Weak oil theory

After months of shadowboxing with the fanciful spectacle promised by Peak Oil Theory — conventional world reserves are running out and prices will soar — now may be the time to move on to another, more realistic perspective. A number of analysts are gearing up for a major oil-price correction, one that could drive a barrel of crude back down to a level that better reflects oil’s long-term price: US$30.

Yesterday Russia announced a reduction in its expected average price down to US$55. This is unlikely to be the last Russian reworking of its oil price outlook. For a variety of reasons, the world price of oil is heading lower. Whether it will hit US$30 would be guesswork, but the band of oil-price skeptics keeps growing.

Weak Oil Theory, to coin a concept, holds that the long-term price trend for commodities is generally down. The history of world oil prices over the last 60 years is mostly flat, averaging maybe US$20 a barrel in constant dollars, except when the world has been cast into military conflict. The real driver of rising oil prices is geopolitical mayhem brought on by war, terrorism and other horrors created by governments.

Left to market factors, the price of oil would tend to drift lower as new technology increases the supply, not just of oil itself but also the supply of energy that can be extracted from a barrel of oil. Today’s oil refineries get many more Btus out of a unit of crude oil than they used to. At the same time, demand for oil per unit of economic output — or oil intensity — is falling as energy users constantly shift energy practices and technologies. Since 1970 alone, the oil intensity of OECD countries has dropped by 50%.

Financial Post