Oil price developments over the past 40 years have been truly spectacular. In constant money, prices rose by almost 900% between 1970-72 and 2011-13 (Figure 1). This can be compared with a 68% real increase for a metals and minerals price index, comprising a commodity group which like oil belongs to the exhaustible category.
In our view, a number of political rather than economic forces have shaped the inadequate growth of upstream oil production capacity, the dominant factor behind the long run upward price push. The resource curse, represented by domestic and international conflicts over the oil rent, is probably the most important explanation to the extraordinary price developments.
We believe the period of excessively high oil prices has now come to an end. The international spread of two revolutions, described below, will assure much more ample oil supplies and persevering prices far below those experienced over the past decade.
Figure 1: Price indices 1970-2014 in constant money*, 1970-1972 = 100
The shale and conventional oil revolutions: low prices ahead
Beginning less than ten years ago, the shale oil revolution – employing innovations in horizontal drilling and hydraulic fracturing – has turned the long run declining oil production trends in the US into rises of 73% between 2008 and 2014. The shale oil costs become broadly competitive at oil prices of $50 per barrel. An exceedingly high rate of productivity improvements in this relatively new industry promises to strengthen the competitiveness of shale output even further.
The US lead in the shale revolution has many explanations, including large-scale and long-lasting conventional oil exploitation, a well-developed infrastructure, many small adventurous prospecting and production enterprises, a relatively sympathetic public approach to the industry, and the incentive to the landholder of underground resources ownership.
A series of environmental problems related to shale exploitation have been identified, most of which are likely to be successfully handled as the infant, “wild west” industry matures and as environmental regulation is introduced and sharpened.
Geologically, the US does not stand out in terms of shale resources. A very incomplete global mapping suggests a US shale oil share of no more than 17% of a huge geological wealth widely geographically spread. Given the mainly non-proprietary shale technology and the many advantages accruing to the producing nations, it is inevitable that the revolution will spread beyond the US.
We have assessed the prospects of non-US shale oil output in 2035, positing that the rest of the world will by then exploit its shale resources as successfully as the US has done in the revolution’s first ten years. With its 17% share of global shale resources, the US in 10 years expanded its output by 3.9 mbd. Assume, then, that the rest of the world is equally as successful as the US was between 2004-2014 in exploiting its share of the resources between 2015-2035. This would yield rest of world output of 19.5 mbd in 2035, which is similar to the global rise of all oil production in the preceding twenty years – a stunning deduction with far-reaching implications in many fields.
Another related revolution is beginning to see the light of the day, but news about it has barely reached the media. It is being gradually realized that the advancements in horizontal drilling and fracking can also be applied to conventional oil extraction. Several basins in the US and other countries are already experiencing this new phenomenon, which we call the conventional oil revolution. In a similar fashion to the output projections for shale oil, we assume that conventional oil in the rest of the world is able to benefit from the application of shale extraction methods just as US conventional oil did. This would yield a further addition of conventional oil amounting to 19.7 mbd by 2035.
The oil output increases are bound to have a strong price-depressing impact, either by preventing price rises from the first-half 2015 levels, averaging some $57 per barrel (Brent spot), or by pushing them back to these levels if an early upward reaction takes place. Our optimistic scenario, which appears increasingly likely, sees a price of $40 by 2035. The price implications of the revolutions will in turn influence many other conditions that shape human life, be they economic, political, diplomatic or military.
Global implications for the macroeconomy, the environment and for politics
The global spread of these revolutions and the ensuing price weakness that we envisage for the coming two decades will, on balance, provide a great advantage both to the oil industry and to the world economy at large. Successful shale and conventional oil developers could reap benefits similar to those bestowed on the US in its progress in recent years.
Not surprisingly, there would be important negative repercussions on public income from oil in producing nations that fail to compensate for the effects of the oil price decline by expanding output with the help of the revolutions. Juxtaposed against this conclusion is our supposition that the effects of the resource curse will be ameliorated as prices decline.
The two revolutions will apparently cement and prolong the global fossil fuel dependence, with implications for climate policy. At the same time, the expansion and cheapening of natural gas in consequence of the revolutions will make it possible to shrink coal use in power production, thereby reducing CO2-emissions, as is already evident from the US experience since some years. The efforts to develop renewables for the purpose of climate stabilization, however, will become more costly, requiring greater subsidies, in consequence of lower fossil prices.
The abundance caused by the revolutions will lead to hard to fathom changes in international political relations. We assert that much of the oil importers’ urge for political intervention and control will dissipate as the criticality of access becomes less urgent with normalization of profit levels and more ample and diversified oil availability. For instance, the heavy diplomatic and military presence of the US in the Middle East is likely to be questioned when the country’s dependence on oil from the region is further reduced. The growth and geographical diversification of supply would not only suppress prices, but would also promote competition among suppliers and make it more difficult for producers to use energy sales in pursuit of political ends.
Author biographies
Marian Radetzki is Professor of Economics at Luleå University of Technology, Sweden. He has held visiting professorships at Colorado School of Mines, and at Pontificia Catholic University of Chile. In the 1970s, he worked as Chief Economist at the International Copper Cartel, and has undertaken numerous consultancies over the years.
Roberto F. Aguilera is an adjunct research fellow at Curtin University, Australia, and an associate of Servipetrol Ltd., Canada. He has participated in numerous energy studies, including with the World Petroleum Council, US National Petroleum Council and UN Expert Group on Resource Classification.
Their new book, The Price of Oil, will be published by Cambridge University Press in October 2015
The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of The Economist Intelligence Unit Limited (EIU) or any other member of The Economist Group. The Economist Group (including the EIU) cannot accept any responsibility or liability for reliance by any person on this article or any of the information, opinions or conclusions set out in the article.
