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Thursday, November 13, 2003

Letting The Genie Out

I enjoyed reading Chris' postings on oil, although I'm not sure I subscribe to the scarcity argument. I wanted to stick up a slightly different perspective. Scarcity could be right, and I could be guilty of ignoring Cassandra's warnings. I'm no expert, and I don't have my support here with me, but MA Adelman's The Genie Out of the Bottle reformed the way I think about oil economics today.

If I understand him correctly, Adelman says that oil should be considered like any other commodity, only over-politicised, and (to me) over-propagandised - maybe you could argue that the high price includes an information component. Disinformation and windfall profiteering prevent the market from clearing at its true price - royalty income can be win/win for upstream oilcos and countries (remember that x% of a big number is more than x% of a small one).

Before oil will become truly scarce, the true price will rise, the US (biggest user, biggest importer, and, importantly, about the largest producer (warning:xls), depending on what's up in Saudi in a given month) will necessarily respond with innovation and efficiency improvements (there's so much potential in the alternative energy economy, but it's kept out of the marketplace by a perverse favouritism of the oil sector).

Scarcity may come, but it will be met by economic responses and the market will clear; margins will thin; royalties will thin - there is a huge amount of fat in the price of oil today (even inefficient producers can get oil out of the ground for $6/bbl), and it's still as affordable as it was in 1970 at $2.50/bbl. Oil-price inflation has factored through the economy (it took the 70s to do it, and intensive economies are relatively the richer for it). Overpaying for oil through OPEC price-making is more a political decision than anything (in Turkmenistan gasoline costs $0.04 per litre!). Adelman makes the point that at $35 per barrel, there's something like a 150-year supply of proven hydrocarbon reserves. (I am making up the numbers, but they're ballpark). Stuff like shale, oil sands - it all fits in the picture.

Chris was right to include gas as well, but it's worth noting that gas is plentiful and, at high value, liquefaction (through compression, or my preference of condensation) is viable. Gas trades at roughly its fuel oil equivalent price, but it wasn't so long ago that it was just flared as a nuisance (and probably still is in places). At any price level, there are supplies and technologies available to enter the market to lessen the tension of natural or cartel-based scarcity. And there's still a lot of oil out there to find. South America is bringing on new reserves from Ecuador, Colombia and Peru; Brazil and Africa have big off-shore operations; there's a lot of promise in deepwater production. If I'm not mistaken, Kazakhstan has an elephant or near-elephant field under the Caspian sea. Central Asia probably has Middle East-sized reserves, and who knows what's left to find in Russia - it's got a whole lot more oil than it can get to market today.

Further, renewable energy is today available at small multiples of the oil equivalent price. Change focus, or change the price structure, you change the world. Yes, there is a finite supply, but we're not about to reach the limit. I assume oil consumption will continue to grow at roughly world GDP, but production will grow so long as marginal exploration is profitable.

It's been some years since I read Adelman (retired MIT petroleum economist), but since I started thinking about politics in his terms, I've been less surprised about the course of world events, and less persuaded by political action taken in the name of oil scarcity. I recommend this work to anyone who fears we're about to run out of oil.

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