The high price of cheap oil

Declining oil prices are supposed to have a balanced ledger of winners and losers, Cobb writes. But we may be on our way to finding out that in the long run we will have a much larger list of losers than winners.

As a consumer of oil, you may regard recent sharp declines in the world oil price as a blessing. But...

If you work in the oil industry, you will not.

If you work in the renewable energy industry, you will not.

If you work in the energy efficiency business, you will not.

If you work to address climate change, you will not.

If you have investments in the oil industry (and nearly everyone does through pensions or 401k plans), you will not.

If you live in a country that exports a lot of oil (not just Saudi Arabia, but Mexico, Canada and Norway, too), you will not.

The declining price of oil is supposed to have a balanced ledger of winners and losers. But we may be on our way to finding out that in the long run we will have a much larger list of losers than winners.

And, the list will lengthen if the price continues to fall, and especially if it stays down for a long time. (Low prices are not necessarily an indication of future abundance. Remember that oil reached $35 a barrel at the end of 2008 before returning to record average daily prices in 2011, 2012 and 2013.)

Now here is something to contemplate. Is the price of oil falling because we can no longer afford it? This is not an idle question. Record high average daily prices for oil in the last three years have been an unrecognized cause of sluggish overall worldwide economic growth. That subpar growth appears to be exhausting itself now, particularly in Asia and Europe. In dampening growth, high oil prices sewed the seeds of their own demise by ultimately dampening demand.

 

But, low oil prices will make it even harder to secure future oil supplies. The oil industry was already cutting back its exploration budgets before the price plunge. The industry said that there were not enough profitable prospects available even at $100 per barrel. What happens to industry exploration and development budgets with oil prices now around $60? Without exploration there can be no new production; and without new production, oil supply falls automatically.

Now, exploration and development are not being cut to zero. But they are being cut substantially. And, as with any mineral exploration, there is no guarantee of success--even less so with cutbacks. With existing oil production worldwide declining around 4 to 5 percent per year, the industry already had a huge task keeping production growth just barely positive. Now, that will be almost impossible if oil prices remain low.

What that means is supply will likely stagnate or even shrink. Barring a deep and prolonged economic slump now (which would send oil prices even lower and keep them there for some time), as demand for oil reignites, we're setting up for another big price spike later that might then send the economy off a cliff into a serious slide.

For now, those in the renewable energy business are finding it more difficult to be competitive with lower-cost oil. Energy efficiency business owners must tell their clients that many efficiency measures will have a longer payback period while oil prices stay low. Both these outcomes send us in the wrong direction.

And, there is climate change. When petroleum products are cheap, there is less incentive to use them parsimoniously. All things being equal, that means more oil products are burned which produces additional greenhouse gas emissions.

Now, regarding the financial consequences of low oil prices, one could say, "Well, if you've chosen to work in the oil industry or if you've staked your whole country's future on the price of oil, then that's just your tough luck. Some of the wealth that flowed to you is now going to start to flow back to me."

And therein lies a problem. If that money flows too quickly away from the oil industry and the major oil exporters, it could create a financial cascade in the debt markets, in the world's stock markets, in the currency markets--oh wait, it already has. The question is how far will these disruptions carry, and will they cascade in a way that leads to a recession or depression.

One can be passive in the face of such events. But, a smarter plan would be to implement something along the lines I proposed last week--an oil tariff that keeps prices high and so keeps renewables and energy efficiency attractive. In fact, a system that keeps all carbon-based fuels high-priced would do more to move the world toward a sustainable energy system than all the current renewable energy subsidies combined. And, it would prevent the kind of price manipulation now engaged in by OPEC from wrecking havoc on any plan to move toward a renewable energy society.

It is just such disruptions in the fossil fuel markets that make us believe things that aren't good for us--that we can somehow burn cheap oil and forget about climate change. That cheap oil will go on forever. That cheap oil is a sign that the marketplace solves all problems (rather than creating new problems that it can't solve by itself).

We can celebrate lower gasoline, diesel and heating oil prices now. But like any overindulgence, we will pay for it later. When a pusher offers a junkie a discount on his drugs, we shouldn't take it as an act of kindness.