Something a little crazy has happened in the oil market this year, and we begin December with the price of crude below $70 for the first time since the global financial crisis. That figure rang a bell. It’s the ‘economic prerequisite’ that Leonardo Maugeri said was necessary to keep oil supplies on track in his much-quoted report on the future of oil.
If you remember, it was this report that many commentators described as the death knell of peak oil theory (a view I don’t share). It predicted that future oil needs could be met after all. New technology was making more unconventional fossil fuels viable, and we were on the verge of a new era of oil. Good news for the energy industry and oil-addicted consumer economies. Bad news for the planet.
The report reaches this conclusion by looking at decline rates, and offsetting them with new sources of oil. We know that conventional oil supplies are in decline. Just as the better oil depletion writers suggested years ago, that has put us into a period of transition towards much more expensive fossil fuels – shale, tar sands and deep water drilling. As long we can bring these new sources online faster than conventional oil supplies decline, global production can still increase.
However, because these alternative fossil fuels are so much more expensive, they need a consistently high oil price. That, in turn, depends on consistent global economic growth. And that’s where we’re running into trouble.
As David Cameron said the other week, there are “red warning lights flashing on the dashboard of the global economy”. With a slowdown in growth comes a fall in demand for oil, and a fall in the oil price. Couple that with a glut in US oil production, and you’ve got an oil price in freefall. The further it falls, the less money the unconventional oil companies make, in many cases making their projects uneconomic altogether. At $70 a barrel, we fall below Maugeri’s prerequisite price floor for meeting global demand.
What happens next? Well, if the price stays down for any length of time, people will start losing money on oil. Investment will pause on big expensive oil projects such as tar sands or Arctic drilling. The number of new shale rigs will drop, and some smaller shale companies will go bust as their profits evaporate. Banks will start to worry about the returns on their investments – $950 billion was invested in fossil fuels last year, and a big slice of that will be in projects that are now losing money. As I wrote a couple of months ago, that’s a subprime situation and a financial crisis risk in itself.
As I’ve written a dozen times on the blog, the problem of oil depletion is not first and foremost the size of reserves and how much we’ve got left. The problem is the rising cost of getting oil out of the ground. If oil companies pull the plug on planned projects and the banks hesitate to fund new ones, that means shortages further down the line, and the risk of oil prices spiking again. This volatility is par for the course in the age of expensive oil.