14 Points

Another second contributing element of demand is the rise of consumption within oil producing nations. Growing oil wealth is coupling with subsidized oil prices in countries such as Russia, Saudi Arabia, Iran, and Venezuela to drive rapid increases in domestic demand. Even with the vast amount of petrodollar revenue generated by the quadrupling of the price these past five years, some countries are struggling to maintain their expensive subsidies. For instance, Iran had to ration fuel to its own citizens last summer since they were spending an unsustainable amount to keep the price at ~30 cents per gallon. Such low prices incur an artificial increase in domestic demand that takes a bite out of the oil these countries could export. But domestic pressures to maintain these subsidies will probably persist into the future, further facilitating further high demand[JTR1] .

Lastly, the US continues to increase its demand, although at a slower rate than the countries mentioned above. Oil demand has proven to be so price inelastic that the recent spike in the price of diesel and gasoline at the pump has not prevented growth in consumption. Oil prices would probably be even higher if the sub-prime mortgage woes in the US housing market weren’t threatening a recession, potentially curbing oil consumption in the short-term. Looking years into the future, while more efficient vehicles may slowly integrate into the US fleet, demand growth seems to have strong inertia as the population continues to grow and the public transit infrastructure remains a lower priority than interstate highways and the suburbia lifestyle.

In sum, increased demand from China, India, oil-rich countries, and the US has not stopped as prices skyrocketed during the last five years, and they show few signs of halting in the near future at current prices. Now let’s turn to the supply side to see if global producers can satisfy growing demand and add enough spare capacity to get prices under control.

Key factors on the Supply Side

The story of global oil supply is becoming very interesting, and potentially alarming, of late. Even though the price of oil is quadruple what it was in 2002, production has remained flat since 2005. In fact, production has actually dropped slightly in 2007, averaging around 85 million barrels per day (mbd). Most economists would predict that such price increases would cause a rapid profit-taking expansion of production that would bring the price back to a lower equilibrium, but mysteriously that hasn’t happened. There are two main components of the oil producing world to search for answers, non-OPEC and OPEC countries.

First, we can take a look at the non-OPEC supply picture. Over the past few years the competitive non-OPEC producers have been unable to increase their aggregate output, even though the increasing price gives them every incentive to do so. Aging oil fields in Norway, Mexico, the UK and the US offset increased production in Russia, Brazil and Azerbaijan. A rapid increase in drilling and new techniques of extraction can only slow the decline of major oilfields that are getting drained after decades of easy oil flow. A recent report by Platts showed that oil production in seven key oil corporations (ExxonMobil, BP, and the like) is actually decreasing these last few years, with their 3^rd quarter 2007 production 6% below that in 2006 (10.3 mbd vs. 11 mbd). Thus, if we are to increase global supply, we’ll have to drill somewhere other than the non-OPEC world.

But even OPEC nations seem to have trouble growing their production. Iran, Iraq, Nigeria and Venezuela produce about the same amount of oil that they did five years ago, while little spare capacity remains in Kuwait and Saudi Arabia. With flat production in the non-OPEC world, the IEA estimates a “call on OPEC” of an additional 10 mbd within 10 years. But many geologists and energy analysts doubt the ability of OPEC to generate such an increase. Experts like Matthew Simmons believe Saudi Arabia’s capacity as the global swing producer is evaporating because its world’s biggest super-giant, Ghawar, after producing oil since the early 1950s, seems to show signs of decline. Simmons and others point to deteriorating production in the US, Indonesia, Norway, Egypt, Mexico, and dozens of other countries as a glimpse of OPEC in the near future. Princeton’s own Geology professor Kenneth Deffeyes believes oil production has peaked and will inexorably fall from here on out. A late October report by German-based Energy Watch Group concurs, saying that maximum production took place in 2006 and that production will decline to ½ the current level or only ~40 mbd by 2030. Others concerned about peak oil are less convinced of such a rapid drop but believe that we will hit maximum production by 2018 and urge rapid efficiency programs to prepare for such a shock to our energy system.

Whether oil production by OPEC over the next several years can make up for declines in non-OPEC states and add additional millions of barrels to the world market is an open question. But these last few years surely show that increasing production is not just a matter of turning the spigot. Unconventional oils such as Canada’s tar sands and Venezuela’s heavy oil will play a role if the easy oil is dwindling. But such projects take many years to tap, have serious environmental consequences, and may only slow the production decline.

And geology is not the only factor limiting production. Other concerns in current and future supply include political and weather-related constraints - such as Iraq’s lower production totals since the US invasion in 2003, disruptions in Nigeria as many people feel they have not received benefits from production in their native lands, and hurricanes such as Katrina and Rita in 2005. All of these factors combine to make the current supply picture a plateau amidst rising prices, an alarming sign with serious implications for the future.

Conclusions & Connections

A continued demand increase simultaneously occurring with a supply plateau (or even decline) would elevate the price to levels unimaginable just a few short years ago. Prices would rise until people curbed their demand, whether that price point is $150/barrel oil and $5/gallon gasoline or even higher. The ripples from this shift would flow throughout the global energy system, as already evident in record prices of coal and recent price hikes for natural gas. The declining value of the dollar versus other currencies makes the price increases especially noticeable here in the US. We are entering the new frontier of an energy-constrained world where choices have to be made for our path forward.

This juncture provides the perfect setting for the transformation of our energy infrastructure. A fraction of the trillions of dollars currently flowing toward fossil fuels can get us on a new energy path that efficiently provides more and more fuel and electrons from solar, wind, geothermal, and other sustainable means. Rather than invest in coal-to-liquids, we can take this opportunity to build a renewable energy economy not only as a moral imperative to address global warming and its effects on our ecosystem and people, but also as a way to guarantee mobility and power to the billions of poor and middle-income people throughout the world.

Policy development and implementation is necessary to ensure that we take this opportunity. Because transportation is 90+% dependent on oil, it makes sense for us to focus within that sector on initiatives that support growth in fuel efficiency, plug-in hybrid electric vehicles (powered by low carbon energy), bio-waste fuels such as cellulosic ethanol, public transit infrastructure development, bikable and walkable routes from homes to work, and behavior changes like carpooling and increased telecommuting. To ensure the co-benefits of air quality and greenhouse gas (GHG) emission reduction we will need to establish clear signals, whether through price or otherwise, that prevent a shift toward more carbon intensive coal-to-liquid (CTL) or tropical forest denuding biofuels. If we do include CTL and more coal plants due to coal’s abundance and lower cost at the moment, we need guarantees that any such projects would include carbon capture and storage. A federal renewable portfolio standard and the passage of a comprehensive GHG emissions reduction bill, as Congress is debating right now, could help to steer momentum in the right direction.

The high price of oil brings us to a new frontier - a place where we can choose to foster a sustainable energy economy that trades dirty fossil fuels, their volatile prices and resource conflicts, with the efficient use of clean renewables that will improve in coming decades to provide energy for people everywhere the wind blows and the sun shines. Our current energy system is struggling to meet increasing demand as our biggest source, oil, has a diminished capability to provide for us. Such a point in history requires strong policymakers in the US and throughout the world who are ready and willing to step up and usher in a sustainable energy future.

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Dennis Markatos-Soriano is co-founder of Princeton SURGE, Students United for a Responsible Global Environment, and 2008 Master in Public Affairs Candidate with a Certificate in Science, Technology & Environmental Policy at the Woodrow Wilson School of Public & International Affairs at Princeton University. www.princeton.edu/~surgers