Cheap oil forever?

by Mike Newland

A joyous outburst of economic optimism has been generated by the recent huge fall in the oil price.

Economic pundits predict a bright future based on cheap energy. Anyone might be excused from thinking that there is no longer a key scarce resource called oil. Ample supplies into the foreseeable future at bargain prices! The world before the 1970 price hikes is back!

The reality is radically different as is the longer term outlook.

Oil has not become suddenly cheaper to find and exploit. What has happened is that those who produce it are finding themselves having to part with it at much lower reward to themselves while those buying it gain. All that has happened is a transfer of wealth from producers to users.

Why should this generate better economic prospects? Because, as during the 1970s, users tend to spend their wealth faster than suppliers who are often rolling in money anyway – at least from their oil supply activities. Cue sheikhs with supercars roaming the West End of London and parking anywhere. But as a whole we are not better off at all in terms of core resources.

What then has provoked the dramatic fall in price of liquid gold?

The fall appears to be generated by a multiplicity of factors political as well as economic. Oil prices are in particular a hugely political issue. The US wants Russia and Iran economically squeezed. Russia in particular depends heavily on oil exports and is out of fashion in Washington because of rivalry in Eastern Europe. Iran is now in fashion but is receiving a warning that it had better toe the line. The producers of oil with the cheapest sources would like to drive out of business its competitors and then take the pot.

An explosion in production by means of fracking was propelled by the rising costs of oil extraction over a very long period. Fracking does not spell cheaper oil in the long run. It indicates that it is increasingly expensive to obtain oil. Fracking would not have been economic in earlier decades.

The key thing to appreciate where oil is concerned is the ‘EROEI’ or ‘energy returned on energy expended‘. It takes energy to get out the materials which provide energy. In the 1970s it took only a percent or two of the energy extracted to do the work of extraction. The costs of oil are steadily increasing – pushing up towards ten percent and inevitably increasing in future as finds become more and more difficult to get out. Shale is far more costly.

The concept of peak oil is misleading. There is always more to be found but at what cost?

Since all economic development has been based for 200 years on energy from more than human and animal muscle power – plus some wind and water – the more that disappears in obtaining it the less to fuel production of the goods it produces. As Dr Tim Morgan says, the correct way to view money is as energy vouchers since everything it can buy is based on the energy needed to produce the goods. No energy no goods.

Oil prices in the long run must rise even if the split in the goodies between producers and consumers changes. A prolonged fall in the oil price may also inhibit the development of alternative energies as safe and cheap sources.

We are not magically off the hook in supplying ourselves with energy. The golden age of cheap energy is over without some miraculous invention. Wind, wave and nuclear powers are not cheap sources of energy. We are a long way from the prognostications of the 1950s about free electricity from nuclear fission.

There is now a risk that we become hoodwinked into imagining there to be no energy problem by the girations of a restless market in oil. The reality is that, if the cost of energy rises sufficiently in relation to the amount produced, the current economic world we now take for granted will be obliterated.