The beginning of the end of the oil age

The price of oil is set to fall, says Robin Jackson, but other newer technologies are already set to take its place.

With fuel prices in both the UK and US at record levels there would seem to be no end to the upward march in the price of a barrel of crude oil. Despite falling back from its recent flirtation with $100 a barrel, the general consensus is that black gold will drive through $100 a barrel to maybe as high as $150 a barrel. These predictions
are wrong. The opposite is on the cards. The fundamental principles of supply and demand indicate that current prices are not only unsustainable but already too high.

Let us consider the reasons for my prediction about the price of oil in the immediate future. First let’s take supply. There are abundant supplies of oil in storage tanks around the world, standing at a near all-time high of 4.2 billion barrels. This is the equivalent of about three years of the total output from Iran in the unlikely event of a
disruption in supplies due to a war or other conflict that stopped Iranian exports.

There are massive supplies of oil underground too. According to BP, the world’s known reserves of crude oil are now 12 per cent higher than they were 10 years ago. If you include tar sands of Venezuela and Canada, reserves stand at 3.1 trillion barrels. That is the equivalent of about 100 years of supply at current production rates.

The rate of extraction is increasing. High oil prices have encouraged new drilling. There are 45 per cent more oil rigs in service today than only three years ago and new technology is also allowing producers to squeeze more oil out of old wells too, so prolonging their life.

The cost of production of a barrel of oil remains cheap. Shell estimates the average cost of extraction at $9 per barrel. In Saudi Arabia, with the world’s largest reserves of crude oil, extraction costs, estimated by Saudi Aramco, are about $5. Even in the most challenging of oil fields, Canada’s oil sands, for example, capital and extraction costs combined amount to no more than $30 per barrel.

So oil remains cheap to extract and both underground and above ground there are and will continue to be abundant supplies of oil. Now let’s consider the demand side. The current high price of a barrel of oil is driving consumers to reduce consumption and seek alternative fuels. Both US and Europe oil consumption contracted in 2006 and the major producers are now forecasting reduced growth in consumption for the foreseeable future.

Oil is looking expensive as a fuel and is now trading at 13 times the price of natural gas compared with its more usual six times. King Coal remains by far an even cheaper and abundant source of energy and is now, despite global warming concerns, making a comeback.

According to reports China is opening one new coal-fired power station every week. In the Americas more coal-fired generation capacity is being built than at any time in the past seven years. In Germany the utility company RWE is building three new coal-fired plants and Enel in Italy is converting three previously oilfired stations to coal and has plans to convert more. On current estimates the UK has 227 years of reserves of coal. Taking into account deep reserves, particularly those under the South North Sea, this number could easily be five to 10 times higher.

High oil prices and worries about global warming are also driving renewed interest in nuclear power, even in states such as Russia and Iran who have their own reserves of oil. High prices are also driving increased interest in new technologies such as wind, wave, solar energy and hydrogen. Growth is rapid and ambitious renewable energy targets supported by government subsidy have been set by many of the leading industrial nations.

Finally, the recent credit crunch is likely to spill over into the economies of the world and reduce if not eliminate GDP growth. High prices, a switch into alternative fuels such as gas, nuclear and coal and the rapid growth in new energy technologies are all contributing to a reduction in the demand for oil.

It is likely then, given these economic fundamentals of abundant supply and flat if not yet declining demand, that the current high price of oil is not only unsustainable at current levels but a significant downward adjustment is now overdue. It is highly likely that speculators are fuelling current prices and so it is not a time to be betting on ever-higher levels in the price of oil. Buyers must be cautious when buying oil futures.

Indeed, the high price of oil has triggered a set of irreversible activities to seek alternative energy sources and reduce consumption that would suggest that we are now at the beginning of the end of the oil age. Over time a range of cheaper and better technologies will substitute for oil in many aspects of our lives.

Eventually reserves will be left in the ground just as coal and tin have been in the UK. As someone once said, the Stone Age didn’t end because the world ran out of stone but because something cheaper and better came along. So it will be with oil.

Robin Jackson is CEO of ADR International

This article has been provided by ADR International, one of our global underwriters and network partners, and represents the views and opinions of that company. The Procurement Leaders Network has no involvement in the production of this article and its final content.