Exploring Hydrocarbon Depletion
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Page added on April 29, 2012
I think everyone’s wallet should have convinced them by now that the days of cheap oil are over.
Compared to the end of cheap oil, “peak oil,” or the moment when worldwide production hits its peak, is irrelevant, at least from an economic standpoint. What we really care about is how much we’re paying for the oil that keeps our economy running.
As I demonstrated in my most popular article to date on Forbes, The End of Elastic Oil, the global market for oil has had a regime change in the last 10 years.
The New Oil Regime
In the old regime, oil production was flexible, with plenty of spare capacity in places like Saudi Arabia, and supply easily adjusted to accommodate changes in demand. In the new regime, that is no longer the case. Today, oil supply shifts in response to demand only slowly, so demand has to shift to accommodate changes in supply. Since most oil demand is inelastic (we have to drive to work or we lose our job), large price changes are needed to significantly impact demand. Hence we now see much larger price swings (and generally higher prices) than we have ever seen before.
In short, the peak oil crowd is right, but, like anyone who gets used to being criticized for accurately stating the facts, they can take the argument too far. The concept of “Net Exports” is a case in point. My friend Jim Hansen explains Net Exports this way:
For oil importing countries like the United States, China, India and all of Europe except for Norway the available supply of importable oil on the global market is all that matters. It doesn’t matter to these countries how much global production has risen if that production does not translate into an increase in the global net export supply. An increase in gross Saudi Arabian production is meaningless if it is destined solely for domestic consumption (see this week’s report for more).
I’m sorry Jim, that really does not follow.
An increase in gross Saudi Arabian production isn’t “destined” for anywhere, and it is meaningful.
Market forces are in play even in a subsidized market like domestic Saudi oil consumption. Saudi consumers may not feel the pain of higher world oil prices, but the Saudi government certainly will as long as they keep subsidies flowing. If Saudi net exports fall to the point when the government can no longer afford to subsidize domestic consumption, they will cut subsidies, and domestic consumption will fall. At the same time, net exports will rise.
In short, higher oil prices can and will lead to increases in net exports. Subsidies make oil consumers in many oil exporting countries less sensitive to world oil prices, but those world oil prices will have an effect on those subsidies, and hence on domestic consumption in oil exporters.
Net exports of oil exporting countries do matter, since demand in those countries tends to be less responsive to changes in the oil price than demand in oil importers. But net exports are not everything.
Eventually, the world oil price trumps everything else.