Monday, October 20, 2014

Oil prices keep going down, but this is not good news

Originally published in Italian in "Greenreport" [14 October 2014]

Ugo Bardi


There is plenty of movement in the oil world: after five years of relatively stable prices, the legendary "barrel" is coming down from over $ 100 to under 90, and it looks like it will keep falling. What's happening? Has anyone found new resources? Or is it Saudi Arabia using the "oil weapon" to bring down Russia, the heir of the old "evil empire"?

In reality, it is nothing like that. There are no major new discoveries of oil in the world and the Saudi oil weapon is much less fearsome than it is normally described in the media. But, then, why are prices going down? There are good reasons, but we need to understand them and, more importantly, to explain why the likely future drop in oil prices would NOT be a good thing; indeed it could be a planetary disaster.

First of all, we should take into account that oil is a finite resource, but also that it is subject to the laws of supply and demand; it cannot escape the control of the entity we call "the market". So, we are seeing two contrasting trends in the oil market. One is the gradual depletion of the so-called "conventional" oil; that is liquid oil extracted at relatively low cost from wells. As a consequence, the production of conventional oil is static or declining almost everywhere. The other trend is the increase in the production of "unconventional" oil, that is combustible liquids which are obtained, for example, by treating oil sands, or biofuels, or "oil shale," the kind you obtain by means of the "fracking" process. 

Up to now, the rapid development of the production of unconventional oil - especially shale oil in the United States - has compensated ​​the worldwide decline in the production of conventional oil; it has, in fact, allowed production to keep growing. At the same time, many of the major economies are in recession and are reducing their energy demand. Italy, for example, has lost 25% of its oil consumption over the last five years, and the descent continues. Other economies, such as in Germany, are in trouble, even if not yet in recession. This causes a decrease in the world demand. 

So, the two factors - increase in supply and decrease in demand - go in the same direction: the market wants the price of oil lowered, and it goes down. We should also take into account that these phenomena are often heavily influenced by the perceptions of financial operators: if everyone thinks that the price of oil should fall, then it will fall. In practice, we risk to see not just a drop in oil prices, but also a true meltdown of the oil market, like that witnessed in 2008-2009.  

Many people would be tempted to believe that lower oil prices are a good thing, but it is not so. If we will see a repetition of the scenario of 2008-2009, the result can only be a disaster (as it was at that time). The problem is that oil resources are not all the same: to produce certain types of oil is very expensive. Extracting from tar sands or from oil shales, for example, is more expensive than extracting from traditional wells. So what happens if prices go down? It happens that extracting and marketing certain types of oil does not generate a revenue anymore. Then, those types of oil are not produced any more. Who would ever want to produce at a loss?  

In practice, if prices decrease, the world's oil production decreases: have you ever eard of "peak oil"? It is just this phenomenon: "peaking" does not mean running out of oil; absolutely not. It means that producing more oil is not as convenient as it was before, hence less is produced. Therefore, we see a peak in the production curve. That's peak oil.

And that's exactly what may happen in the near future. Oil at over $ 100 a barrel allowed the industry to maintain a fairly constant production - actually even to increase it slightly over the past few years. Oil at significantly lower prices does not allow it anymore, and it forces the industry to reduce production. This leads, among other things, to the closing of many refineries, as is happening in Italy.

In the end, it is perfectly possible that oil will cost less in the future, but also that we won't have the money to pay for it. There is nothing to do about that: it is the market, baby! But above all, the troubles come from our attitude that continues to make us believe that oil will last forever. It is not possible. Let's start thinking about that!


Ugo Bardi is a member of the Club of Rome, faculty member of the University of Florence, and the author of "Extracted" (Chelsea Green 2014), "The Seneca Effect" (Springer 2017), and Before the Collapse (Springer 2019)