The Oil Shock that Never Was

The price of oil was supposed to skyrocket after September 11 th due to political instability in the Middle East. Instead, it has dropped by 30% to under $20 a barrel, the lowest level in two years.

This drop is due to three causes. First, recession has hit certain high oil consumption sectors such as air transport hard and so demand for oil has gone down. Second, American policy has (until now at least) avoided an open confrontation with the countries of the Persian Gulf; and Afghanistan, thank God, is not an oil producer. Third, Russia, coming out of its post-Soviet crisis, seems decided to continue expanding of its own oil production, despite its recent sop to OPEC.

But this short-run fall in the price of oil should not let us lose sight of the long-term political problem; namely the fact that the major part of the present oil production is concentrated in countries governed by autocracies which use oil resources to maintain repressive patronage regimes, finance extravagant consumption by the elites, and acquire a terrifying amount of arms. The existence of the enormous oil revenues and their unequal distribution are a continuous source of internal instability and external aggressiveness, as demonstrated by Iraq's recent history.

So is it our destiny that the scarcity of oil and its concentration in the Middle East remain a permanent source of global uncertainty? Not necessarily. In reality, there is now in a global abundance of oil and a great part of it can be found in one of the most stable countries on the planet: Canada.

In the last 20 years, the cost of Canadian oil extracted from non-conventional fossil deposits has dropped by more than half, and now stands at $11 a barrel. In 1997 a study by the American government estimated that it is possible to produce more than 500 billion barrels of oil from non-conventional sources (``shell oil'' and ``tar sands'') at less than $30 per barrel. The non-conditional reserves of oil are equal to about 250 times the conventional reserves and in theory could satisfy world energy needs (at today's levels) for the next 5000 years.

For now the non-conventional reserves are for the most part unexploited because they are uncompetitive on price with conventional oil and other sources of energy, such as natural gas. Perhaps it will never become necessary to use these reserves of non-conventional fossil fuel, if the development of alternative technologies (for example, liquid hydrogen) should render oil obsolete. But non-conventional oil reserves exist, and if one adds to it that the conventional reserves are sufficient to cover world consumption needs for the next few decades, it is clear that the problem of oil is not its scarcity. The problem is that production nowadays is concentrated in an area that is politically and economically unstable.

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Certainly, oil reserves are not infinite. But there is no reason to think that they are becoming more ``scarce.'' If anything, technological innovation and new discoveries are reducing the importance of oil in the productive process. The price of oil, corrected for inflation, in the last decade has not increased, and, despite all the ``oil shocks'' the world has seen, its price has, on average, oscillated around a price not much different from today's prevailing price.

Indeed, oscillations in the price of oil do not reflect ``structural'' scarcity in the long term, but are due to movements of demand and supply in the short and middle run. In the short run, the demand for oil is ``inelastic,'' that is, it responds little to changes in price, and even small reductions in supply result in great price increases. In the middle run, high prices lead to expansion of supply and reduced demand, and the price comes down again. At that point producer countries - which depend on oil revenues to maintain consumption, political power, and patronage - try to raise prices by cutting production, and the cycle resumes.

This process increases political instability in producing countries and involves them in a vicious circle. When the price of oil is high, their governments spend the money on arms and palaces fit for Pharoahs. When the price of oil falls, they risk discontent, coups d'états , wars, and revolutions.

In sum, the oil market does not have a problem of ``scarcity,'' as much as one of ``volatility.'' As noted by former Saudi oil minister Sheik Yamani, sooner or later the age of oil will end, but not because of a lack of oil; much as the Stone Age did not end because of the lack of stones.