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Foreign Affairs
Two Cheers for Expensive Oil
Leonardo Maugeri
Summary: Prices of crude oil are high these days not because oil reserves are waning -- in fact, they are plentiful -- but because inadequate refining capacity has limited the quantity of crude available on the world market. And high prices come with an upside: they could convince the oil industry to invest in new capacity.
Leonardo Maugeri is Group Senior Vice President for Corporate Strategies and Planning for the Italian energy company ENI and the author of the forthcoming book The Age of Oil: The Mythology, History, and Future of the World's Most Controversial Resource.
THE MARKET AT WORKWidespread fears of waning oil reserves are obscuring the real reasons for the cost of crude oil today. The truth behind high prices is mundane: they are the result of extreme economic processes, not geological limitations. The current "crisis" is being driven by the reduced availability of crude on the world market and the inadequacy of the oil industry's refining capacity. Both conditions were brought on by years of low oil prices, inadequate investment in infrastructure, and producers' fears of surpluses. Since 2003, the situation has been exacerbated by an unexpected increase in the global consumption of crude.
As market forces have kicked in, high prices have already started to generate more investment, which will boost both production and refining capacity in the future. In other words, high oil prices are a painful but necessary cure for the disease that has affected the oil market for about 20 years.
Still, the danger remains that prices could stay too high for too long, provoking a drop in demand just when new production and refining capacity start to come on-stream. This, in turn, could send prices spiraling downward and put an end to the current move toward greater investment, leaving the fundamental problems of the oil market unsolved. Such a development would delay needed changes in the consumption habits of industrialized societies and set them up for another crisis in the future.
NOT SO DRY
Despite all the predictions of impending catastrophic shortages, the world still possesses immense oil reserves. "Proven" reserves alone, more than 1.1 trillion barrels, could fuel the world economy for 38 years even at current rates of consumption. And this figure understates potential production, because the accepted definition of proven reserves includes only those reserves that can be exploited with currently available technology at conservatively projected prices. An additional 2 trillion barrels of "recoverable" reserves are not classified as proven but will probably meet that standard in a few years as technological improvements, increased knowledge of the subsoil, and the economic incentive created by higher oil prices (or lower extraction costs) come into play. Consider, for example, that only 35 percent of the oil contained in known oil fields worldwide can be recovered today with existing technologies and based on current economic fundamentals (up from 22 percent in 1980). Current estimates of recoverable supplies also ignore large deposits of so-called unconventional oil, such as ultraheavy Venezuelan oil and oil that can be extracted from Canadian tar sands. Moreover, huge areas of the planet have yet to be thoroughly explored.
In other words, what little is known about the world's underground oil resources justifies a positive view of the future, not the alarmist vision of oil catastrophists. The pessimists assume that the world has been fully explored, that neither the dynamic of crude prices nor technological progress has any bearing on the "finite" nature of oil resources, and that consumption is bound to increase more and more, inexorably depleting the existing oil stock. Their pseudoscientific fatalism, camouflaged with quasi-sophisticated models, has ...