It has been over 160 years since a commercial quantity of ‘rock oil’ was found. Through much of that time, uses for its refined liquids gradually expanded, from lighting to fuel oil to gasoline and the automobile. Gradually petroleum became the energy source of choice, though coal and natural gas were large competitors. During World War II, the Allies recognized that control over oil reserves was critical to success on the battlefield, but it was not until the 1970s that the world realized that oil supplies and prices were now one of the determinants of prosperity.
In the early 2000s, a 15-year period of price stability was broken and the world went through a decade and more of gyrations in both oil prices and economic growth. The rise of US oil production to the point where that country may not become a net importer for a number of years has pushed the world’s producers into oversupply, just when many other producing governments have become extremely dependent on this revenue for various policy reasons.
Now, some 50 years after oil prices began to dominate world thinking, the broader situation is starting to change. First, we are starting to slide into what might be called ‘the electric economy’. By this, I mean that the core economic form of energy is electricity and its production is coming from sources that are more diverse than ever before. Here are some examples.
Across the economy, social function after social function is being subsumed into the broad internet. We see this most obviously in terms of communications, such as cellphones and products like Facebook, Twitter, Netflix and video streaming. The wired world also is expanding into production via 3D ‘printing’, into automobiles, both in terms of electric vehicles and in terms of the electronics that govern steering, braking and even actual driving. Now there are discussions of the ‘internet of things’, where household functions, such as heating and refrigeration, may be linked to programmed responses. Such an economy may still use petroleum products, but not in the intensive manner as, say, in the 1970s.
Of course, a lot of electricity is generated by petroleum products, but even here, there is change in the works. Alternative energy sources, such as wind and solar, have grown 20-fold from a small base over the past 20 years while oil production has grown 25%. The World Energy Organization expects energy alternatives to grow another 4-fold in this decade, while petroleum production increases 18%. The price for electricity from some solar and wind sources is now competitive with some coal and oil-produced electricity, even without subsidies.
The relative size of today’s production from all these sources is not the question to ask. What is important has to do with congestion theory. It does not take much change in the number of drivers trying to cross a crowded bridge to go from a free flow of traffic to a traffic jam. Similarly, it does not take a large injection of technologically sophisticated alternative sources to cause a kind of energy ‘traffic jam’ where oil production growth falters as alternatives prove economic and prices stay low for a long time. While the present price decline might interfere with new installations of relatively expensive alternative energy facilities, the technological forces behind the industry will continue to search for more cost efficiencies to be deployed when next the oil price rises, as it did after the travails of the 2020-22 Covid emergency and its aftermath.
There is another subtle force at work in the global economy that hardly existed when oil prices rose around the turn of the19th century. That is the spread of aging demographics in nearly all developed countries. As larger proportions of people in Europe, Russia, Japan, Canada and Australia—and soon China— begin to retire, their incomes will decline. Pensions as a rule do not pay as well as salaries. These pensioners will either cut back on consumption or will dis-save to replace the missing income. In both cases, the prospect of deflation emerges. Rather than declines from oversupply at high prices, prices decline because structural demand declines. Japan has been in this situation since the mid-1990s and the rest are following. Again, it does not take a large proportion of the population to reduce its consumption to create deflation. We have no idea how to live with deflation.
Energy requirements in many economies are also affected by the continuing dissociation between GDP growth and energy usage. This has been going on for decades, but when it is combined with the deflationary effects of demographic change, it can affect energy pricing. Given the need to choose between a tank of gasoline or access to Netflix, what shall a senior do? These things sound trivial on the surface, but if they affect nearly half the population in countries that consume most of the world’s oil production, they can really add up.
Finally, for as long as the US is able to be nearly self-sufficient in oil, or at most self-sufficient with the help of Canada and Mexico, the ‘almighty’ dollar is going to continue to be almighty again. Japan is trying to devalue the yen; other countries may imitate it, but no matter. The dollar will appreciate anyway and this will challenge the rest of the world’s producers and consumers. Oil is sold in US dollars and any generally serious appreciation in the dollar will lead to further pressures on producers to lower their prices. In fairness, lower oil prices will constitute an incentive to consume more over time.
All in all, the international arrangements that have characterized the ‘oil economy’ for the past 50 years are not collapsing, but they are beginning to crumble. Alternative energy technologies, the internet of things, aging societies and the rise of new production techniques in the United States have all begun to change the traditional arrangements around the production and sale of this commodity. There are other forces at work, such as the existence of huge shale gas fields in China, that should go into the new mix as well, but maybe we can come back to those later.
Old Professor by the Sea 