Will we see $3 gasoline before $5?
A: It certainly looks that way.
When I first posed this question in August, I began my answer:
A: "Who knows?" and "It doesn’t really matter." Much higher gasoline prices that are sustained for a long, long time are now inevitable. The fundamentals in the oil market are that we are in the beginning stages of peak oil. Supply can no longer keep up with demand, which has kept soaring even in the face of record prices.
In August, I had assumed that things had gotten as grim under President Bush as they could get. My bad. I did, however, point out:
In the short-term, I suppose it is possible that we can go back to $3 gasoline, although that would probably require a deep global recession, and prices would only stay low for the extent of the downturn.
But I didn’t think that would actually happen, as evidenced by my 401K. Nonetheless, the fundamentals of supply and demand mean prices are inevitably headed much higher in the medium term. A figure from a new CIBC report (PDF) makes that clear:
[Note: This is total world production of crude oil (excluding natural gas liquids).]
Even in the face of the staggering rise in oil prices of the last few years, production has barely budged. What about demand? As I noted in August, despite a sharp drop in U.S. oil consumption, “global consumption rose by roughly 500,000 barrels per day [PDF] (bbl/d) during the first half of 2008.” And that led me to the obvious conclusion that only much, much greater demand destruction can stop the inexorable rise of oil prices. And that obviously requires much higher prices than what we’ve seen in the first half of this year.
That conclusion remains true for the medium-term, but there is another way to get serious demand destruction in the short term — a major global economic slowdown. Given that people have started to use the D-word to describe where our current mess is headed, oil prices can clearly go lower and stay there awhile. If we assume, optimistically, that we avoid a true depression and only end up with a major recession, then the WSJ Environmental Capital blog has a good summary of new price projections:
Analysts and economists at BNP, Goldman Sachs, Toronto Dominion, and Bernstein Research have all said this week crude should be priced between $75 and $80 a barrel. Others, like Canada’s CIBC World Markets, think marginal production costs are the ticket, but that the floor price is a little higher, around $90 a barrel …
And historically, oil prices overshoot the marginal cost of production going up and coming down …
That will make OPEC’s emergency meeting next month in Vienna all the more interesting. If the cartel seriously cuts production to keep prices stable, it risks whacking the global economy while it’s down and destroying demand even faster. But if it keeps oil output more or less intact, history suggests, crude could plummet below $50 a barrel.
[Note to GOP: Drill, baby, drill.]
So even $2.50 gasoline is possible. We are obviously no longer "likely" to see $150-$200 oil by 2010, as Goldman Sachs projected in May, nor are we likely to see $7 gas by 2010, as CIBC projected in June, though CIBC may still be right we are due for "1970s style GDP growth."
Of course, betting on the market or oil prices in the short run is obviously a fool’s game. But the medium-term analysis remains unchanged. As Jeroen van der Veer, chief executive officer of Royal Dutch/Shell, e-mailed his staff in January, the world will peak in conventional oil and gas within the decade. He wrote: "Shell estimates that after 2015 supplies of easy-to-access oil and gas will no longer keep up with demand" (see "Shell: Conventional oil peaks within 7 years"). And the normally staid International Energy Agency warned in July of an impending oil and gas supply crunch "with OPEC spare capacity declining to minimal levels by 2012."
Disastrous economic policies cannot prevent peak oil or, rather, its terrible consequences, only very smart government policies can (see here).
Amid all this pessimism, let me end with one optimistic figure from CIBC’s must-read financial market update (PDF):