Common Tragedies

Thoughts on Environmental Economics

Shocking news: oil is in demand

Posted by Evan Herrnstadt on November 9, 2007

The International Herald Tribune notes today that the world is undergoing its first demand-led oil shock:

Unlike past oil shocks, which were caused by sudden interruptions in exports from the Middle East, this time prices have been rising steadily as demand for gasoline grows in developed countries, as hundreds of millions of Chinese and Indians climb out of poverty and as other developing economies grow at a sizzling pace.

Why is this different from oil shocks of the past? Because those were caused by geopolitical conditions in isolated (if important) shares of the market. However, when those sticky diplomatic situations cleared up, oil prices at least came down to some extent as supply resumed.  We now find ourselves in a situation with no easy policy response.  It seems unlikely that someone will suddenly discover enough new oil to significantly reduce prices:

Some analysts see [oil prices] falling next year to $75, or even lower, while a few project $120 oil. Virtually no one foresees a return to the $20 oil of a decade ago, meaning consumers should brace for an era of significantly higher fuel costs.

Even if we start really going at tar sand extraction and enhanced recovery, these are surely producing the marginal barrel of crude. Hence, these more expensive methods will be setting the global market price. Although oil price projections are notoriously inaccurate, the situation is clear to Thomas Bentz of BNP Paribas:

“Oil will stop rising when we see demand destruction. We haven’t seen that yet.”

Hmmm…demand destruction. How are we going to see this in this era of industrialization and development of Chindia? Well, prices may go high enough that substitutes, e.g. biofuels, become cost-competitive. Or we could slap that price on carbon, which would reduce oil demand the old-fashioned way. However, that would only reduce the base price, not the price faced by consumers. Increased efficiency has to be part of the solution. However, we may just have to face up to the reality that this golden age of fossil fuel-powered prosperity is gradually becoming a bygone era.

Although I do love to predict doom without suggesting solutions, I also just figured that there are plenty of earlier posts pertaining to the pros and cons of policies such as carbon pricing, RPS, and R&D policy.

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