Oil at $100 a barrel – the halfway point

When I started developing Project Better Place as a white paper for the World Economic Forum, oil was hovering around $50 a barrel. I predicted in my calculations that by the end of the decade we will reach $100 a barrel. That point was very contentious at the time, as most people predicted that we are in a cyclical industry. One of the industry experts even told me that I do not understand oil (a correct statement at the time), and that "...Oil is cheap and abundant...whenever an alternative solution will show up the price will go down till the alternative is not viable". On the flip side, sometime early this year, I had made a bet with my friend and co-conspirator Andrey Zarur, who claimed that Oil will reach $100 before the end of the year - I won that bet by a narrow margin of 3 days.

"...Oil is cheap and abundant.." - oil expert

At any price under $30, oil is practically not a factor in governmental decisions. During the Clinton days we had oil at $10 bbl and the total daily import cost of oil to the American trade balance added up to roughly $100M. Even when we add it up across an entire year the cost is $30B, not easy to swallow for most country budgets, but negligible for a super power. On Jan 3rd 2008 the cost of importing oil to the US was $1.3B a day - roughly 2 weeks worth of oil in 1999 - and if the price point stays where it is the US will see another $500B disappearing from its trade balance in 2008. Adding in the cost of subsidies for the domestic oil industry, the delivery and refining costs of gasoline, the healthcare cost of using it, and the cost of securing oil sources around the world and we are looking at probably the same amount in "externalities" of oil which the US budget loses every year. The combined sum is a staggering ANNUAL Trillion US dollars - roughly the Chinese federal cash reserve.

Oil, we found out, is neither cheap nor abundant. It is dwindling and hard to extract. The issue at hand is not whether we have enough reserves, but rather whether we have enough of a pipe out of the current reserves to feed the global addiction. We have moved from supply side constraints to demand based pricing. As another oil expert explained to me we are at the mid point of oil prices as they move from an equilibrium at $50/bbl to a new level at $150/bbl. He had a chilling analysis for the two sides of the oil price spectrum. "...At $50/bbl governments invest in demand; At $150/bbl they secure supply...". I see that statement as one of the most profound statements I had heard about the oil market and the role government plays in it.

"...At $50/bbl governments invest in demand; At $150/bbl they secure supply..." - Another Oil Expert

What he meant is that governments at $50 bbl have enough time to invest in finding alternatives that will reduce their demand for oil. Dependence on a scarce and expensive substance is called an addiction. We are all addicts. We value our freedom to drive more than many other freedoms that have a specific amendment in the constitution. We wasted the good years, when we could take the time and research alternatives. We wasted them on hydrogen research and ethanol subsidies. Don't take me the wrong way, it wasn't all waste - fuel cells will give us solid electric drive trains (only no need for hydrogen), and ethanol might buy us some precious time until we get completely off the need to burn something in an inefficient engine. But hydrogen is never going to be an efficient way to distribute electric energy (wrong package for an electron), and ethanol will never scale to provide us enough liquid fuel without destroying the food markets (oh, and run out of water). We were enamored with ideas that solved a technical solution but didn't scale.

"We will not reduce our use of oil until it is significantly more expensive. Hence oil is bound to become very expensive" - Smart man about oil

The other side of the spectrum is best demonstrated by a scenario-planning event run by SAFE in DC two months ago. During the event staffed by former cabinet members advised a president (not present, nor identified by gender) what to do whenever the price of oil reached a new high (increased by $10/bbl through external events). To make a long story short, at $150 bbl the president was left with two alternatives - (a) instruct all Americans not to drive on Sunday or (b) take over the Persian gulf. You guessed it right, Football games were not suspended. At the same time, The US is not the only country which cannot afford the implications of $150 bbl, China's economy depends on cheaper Diesel, and at $150 bbl, they have no choice but to raise Diesel prices to roughly $4.50 a gallon - implying a significant inflationary pressure on all basic commodities. Will we have a timeshare agreement with China and the US over oil sources?

"Given the choice between driving on Sundays and our military securing oil sources we will prefer our freedom over others" - Unfortunate reality

The question that remains open in many people's mind is which statement to believe regarding state of oil in the world - "cheap and abundant" or "apocalyptic scenario". The hidden factor in all of this assessment is the negative feedback loop the oil market has entered over the last two years. Countries that sit on reserves are smarting up - and had become very reluctant to extract and sell it at any price. If you are a leader of a country that is lucky to have extracted oil for the last few years, your reserves do not require a cash infusion any more. What you do is the same as any driver does in times of shortage - you store some oil for rainy days. Countries on the verge of running out of their reserves in the next decade or so, decided to stop exporting oil (smart planning). On the other hand, countries that are importing oil, but have fields are shifting the ownership on the new fields to the national oil companies. Some of those companies (not Saudi Aramco or Petrobras), do not have the same technology that global-oil is using, so their pipes move oil a bit slower than the big guys can - hence the constraint is now on the width of the pipe, not the size of reserves (although that will be an issue soon enough).

What do we have to do - we have to put our money into easing demand before it is too late. Addicts who wait for the crisis do not recover in the same shape as they were before a stroke or heart attack hit them. In the world of oil a heart attack is a global recession, and a stroke is probably global war. We can't afford either. Only solution to addiction is drying up on the substance. We may be too late, but we still need to try - putting more money into oil without putting any money into oil independence will make us dream of days when oil was cheap and abundant - at only $100 a barrel.

See more:

Comments are closed.