Worldwatch Perspective: The Meaning of $80 Oil

World oil production is unable to keep up with rising demand.
Photo by poorfish via Flickr

The price of oil hit its highest level in a quarter-century this week—and is now closing in on the inflation-adjusted record set in 1981. What’s so surprising, though, is not the high price of oil—at over $80 a barrel—but the timing of this price increase. Most economists predict that the world economy will soon cool, and autumn is usually the season when oil prices fall.

Short-term explanations for the price hike abound—from the latest interest-rate cuts in the United States to the latest hurricane in Mexico or the pipeline explosion in Iraq. Others blame the maneuvering of hedge-fund speculators. All of these can move oil markets, but none can explain the 200-percent rise in oil prices over the past four years.

For that, we must look to something more fundamental: demand and supply, with an emphasis on supply. Even with the accelerating demand for oil in China and the Middle East in recent years, world oil demand is still averaging less than 2 percent annual growth. But oil supplies are not keeping up with even that modest rate of increase.

When oil prices first began to soar in 2004, many experts were quick to dismiss the notion that limits on supplies had anything to do with it. Those who argued that world oil production would peak and begin declining within the decade were widely dismissed as apocalyptic know-nothings. Rather, oil prophet Daniel Yergin predicted that within a few years, the world would again be awash in oil.

World oil production is still going up, but growing evidence suggests that we are beginning to “feel” the ceiling. Production is falling in 33 of the 48 largest oil-producing countries, including 6 of the 11 members of OPEC. Among the major producers where output is now flat or declining are the United Kingdom, Indonesia, Mexico, Norway, and the United States—where production peaked 36 years ago.

Fueled with unprecedented profits and employing the latest technologies, oil companies are devoting extraordinary efforts to finding and producing oil. But they are now fighting geological realities—the remaining oil fields they are finding today are much smaller than the giant oil fields of the 1950s and 1960s that are currently being depleted.

Problematic geology is complicated by even more problematic geopolitics: roughly 80 percent of the world’s oil is now owned by governments rather than companies, and in countries ranging from Nigeria and Venezuela to Iran and Iraq, political problems are impeding the pace of exploration and development. This will likely delay the date of the global oil peak, but it will also likely cause it to peak at a lower level than it otherwise would.

According to a report released by Goldman Sachs this week, oil prices could reach $95 a barrel by the end of 2008. The Goldman analysts note: “The current market deficit is being driven more by supply shortages than by excess demand, which is why upside price risks are so high despite significant economic growth concerns.” And even the National Petroleum Council, chaired by the former CEO of Exxon, shifted its view in a report this July that predicted a looming shortfall in world oil supplies.

Christopher Flavin is president of the Worldwatch Institute, an environmental research organization based in Washington, D.C.

This story was produced by Eye on Earth, a joint project of the Worldwatch Institute and the blue moon fund. View the complete archive of Eye on Earth stories, or contact Staff Writer Alana Herro at aherro [AT] worldwatch [DOT] org with your questions, comments, and story ideas.