Matt Ridley, 09 February 2016

The continuing plunge in the price of oil from $US115 a barrel in mid-2014 to $US30 today is really, really good news. I know just about every economic commentator says otherwise, predicting bankruptcies, stockmarket crashes, deflation, political turmoil and a return to gas guzzling. But that is because they are mostly paid to see the world from the point of view of producers, not consumers. Yes, some plutocrats and autocrats won’t like it, but for the rest of us this is a big cut in the cost of living. Worldwide, the fall in the oil price since 2014 has transferred $US2 trillion from oil producers to oil consumers.

Oil is the largest and most indispensable commodity on which society depends, the vital energy amplifier of our everyday actions.

The value of the oil produced every year exceeds the value of natural gas, coal, iron ore, wheat, copper and cotton combined. Without oil, every industry would collapse — agriculture first of all. Cutting the price of oil enables you to travel, eat and clothe yourself more cheaply, which leaves you more money to spend on something else, and gives somebody a job supplying that need, and so on.

Sure, the low oil price is partly a symptom of a weak global economy (and a mild winter), and, yes, it has probably overshot so that many producers and explorers will go out of business, making some rebound in the oil price inevitable. Plus, it has utterly discredited the public finance plans of the Scottish Nationalists who would be presiding over a cold version of Venezuela now if they had persuaded Scotland to vote for independence. But lower energy prices will boost living standards.

The shale revolution is the dominant reason for the fall. I know columnists are not supposed to say I told you so, but I did: “Oil prices look set to fall as America exploits a shale cornucopia,” I wrote here in 2013, when the price was persistently high: “Shale gas is old hat; the shale oil revolution is proving a world changer.” This was at a time when pessimistic predictions that we had reached “peak oil” were still widespread, and many thought oil prices would rise even further.

A combination of horizontal drilling and much improved hydraulic fracturing, first developed for shale gas, then adapted for oil, has unleashed a gusher from North Dakota and Texas in particular. It has taken the US right back to the top of the oil-producing league, reversing a 30-year decline (of almost 50 per cent) in just three years. This is one of the most momentous innovations of the modern world.

The Price of Oil, a book by Roberto Aguilera and Marian Radetzki (fellow and professor of economics at universities in Australia and Sweden respectively), predicts that this shale revolution has a long way to go. Although the current low oil price is bankrupting many producers and explorers in North Dakota and elsewhere, and many rigs are now standing idle with jobs being lost, there has only been a very modest fall in production.

That is because the technology for getting oil out is improving rapidly and the cost is falling fast, so some producers can break even at $US30 or even $US20 a barrel and it takes fewer rigs to generate more oil. It is one of the cruel features of innovation that it usually benefits the consumers more than the inventors.

This means the shale industry can now put a lid on oil prices in future. Aguilera and Radetzki argue that not only is the US shale industry still in its infancy, but that there is another revolution on the way: when the price is right, conventional oilfields can now be redrilled with the new techniques developed for shale, producing another surge of supply from fields once thought depleted. They also expect that other countries — beginning with Australia, Argentina, China and Mexico — are ripe to join the technology revolution begun in American shale.

As a result, they calculate that, barring political crises, the oil price could well stay low till 2035 — about $US40 to $US60 a barrel in today’s prices. This is in sharp contrast to both the International Energy Agency and the US Energy Information Administration, which forecast an oil price in 2035 of $US128 and $US130 respectively. As Aguilera and Radetzki point out, the shale revolution has repeatedly made fools of forecasters, who persisted until very recently in seeing shale oil as a flash in the barrel.

Why is the price of oil so volatile? I thought I knew the answer — scarcity and OPEC — till I read Aguilera and Radetzki. They make the case that depletion has never been much of a factor in driving oil prices, despite the obvious drying up of certain fields (such as the North Sea today). Nor did OPEC’s interventions to fix prices make much difference over the long run. What caused the price of oil to rise much faster than other commodities, though erratically and with crashes, they argue, was the confluence of two factors.

First, there was a wave of nationalisation in the oil industry beginning in the 1960s. Today some 90 per cent of oil reserves are held by nationalised companies. ExxonMobil and BP are minnows compared with the whales owned by the governments of Saudi Arabia, Venezuela, Iran, Iraq, Kuwait, the United Arab Emirates, Nigeria and Russia. Post-colonial nationalisation affected many resource-based industries, but whereas many mineral and metal companies were privatised in the 1990s as their grotesque inefficiencies became visible, the same has not happened to state oil companies.

The consequence is that most oil is produced by companies that are milked by politicians, and consequently starved of cash (or incentives) for innovation and productivity. Lamenting “politicians’ extraordinary ability to mess things up”, the two authors note “the severely destructive role that can be played by political fights over the oil rent and its use”.

If politicians don’t get in the way, and we have two decades of relatively cheap oil, it will be bad news for petro-dictators, oil-igarchs, Islamic State thugs, and the promoters of wind power, solar power, nuclear energy and electric cars. But it is good news for everybody else, especially those on modest incomes.

The Times

Extracted in full from The Australian.

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