Washington, DC, June 13, 2006 --  

High oil prices are bringing ever closer the end of boom times for oil producing countries.

When historians look back on the more interesting trade patterns of the late 20th and early 21st centuries, perhaps one of the most fascinating oddities will be the bizarre dynamics created by the oil trade. For over a half century, billions of dollars in goods have been flowing from advanced countries to less sophisticated places where a sticky, black, flammable liquid pools beneath the surface.

In Dubai, a enormous, gleaming metropolis has risen in an unlikely spot where an inhospitable desert meets the sea. Its growth is based on the emirate's past oil wealth, and a continued massive flow of petrodollars from neighboring countries into its non-oil-based businesses.

The days of these unusual transfers of wealth are now within sight of the inevitable end. This may seem ironic given that record oil prices have recently accelerated the transfer of wealth, but it's exactly as expected. Scarcity of supply relative to demand has driven up oil's price, sending massive wealth to producers in a last great hurrah. Once oil stops flowing, terrible doom will befall countries that have been spoiled by years of money for nothing.

Experts have long argued about the exact time when oil production will begin to decline. Thinking on the subject started with a paper published by Marion Hubbert in the 1956, which is popularly referred to as "Peak Oil Theory."¹ The traditional methodology for predicting a date involves calculating the total reserves of oil in the world, and making a number of guesses about demand, the ability to extract the oil, new oil discoveries, and technological advances allowing access to hard-to-extract oil reserves. Based on such calculations, various prognosticators have said that the peak would come at anywhere from the late 1980s to the mid 2100s, with most settling on a date between the early-to-middle 21st century.

While experts agree that oil won't last forever, there are many critiques of peak oil predictions. Calculations of oil reserves are notoriously flawed -- many OPEC countries deliberately inflate figures about their oil reserves in order to get higher production quotas from the cartel. Perhaps more importantly, a static analysis of oil production capacity ignores changes in market conditions that provide incentives to develop replacement fuels for oil.

This is critically important, because market conditions have changed drastically in recent years. While Hubbert's theory focuses on the supply side, changes in today's oil market are driven by the demand side. Ever since China began coming out of its economic coma in the 1980s, its oil use has been growing drastically. China's oil consumption more than tripled from less than 2 million barrels per day in 1980 to 7 million barrels per day in 2005², and shows no signs of slowing down. Today, China uses far less oil than the United States, even though there are four times as many Chinese as Americans. Since the billion plus people in China strive for the same level of prosperity and energy-consumption as the West, Chinese energy demand will surpass that of America sometime in this century. The same is true for the billion plus people of India.

The important factor in the oil market, therefore, is not the supply side, but the demand side. There is very little chance oil producers will be able to keep up with this demand, because production would have to rise much faster than ever before. As a result, the price of oil is bound to remain high and go even higher until the inevitable end.

Some doomsdayers, believing in the static analysis of the Hubbert theory, predict a collapse of civilization. This will never happen. Since oil prices surpassed $50 then $60 per barrel over the last few years, a number of long-known energy technologies have started to become economically viable. Some of these involve extracting more oil, such as the gargantuan project to squeeze oil out of Canada's vast tar sands. Others involve replacement fuels, such as cellulosic ethanol and coal liquification.

While none of these technologies promise a near-term replacement for oil, market conditions that encourage serious energy research mean that viable large-scale alternatives are much more likely to be developed than before. The likely outcome is that a tight oil market will cause the commodity to be replaced with a higher-volume alternative long before oil ever runs out. Simply put, oil will be obsolete well before we ever have a chance to pump it all out of the ground.

Nobody knows how soon or how abruptly this change will come. But odds are the oil trade will be much less important to the world in the next few decades. Countries that have benefited from the mass transfers of oil wealth should enjoy their last hurrah. Soon enough, a slow decline or abrupt depression will arrive in places where wealth once came easily. For places like Dubai, where massive investments have been made in non-oil businesses, it remains to be seen whether the economy can survive the end of oil. Those who are curious will likely be rewarded -- most of us will live to see the answer for ourselves.

Notes:

1. Wikipedia, Hubber Peak Theory, as posted June 13, 2006

2. U.S. Dept of Energy, Energy Information Adminstration, Country Analysis Briefs: China, August 2005