The Trillion-Dollar Question: Are Low Oil Prices Here to Stay?

"Any number of headlines could drive prices back above $100 a barrel very quickly, even more rapidly than they have fallen." 

The recent collapse of oil prices raises questions not only about why, but, more significantly, about whether the new low-price regime will last. The answer on oil, as always, requires a look at three component considerations: (1) actual global demand for oil and gas, (2) actual global supply and (3) anxieties, usually based on geopolitics, about the first and second considerations. All three change constantly, seldom as forecast, but it is the third, the least stable of the three, that causes the sudden, dramatic price moves, including this recent one. Moderating demand and increasing supplies have played a role in the recent drama, to be sure, but the price decline stems largely from an abatement in geopolitical anxieties, at least as they pertain to oil. Such concerns will, however, likely return, confirming the now-well-established historical rule that no oil-price regime lasts long.

Moderated Demand

The demand part of the picture is the most straightforward. The use of oil and gas, in developed economies especially, has grown at a much slower pace than overall levels of commercial activity (or than was forecast at intervals along the way.) To some small extent, this shortfall has its roots in the growth of alternative energy sources—solar, wind, biomass and the like. But, for all the political emphasis and investment interest, this area accounts for the least of the change. According to the Energy Information Agency (EIA), alternatives amount to only 9.5 percent of all energy consumed in the United States. The figure is slightly higher in other developed economies and slightly lower in emerging economics. No doubt alternative development has kept oil and gas prices lower than they otherwise would have been, but not significantly and certainly not with the kind of sudden impact that would account for recent dramatic price moves.

Hydrocarbon efficiencies and conservation have played a bigger role. Even in the 1980s and 1990s, when the global economy was increasing at a brisk pace, efficiencies held the growth of global oil demand to a mere 2 percent a year. In the early years of this century, global energy demand accelerated, largely because emerging economies became a larger part of the picture, and they had neither the infrastructure, nor the wealth to apply the efficiencies that had become commonplace in the United States, Japan and Europe. Still, the application of efficiencies continued. The United States today, for instance, produces a dollar of gross domestic product (GDP) with less than half the oil and gas it required twenty to thirty years ago.

While there can be no doubt that these efficiency gains in North America and elsewhere have made room for recent price declines, the poor performance of the world economy has had a more immediate demand effect. Japan, after a brief surge, has fallen into recession. Europe, under the weight of its fiscal-financial crisis, has also performed poorly. From a technical standpoint, the eurozone may have avoided the recession designation, but it is only technicalities that distinguish its economic performance from recession. China is growing at a much slower pace than previously. Having expanded in real terms at 10-12 percent a year not too long ago, it now struggles to sustain a 7 percent real growth rate. Other emerging economies, including India, have slowed along similar lines. The U.S. economy has accelerated of late, but it is far from apparent that the new, more-rapid growth pace is sustainable.

Rising Supply

More than slowed demand, a surge in global oil and gas supplies has made still more room for price declines. Here, fracking is the star of the show. This technology has increased U.S. oil and gas production by more than half during the last five years. The surge has added fully 4.0 percent to global oil flows since 2009, a not-insignificant difference. In addition, technological advances have also enabled Canada to access its tar sands deposits more cost effectively than in the past. That country has increased its overall production by more than a third during this time, adding another 1.2 percent to overall global output. Meanwhile, other new technologies have allowed producers to get more oil and gas from existing conventional wells, enabling production in some places to pick up even in the absence of new finds.