energy

Why cheap oil is as problematic as expensive oil

The oil price continues to bump along – today it’s at $42 a barrel, as low as it has been since the financial crisis. For some commentators, this is a good thing, a boost to a flagging global economy. But cheap oil is a problem too, something Samuel Alexander explores in his Simplicity Institute paper The Paradox of Oil.

For starters, some people are going to lose a lot of money. The lower the oil price falls, the larger the slice of global oil production that becomes uneconomic. Alternative fuels such as the Canadian tar sands, or some US shale, need a high oil price to break even. Bankruptcy and falling production will follow if prices stay down long enough.

Building on that, cheap oil scares off investors hoping for the high returns that expensive oil brings. When prices fall, so does the return on investment from oil production. Oil companies pull the plug or postpone medium to long term production plans. The problem with this is that it leaves a shortfall in the future. A couple of years down the line, when that oil is needed to keep up with demand, it won’t be there. If it’s a big shortfall, that could mean a price spike, with the potential knock-on effects of recession and rising food prices.

As well as the break-even for oil companies, there’s a ‘fiscal break-even’ to consider too. Governments of oil-producing countries plan around a certain tax take, based on profits made from selling their fossil fuel resources. With falling prices comes falling revenue to the treasury, meaning financial crisis for countries like Russia, Iran or Venezuela. Half of Russia’s budget is from oil and gas, so a halving of the oil price means serious debt or painful austerity.

Those aspects have been discussed and are fairly well known. The environmental aspects of cheap oil aren’t quite so visible, Alexander argues. Renewable energy is falling in price all the time, improving its competitiveness against fossil fuels. However, cheap oil delays the moment of parity when renewable energy is as cheap, or cheaper than fossil fuels. By making renewable energy less competitive, cheap oil deters investors and delays the transition to clean energy.

Finally, cheap oil reduces the urgency of oil dependency. “Just as expensive oil suffocates industrial economies that are dependent on cheap energy inputs to function, cheap oil merely propagates and further entrenches the existing order”.

In a striking comparison, Alexander likens our oil dependency to a heroin addiction. When heroin is expensive, addicts cut back on other things to pay for it, even things essential to life. When it’s cheap, they consume more and make it ever harder to give it up. “Oil acts as industrial civilization’s own form of heroin,” he says, “and whether it is cheap or expensive, addicts today are in as much trouble as ever.”

10 comments

  1. So some oil companies lose some money. They took a risk and deserve high profits if they succeed but should take the hit if they lose.

    Shale has changed the economics of the oil industry. Previously new fields took a long time and lots of investment to bring to market, and had a long lifetime. Now shale wells can be drilled quickly and only last a short time, so can be scaled back quicker in line with changing demand. So the old trope that low prices now will mean higher prices in the future is not so true but that fact hasn’t got through to many worrywarts.

    And not a tear is shed for Iran, Venezuela or Russia.

  2. Ah the conundrum. Dammed either way. Supporting and encouraging a destructive industry is a nihilist concession. One dreams Russia, Iran and Venezuela may see the wisdom in diversifying their economies and liberalizing politics. In your last assessment you discussed The Guardian (and 350.org) position that that civilization must keep proven reserves of fossil fuel buried beneath the ground to avert the disastrous consequences of climate disruption. If only economics included external costs to society we’d be on the way to recovery from this Industrial Age habit that has become fatally addicting and creating better scenarios for prosperity. What does it take to unleash all the ingenuity and productivity available in our human race? It is possible – even desirable. History provides little comfort.

      1. In the past a cut in investment die to low prices would cause a big spike in the future is that previously it took a long time and required lots of investment to bring new oil fields to production. Only Saudi could quickly ramp up or down production.

        Shale or tight oil from fracking changed that. The development in the US has been amazing. Given that this only started just over 10 years ago the productivity increase has been immmense. These wells can be drilled ever more quickly for ever less money and produce ever more oil. Sure low prices now cut the number of new wells drilled but if the price rises the US driilers can ramp up production quicker than regular oil fields outside Saudi since New wells can be drilled so quickly.

        Added to the fact the wells don’t last a long time means production rises and falls far more closely with demand than traditional oil wells. This reduces over and undersupply meaning you won’t get such wild swings in oil prices.

        The advances in fracking have been so quickly that lots of analysis doesn’t have the full implications. Mr Alexander has missed it unsurprisingly.

        1. Yes, US production is very flexible, but there’s quite a big jump from acknowledging that to claiming that it can ramp up production at will to offset any lost production elsewhere.

          Goldman Sachs reckon a trillion dollars of investment is at risk, globally. Can US frackers offset that degree of lost production?

          1. Well if that trillion dollars is in very expensive oil such as in the Arctic, Alberta tar sands or Brazilian presal then shale is a better bet.

            US oil production has increased by 50% in a few years to be the largest oil producer.

            Given how common shale is it really is ludditism to oppose its expansion and I expect many countries to follow the US lead.

            Now I’m not saying oil prices won’t move around but oil is now more like other industries where supply and demand can be matched more quickly so booms and bust will be moderated.

  3. It’s that last line where this goes wrong in my opinion – ‘oil is now more like other industries’, as if the whole industry is now as flexible as shale. Swing producer or not, the US is not typical and long-term planning and funding is still vital.

    1. Prices being set at the margin, having another swing producer, especially one closely linked to demand, has a bigger effect than the volume suggests.

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