At the end of last year I predicted that the price of oil would go down; so far I have been terribly wrong. My prediction, shared by many other economists and energy experts, was premised on a reasonable assumption: Since the world was headed for an economic slowdown, brought about the housing bubble and the financial crisis, global demand for energy would likely moderate, putting downward pressure on prices. While it was a sensible prediction, I am happy that no one took me up on my bet.
So what happened?
While many attribute the rapid price rise as validation of the “peak pil” theory, there is simply no way right now to disentangle all the forces influencing energy markets. The peak oilers may be right, but there are other significant forces at work. There has been large-scale political instability in major oil-producing countries (Iraq, Iran, and Nigeria) and the role of speculators is still not fully understood. Perhaps even more importantly, the majority of the world’s oil is controlled and produced by essentially authoritarian powers, many of whom are using oil proceeds to line their pockets and for short-term political gain, instead of reinvesting in their oil sectors. The reality may be that there is plenty of oil in the ground, but not the production capacity to extract it at a faster pace.
Bottom line: No on really knows what’s going on. Yes, the demand from India and China is rising, but not at a greater pace than it was a couple of years ago. Of all the markets I have studied over two decades, I have never seen so many smart people unable to agree on the causes of such a major economic phenomenon.
So what will happen to oil and energy prices in the future? I have no idea. Arguments for even further price rises seem as reasonable as those that predict a steep decline in prices over the next couple of years. We are truly in unprecedented times since global slowdowns have never been met with such commodity price inflation before.
What I do know is that what we are going through represents one of the greatest policy failures of a generation. Economists and other policy makers have for decades been calling for a gradual increase in energy taxes to help America transition to a less energy-intensive economy. Democrats and Republicans alike have opted for political expediency and missed opportunity after opportunity to get the American people on board (Clinton when oil prices were at record lows and Bush II after 9/11).
The worst of all possible scenarios has now come to pass: We are witnessing a massive transfer of wealth from America (and the Western world) to autocratic regimes that are openly or indirectly hostile to our interests; because of the suddenness of the price increases, people are feeling real and pronounced economic pain; and because the price increases have not come from higher taxes on energy, pollution-intense sources of fuel such as the Canadian tar sands are now booming.
But a paradigm shift is underway.
Americans for the first time in decades are driving less, sales of SUVs are plummeting, new investment in alternative energy and new technology is booming, and the average consumer seems to finally get it that conservation is not just a personal virtue but should be the basis for sound policy (even though they also now favor increased drilling too).
At the end of the day, the fundamental economic prediction always turns out right: Higher prices lead to changes in behavior. We are just now witnessing the tip of the iceberg of what will be a radically different world with respect to energy usage over the coming decade. It may not yet be the “end of oil,” but hopefully the beginning of the end.