IN 1980 MOST EXPERTS agreed that oil prices could only go up. Following the panic of the Iranian revolution, the price spiked to more than $80 a barrel adjusted for inflation. I gained some notoriety at the time by publishing an article with William Brown, a Hudson Institute colleague, in the Wall Street Journal predicting that oil prices would fall in 1980 and that the 1980s would be a decade of decreasing, not increasing, oil prices. Indeed, the price fell sharply in 1980 and by the late 1980s the price had fallen to around $30 a barrel, and it dipped to around $20 in the late 90s.
Today there is a great chorus, in which New York Times columnist Thomas Friedman's voice stands out, calling upon the United States and other nations to radically reduce their oil consumption because, as Friedman and others contend, the world will soon run out. In the mean time, they say, our continued dependence on (or "addiction to") oil means a continued dependence on oil exporting countries--so many of which are run by less than democratic governments--and high energy prices of $70 a barrel, or more.
But a deeper understanding of the supply side and a longer term perspective of demand produces a different view. Between now and the middle of the century $30 is likely to be more typical of the price of a barrel of oil than $60. Most of the time sellers will be competing for buyers, not pushing them around. And the Arabs are likely to have a smaller share of the market in the future, not a larger one. Before long the fear of Arab oil power is likely to seem unimaginably dated.
Two factors influence oil prices. First is the amount of oil in the ground. Second is the capacity of oil production and transportation facilities. Too few wells and pipelines create oil shortages, and therefore high prices, regardless of how much oil there is in the ground. For our purposes, "oil in the ground" refers to oil that investors think they can bring to market for less than $20 a barrel if things go near enough to plan. Capacity, on the other hand, refers to every element of the process from extraction to delivery, including the production of equipment associated with each element of that process.
So how much oil is out there waiting to be discovered? Chevron Corporation has been buying advertisements claiming that, "The world consumes two barrels of oil for every barrel discovered." Fortunately Chevron is only speaking the truth if you use an artificial definition of how much oil is being discovered. For example, Canada is now estimated to have 150 billion barrels of recoverable oil in their tarsands. Twenty years ago we couldn't produce that oil at competitive costs. Now we are producing a million barrels/day at a cost of about $15 each. In effect we have "discovered" 150 billion barrels of oil in Canada--more than the entire world used in the last five years--which Chevron doesn't count.
There are other potentially large additions to world oil resources. According to Leigh Price, an expert on oil deposits who died in 2000, there are over 200 billion barrels in the Bakken "oil play" in Montana and North Dakota. It is not yet clear whether Price's theory is correct, but recently a number of drillers have started producing oil from that deposit, which is not even included in standard estimates of oil reserves. Bakken might not turn out to be as significant as Price expected, but the larger point remains: A number of potential sources exist. Recently an Israeli claimed to have discovered how to economically produce oil from oil shale. Since such claims have been made for more than twenty years, we can't put too much faith in this announcement. But there is no reason to assume that we won't solve this problem in the future. There are hundreds of billions of barrels of shale oil in Colorado and probably as much in other parts of the world.
There are two ways to discover oil. One is the conventional way--drilling to find new deposits of the same kind as we produced before. The other is to develop new technologies that either allow us to retrieve oil from formerly out of reach places, or economically recover oil from deposits where extraction is currently too expensive.
The net result is that the known available oil supply in the ground today is larger than it was 20 years ago, or 50 years ago, despite all the oil we have taken out of the ground and burned. Despite this experience, the oil supply in the ground 20 years from now may not be larger than it is today. No one can say either way with any certainty. Still, today, as in the past, oil investors find myriad opportunities to seek oil that is expected to be delivered at a cost of $20 a barrel or less. Therefore we can be relatively certain that present high prices are not the result of a lack of oil in the ground.
