price before projects are generally considered economical.
Emerging world demand growth
Whilst the outlook for supply looks challenging, demand growth is likely to exacerbate expected shortages in the oil market. Currently the developed world accounts for the majority of global oil demand, but the growth in future years will come from the emerging world. China for example currently uses around twice the steel per capita as the United States, but only around one-tenth the oil per capita (note 3). This is to be expected, as the industrialisation phase of an economy is very steel intensive. However as the Chinese continue a transition to a more consumption driven economy, oil usage will rise rapidly. China isn’t alone in terms of a growing demand profile. India is expected to increase their net imports of oil from around three million barrels per day to 5 million by 2020 (note 4). This growing level of demand will place further pressure on an already tight market.
