Iron Denominator - The Price of Oil

Is oil too expensive or too cheap? Arguments abound on both answers.

The expensive side of the argument says that high oil prices retard growth, which overwhelmingly hurts the poor - both domestically and internationally. Therefore, we should cut consumption to reduce the price of oil and aid the development of the third world.

The cheap side of the argument says that high oil prices are what is needed to spur developments in fuel-efficiency and alternative energy supplies. Therefore, we should tax gasoline to encourage conservation.

You can see that both arguments share some goals, but I'd like to suggest that the real answer is neither. Oil is neither too "cheap" or "expensive", but rather it is far too profitable. Even at $30/bbl, the actual cost of production and shipping for conventional (non-arctic) oil is probably less than $10. A $2 profit for every $1 invested is a hefty return indeed. It would probably not be inaccurate to say that oil exploitation is the most profitable human activity in the legal economy.

This, then, is why huge companies like Shell, Exxon and others - who could, in a second, solve the world's energy problems with a small percentage of their revenues - don't yet devote substantial resources to renewable energy. Wind and Solar have come down in price, true, but even if your hydrogen-powered car cost the same to build and fuel, it still probably wouldn't be as profitable oil.

This explanation neatly avoids the assumption (which I still share) that the oil companies of the world are evil. They don't have to be - they're just rationally self-interested. What would you do with a billion dollars? Build a factory to put out cheap solar panels, which might make you a 3% profit every year? Or, in one swoop, triple your money by buying and reselling oil?

Now, as we approach Hubbert's Peak (This year? The next? 2010?), we'll see a marked increase in the cost of production of oil globally, but many individual fields won't approach their peaks for a decade yet. These fields are likely to be dominated by the largest of the oil companies, meaning that many smaller players will have to find other things to do with their money. As the cost of production increases, some - though not all - of that cost will eat in to the profitability of oil. This is when we can expect renewables to really take off - not when they're cost-competitive with fossil fuels, but when they're profit-competitive.

So, if we peak sometime this year, as ASPO predicts, and the cost of production begins to rise quickly after that, I think we can expect the capital markets of the world to start putting serious money in to solar, wind and hydrogen by 2015. Maybe sooner, depending on how Asia turns.

This could be called the "optimistic" scenario, I suppose - another decade of rapacious oil and coal use before we even begin to mend our ways.