Is the Era of Expensive Oil Over?

by Rachel Bronson and Andy Morimoto

Oil prices are going down and going down fast. Since June, the price of Brent crude has dropped nearly 30 percent to $78, and some expect prices to tumble further. Not surprisingly, lower prices have been met with panic from producers who are seeing their profits shrink, and jubilation from consumers who are benefiting from lower prices at the pump. Do these prices signal a new era of cheap oil, or are they a temporary drop in an otherwise expensive energy future?

In the short-term, global demand is stalling and a growing supply of oil and gas is flooding the market, leading to lower prices. On the demand side, growth in China and Europe has been lower than anticipated and efficiency measures taken in Europe and North America mean that less energy is needed for each dollar of growth. On the supply side, America’s fracking revolution and the increasing production from Canada’s oil sands are making North America the epicenter of a global energy revolution. In the Middle East, the conflict in Iraq has not reduced that country’s oil supply as much as some analysts had feared, and Libya has increased production beyond early expectations. Additionally, Saudi Arabia (always the swing state when it comes to oil production) has not reduced its own oil production, deciding instead to accept lower prices and seek a greater market share to blunt the effects of lower prices.

In the medium to long-term, however, several factors call into question whether this is the dawning of a new era of low oil prices. First, some perspective is required amid breathless media reporting about the price drop. At $78 per barrel, consumers are still experiencing historically high prices. The 2008 price of $140 per barrel was record-shattering compared to previous prices, and this summer’s $115 per barrel was again at the high end of the price chart.

Despite short-term falling prices, there are additional factors that could stop or even reverse this trend over the longer term. First, domestic politics could throw a wrench into the exuberant predictions of increasing supplies of oil and natural gas in North America. Political opposition to fracking is growing across parts of the United States, and New YorkVermont, andseveral large cities across the country have implemented bans or moratoria on fracking. In Canada, there is also significant opposition to fracking in parts of the country as well as opposition to many of the planned pipeline routes needed to get local resources to the international market.

Second, while Saudi Arabia advances its geopolitical interests with today’s softened prices, there is a price floor that it needs to maintain in order to honor its domestic commitments. To balance its budget, Riyadh requires a price per barrel in the $90s. Although the Kingdom can ride out a period of lower prices because of the $750 billion it holds in reserves, it is unlikely to do so for long if it risks domestic stability.

Third, a host of political crises threaten key sources of oil production. The expanding conflict in Iraq, for example, has called into question whether international companies will continue to make necessary investments in the country’s oil industry. Similarly, Libya’s government seems incapable of maintaining political order for an extended period, and just this month one of Libya’s main oil fields was forced to slow production because of a new cycle of violence. In addition, Russian energy sanctions pose a risk to global oil supplies, as do upcoming elections in Nigeria and Venezuela.

Fourth, and perhaps most important, strong demand from China and other Asian countries must be factored into any price forecasts. Although demand for oil in China has slowed, it still must be fed as the country grows. Just twenty years ago China was self-reliant on its own oil supply, but over the last two decades China has risen to become the world’s largest net importer of oil, with nearly 60 percent of its oil—6.2 million barrels per day—coming from outside of its borders. Moreover, China’s demand is projected to rise. By 2021, China’s economy is expected to reach $25 trillion GDP, and its middle class will expand to 40 percent of its population. Chinese demand for motor vehicles is projected to grow to nearly 30 million units per year by 2020. Beyond just China, the entire Indo-Pacific region has become “ground zero for growth,” according to Mohan Malik, a professor at the Asia-Pacific Center for Security Studies at Honolulu. India, Japan, and South Korea have grown to consume a quarter of the world’s liquid hydrocarbons. Malik projects that “over the next twenty years, 85 percent of the growth in energy consumption will come from the Indo-Pacific region.”

While prices are dropping, they are still at historically high levels. Thus, there is good reason to be cautious when drawing conclusions from this or next quarter’s energy prices. The best response for the U.S. would be to invest today’s energy savings into conservation efforts, research and development on alternative energy sources, and U.S. energy infrastructure. The less energy the U.S. imports and consumes, the better inoculated it will be to international price spikes. Realizing such energy investments could be the game changer that makes speculation about Chinese demand, Saudi supply, and political crises in unstable neighborhoods less urgent and possibly an exercise relegated to the past.

About the Author

Rachel Bronson is a Senior Fellow, Global Energy at The Chicago Council on Global Affairs. She is the author of Thicker than Oil: America’s Uneasy Partnership with Saudi Arabia. Follow her on Twitter @rachelbronson1. Andy Morimoto is a Program Coordinator at The Chicago Council on Global Affairs. He holds a master’s degree in international relations from the University of Chicago and a bachelor’s degree in history and political science from The University of North Carolina at Charlotte. Follow him on Twitter @AndyMorimoto.

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