All about oil

The amount of hysteria and hype over oil is amazing. A newspaper headline today breathlessly warns that the world is quickly running out of the substance. The ABC news program 20/20 had a recent episode entitled "Over a Barrel: The Truth About Oil" that made repeated ominous references to "America's addiction" to the black stuff. In last year's presidential race John McCain repeatedly cited the need to "stop sending $700 billion a year to countries that don’t like us very much" while Barack Obama stated that "Our goal should be, in 10 year’s time, we are free of dependence on Middle Eastern oil."

Such talk almost invariably leads to calls for the government to do something on the matter and the establishment of a national energy policy, whatever that is. The closer you examine the issue, however, the more you find that overblown rhetoric and an oil market that can trace any dysfunctions to too much government intervention rather than a lack of it. In this post I will try to examine some of the most common arguments in favor of more such intervention and why they are wrong.

We're running out of oil

One of the more common justifications for government intervention is the idea that oil supplies are rapidly dwindling and that public funds should be appropriated for research into alternative energy sources. Few people make a serious case that we are going to run out of oil anytime soon, rather the far more common argument is one based on peak oil theory. Described by wikipedia as the "point in time when the maximum rate of global petroleum extraction is reached, after which the rate of production enters terminal decline" it essentially means that while oil production will not cease, the amount produced will be less and less each year.

At first glance the notion that oil production may be rapidly set to peak may hold some allure. After all, there is only so much oil in the ground and with the demand for oil only increasing it is only logical that the day of peak oil production must be drawing inexorably closer. The problem, however, is that the amount of proven oil reserves is not fixed and demand isn't easy to predict.

Indeed, rather than running out of oil the amount of proven oil reserves continues to increase. This is because of continuous exploration efforts by companies to assure themselves of future access to oil as well as constantly improving technology.

While many people may think of oil fields as big underwater reservoirs that you simply have to essentially insert a giant straw into in order to suck up all the oil, the fields are actually composed of a variety of pockets that have to be individually tapped. Locating and drilling these pockets is quite difficult, and a field can be abandoned with a majority of the oil still left but too expensive to extract. Drilling offshore, meanwhile, presents its own unique set of challenges. With improved technology we can both find more oil as well as extract more of what we already know exists.

World's deepest drilling oil rig drill being towed

In addition, predicting demand is problematic because while the world's population continues to increase, we are also constantly becoming more efficient in our use of energy as demonstrated by this graph:

Even if we were running out of oil I don't think that this justifies public funds for alternative energy. If oil is truly running out then prices will inevitably rise given basic supply and demand theory. That, in turn, will produce enormous monetary incentives for companies to produce an energy alternative and will make existing alternative sources more attractive. In addition, we can safely predict that government funds will not necessarily be directed to the most promising sources of alternative energy, but those with the best political connections.

The oil market doesn't work very well

Given the significant fluctuations in oil prices that have taken place in recent years, there is a sense that the oil market is flawed, with greed on the part of oil producers and speculators frequently cited as a culprit. That, however, doesn't square either with theory or available evidence. After all, if rapacious oil companies could simply increase the price whenever they wanted to in order to boost profits why wouldn't they simply do this all the time? Then there is the fact that oil company profit margins are actually pretty unremarkable.

That is not to say nothing is wrong with the oil market. The ups and downs are a frustrating reality that can make it difficult for consumers to make decisions such as what type of car to buy. The reality is that there isn't a truly free market in oil, with rampant government interference distorting supply and demand. Consider the following:

• Four of the world's top five oil companies are entirely government owned and only seven of the top twenty are entirely in private hands.

• Ninety percent of the world's oil is managed by nationally owned oil companies.

• The five largest private global oil companies together own only about 4 percent of the world's oil reserves.

• Areas prohibited from exploration in the U.S. are estimated to possibly contain 25-30 billion barrels of oil (against about 30 billion of proven U.S. reserves today) and 80 trillion cubic feet or more of natural gas (compared with about 200 tcf of proven reserves).

Governments, not private individuals or companies, most often make decisions about oil production and exploration, the chief determinants of supply and price. Some of the companies are not even chiefly operated as profit generating enterprises but as opportunities for featherbedding and political patronage.

Actually, when you consider all of the obstacles in the way of obtaining oil it is rather remarkable than companies can go out and drill for the stuff, transport it around the world, refine it, deliver it to a local gas station and charge you less for a gallon of the stuff than the same amount of milk at the grocery store.

We're addicted to foreign oil

I don't really understand this line of reasoning. We're not "addicted" to foreign oil, it is simply that we have evaluated our energy options and oil -- which foreigners have a lot of -- gives us the most bang for the buck. If we didn't have access to foreign oil we would be stuck paying much higher prices for domestic oil (since there is less of it) or more expensive alternative energy sources. It doesn't make any more sense to become self-sufficient in oil than it does televisions or any of the myriad other products we import.

Now, I realize that there is a national security argument here, that oil producing nations could pull off a repeat of the 1973 oil embargo and stop exporting oil to the U.S., thus driving up energy costs. I would note, however, that this embargo -- imposed 36 years ago -- hasn't been repeated since as it both costs the oil producers a considerable amount of money and encourages the use of alternative energy sources. It isn't in their own self-interest to carry out such embargoes. Furthermore, Arab countries are not even in the top 3 sources of U.S. imported oil and only account for 4 of the top 15.

We're giving money to people that don't like us very much

Made famous by John McCain, this argument holds that at least some amount of oil wealth is used to fund Al Qaeda and attacks on U.S. citizens. While I have no doubt that some oil money has found its way from the pockets of idle Saudi princes to those of Al Qaeda, I also wonder just how pervasive this is given that Osama Bin Laden is a sworn enemy of the Saudi royal family and his terrorist group has carried out attacks on Saudi oil facilities.

Further, even if we shifted even away from Middle East oil and relied more on sources such as Canada and Mexico, it simply means that there would be more Saudi oil available for others to buy given the fungible nature of the commodity. Either way, the Arab states will remain wealthy. A smarter and easier means of reducing anti-U.S. sentiment would simply be to re-examine our foreign policy, which strikes me as easier and more practical than shifting our energy consumption patters.