Riding the Petroleum See-Saw

By David L. Brown

This is a followup to my recent essay “An Embarrassment of Oxymorons,” in which I made the point that going forward petroleum would either be priced higher, or would not be available at all. I explained that as an example of why it doesn’t make sense to hold onto past economic models beyond their use-by date.

Right now everyone is delirously happy that gas prices have fallen back to affordable levels. Everyone, that is, except the oil producers. There is no joy in the Land of OPEC. In fact, in oil producing nations economic disaster has resulted from plummeting oil prices.

The sad fact is that oil is no longer cheap to produce, and the economies of countries such as Saudi Arabia, Iran, Russia and Venezuela were riding high on expectations of petroleum prices well in excess of $100 a barrel. Now that those prices have dropped to about half that, those economies are crashing. In Russia, the stock market has dropped by 70 percent. In Dubai, until just weeks ago the shining example of Arab economic ascendancy, property values have plummeted by 80 percent. In Iran, civil unrest is spreading and the possibility of a second revolution is not unlikely.

Yes, it is a nice thing that gas prices are down around $1.60—but unfortunately we cannot expect them to stay there. What the roller coaster petroleum market of 2008 has demonstrated is that the world economy cannot support $100+ oil prices. Some analysts predict that prices will settle even lower, perhaps to $30 a barrel in the near future, and some radicals have even predicted oil prices in single digits.

That will not happen, and for a simple reason. Supply and demand is one factor in setting prices of commodities, but another thing that comes into play is the strike price between buyer and seller. Sellers will not for long sell at below their cost, for to do so means losses. When the demand of consumers is for a low price, and the cost of delivering that commodity is higher, perhaps far higher—the supply will simply dry up. The leverage of supply and demand hits a stop when prices are below production costs. (There is no such hard ceiling at the top end; a commodity will bring whatever consumers are willing to pay, although price resistance is an equally hard limiting factor.)

As I pointed out in the essay on oxymorons, oil producers are faced with a lose-lose situation. The more oil they produce at a loss, the more their economies suffer. If, on the other hand, they stop production altogether—their economies will also suffer. There is no wiggle-room for them.

Right now, they are desperate for all the revenues they can get, and thus continuing to pump oil. But this situation cannot continue, and the longer we enjoy low gas prices in the First World, the more the economies of oil producing nations will suffer. There will be serious declines in standards of living, possible famine. National treasuries will begin to be depleted to make up the shortfall in expected oil revenue.

Iran is an excellent case in point. Not too long ago they were boasting that they would soon be rolling in the dough from oil prices in the $150 and even $200 range. They based their national economy on those expectations. Now they are desperately attempting to re-figure their budgets based on a projection of $30 oil. Talk about a come down! And other nations that were high-flyers just a few months ago are facing similar economic disaster.

So enjoy the low gas prices while you can, because it cannot continue. But neither will we likely see $150 oil prices. As the present low prices cause demand to edge up, and oil producers shut down their wells to avoid making a loss on every barrel they produce, supply and demand forces will push oil back to higher levels.

What we have seen this year is a see-saw effect, with oil prices swinging the world economy first one way, then another. We will see more swings, but the trend will be toward reaching a midpoint between the greed of the oil producers and the ability of consumers to pay.

In rough terms, it seems that what the consuming public wants is oil in the $40-50 range. What the producers need is in the $80-100 range. Nobody is going to be deliriously happy about this, because nobody is going to get what they want. However, If oil settles around the $90 level, for example, it will not be the kind of disaster that $150-200 oil would be.

With oil in that range, we could expect to pay something like $2.50 a gallon for gasoline. That is not the greatest thing to look forward to, but it beats paying twice that or more, a price point that has been demonstrated to be unacceptable to consumers.

At slightly above production costs, the oil producers can make a few dollars, but they won’t be rolling in trillions of dollars extorted from the West. They’ll find they will have to cut back on their national goals, and that will be a good thing for the world since all too many of them Muslim nations lean toward using excess oil profits to finance jihad against their customers. (What a concept!) Nor will they be able to use their pumped-up national treasuries to buy up Western properties and companies.

The present prices are too low to stimulate the kind of serious attention to the development of sustainable energy alternatives that we need. The highest prices earlier this year were so high that they threatened (and may have succeeded) to break Western economies. Some midpoint in the high double-digits would provide the incentive for major efforts in solar, wind, tidal, geothermal and any other technology that could begin to wean us from the addiction to petroleum. And that will be a good thing.

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