Whatever Happened to Peak Oil?

As oil settles at one thin dime over $100, the question inevitably arises, "what happened to the oil crisis?" Wasn't oil supposed to get more and more expensive until we all had to ride horses? Dude, where's the oil shortage?

It's a fair question.

The answer, I fear, is that peak oil and the oil shortage are still very much with us. Even at $100 a barrel, oil is still up approximately 30% from where it was last year around this time. That's still quite an increase. But why is is going down at all?

There are several answers to this. First, that's what commodities tend to do. Market forces tend to kick in and over-correct for large price movements. If the price of widgets plunges 40% one year, people tend to buy more widgets and producers cut back on production. So a year or two later, widgets are likely going to be more expensive than they were before the widget crash began.

When oil got expensive, most of the low-hanging conservation fruit got picked. People checked their tire pressure, traded in those SUVs and bought economy cars, moved closer to the office, and so on. The economy itself wilted, reducing oil demand.

Other factors intervened, too. While oil production overall has peaked, most oilfields have marginal wells that are turned off when oil prices are low, but switched on when prices rise. Oil speculators also sensed the ride was over, and sold off oil futures. Some also believe the Bush Administration pulled some strings with the Saudis to get them to squeeze out some extra production to bring oil prices down in time for the election. I'm not going to say I necessarily believe that last item, but it wouldn't surprise me; his entreaties to the Saudis last spring are on the record.

So add all that together, and oil came partway back down. However, the forces that led to the last run-up in prices are very much in place. China, India and other developing countries are continuing to demand more oil. We continue to burn several times as much oil as we discover. More and more countries are shifting from being oil exporters to oil importers; Indonesia didn't bother to renew its OPEC membership because it now uses more oil than it pumps from domestic wells.

The difference is that, the next time a supply pinch occurs, we're going to have a harder time reducing demand. We've already traded in many of the SUVs, and otherwise taken the easy steps to conservation. And at some point, I'm sure we'd like the housing correction to end and for the economy to grow again...when it does, that means more oil consumption and higher prices. Of course we don't want to have to endure a recession every time oil prices go up just to get gas down below $4 a gallon.

But in the absence of vigorous conservation elsewhere, that's exactly the scenario we're looking at. And it gets worse from there: if production continues declining, we'll reach the point where even a recession won't tamp down demand for oil enough to bring prices below nosebleed levels.

The bottom line: don't be fooled. And for goodness' sake, don't start thinking it's safe to buy SUVs again. This is a temporary lull. If you started making plans to trade in for a more fuel-efficient vehicle but are wavering because you see gas prices falling, stay the course and make the trade. A few months or a year from now, you'll be glad you did.