The Real World: Oil’s Creative Destruction

Date: 06-13-2008 | Category: Articles, Energy Security, Geopolitics

The Real World: Oil’s Creative Destruction


                                                                  By Ariel Cohen

Oil demand appears in unexpected places, where there was very little demand in the recent past. The oil thirst is mounting in the Persian Gulf, Russia, even in Africa, due to expanding wealth, booming construction projects, and growing populations. Government fuel subsidies, typical in energy exporting countries, are increasing demand for gasoline. No wonder that the oil prices are going up, up and away.

According to Fatih Birol, chief economist at the International Energy Agency (IEA), the rising demand in the Gulf is second only to that of India and China, and it will increase in the future. Edward Morse, chief energy economist at Lehman Brothers, has stated that at least 1 million barrels a day did not reach world markets last summer because of rising consumption among energy producing nations, and the situation will repeat itself this summer.

Additionally, as demand increases and aging oilfields produce less, some major oil-exporting countries are switching from being net exporters of oil to net importers. Two well-known examples are Indonesia and Great Britain. In fact, Indonesia has recently announced it is quitting the ranks of OPEC. Algeria, Malaysia, Mexico, and Iran appear to be on this path as well. This scenario may even offset planned Saudi increases in spare capacity, according to Amy Myers Jaffe, an oil expert at Rice University in Houston, Texas, U.S.

As oil and gasoline prices surpass $135 per barrel and $4 per gallon, respectively, it is clear that significant change is underway in global energy markets, portending major challenges for the global economy and energy security. A perfect storm of demand and supply factors is driving the high oil prices.

Goldman Sachs predicts oil will reach $200 per barrel by the end of the year – exactly where Osama bin Laden said it should be back in 2001. Absent significant changes, high prices are here to stay, and, a correction notwithstanding, may keep increasing in the long term.

The supply and demand equation responsible for this situation is changing quickly. Demand for oil is no longer driven by developed economies like the United States and Western Europe. China, India, other developing countries, and energy producers themselves are transforming global energy markets through their sheer size and pace of growth.

According to the Paris-based IEA’s analysis, "World Energy Outlook: China and India Insights," between now and 2030 China and India will account for 70 percent of the new global oil demand; their combined oil imports will skyrocket from 5.4 million barrels per day (mbd) in 2006 to 20 mbd in 2030 – overtaking the current combined imports of Japan and the United States.

The energy needs of China and India will continue to grow as these countries transition from developing to developed nations. Rising incomes, strong growth in housing and construction, and the increased use of electrical appliances will substantially increase demand.

China is in the midst of an unprecedented construction boom in heavy industry that requires enormous amounts of oil. Massive infrastructure and construction projects generate a heightened demand for oil in China and India, as they did in the United States in the last century and Germany and Japan after World War II.

In terms of vehicles on the road, China will surpass the United States by 2015, becoming the largest automotive market in the world. Rising demand, however, is not isolated to East and South Asia.

With diminishing global spare capacity and the growing geopolitical potential for future supply disruptions, it is time to confront these anti-competitive policies head-on.

To increase investment, open access to the remaining oil and gas reserves, and diversify the basket of transportation fuels, international oil companies and consumer countries should increase pressure on OPEC and non-OPEC countries to level the playing field and to open access for international oil companies to develop existing petroleum reserves.

The rule of law and competitive market principles and institutions should be put in place to facilitate further development of energy resources. This includes cessation of cartel-like behavior by OPEC, which is illegal under U.S. law. Consumer nations should make energy investment a part of their bilateral agenda with all energy-producing countries.

Governments of consumer nations should also keep in mind that the national oil corporations depend on imported oil services, information technology, banking and finance, food, and other external providers to function adequately – just as consumers depend on fuel producers. Consumer countries may begin conditioning supply of these vital services on equal access to energy resources.

Consumer countries should also promote market-based energy-saving technologies and unconventional sources of fuels world-wide. Japan and the United States are the world leaders in industrial and residential energy conservation, whereas the fast growers (China, India, the Middle East, etc.) are energy inefficient.

U.S., Japanese, and other Western companies can do well by doing good, marketing energy-saving technologies. Governments can prioritize energy saving through their export promotion activities. Technology is also key to oil production from unconventional sources, such as oil sands (Canada, Venezuela, Congo, etc.), oil shale, and deep water drilling, using the most the environmentally friendly methods possible.

Finally, automotive industry around the world needs to prepare for the likely transformation of private and public transportation as market forces are shifting it to electric, hybrid, and plug-in hybrid cars.

If oil-producing countries do not take measures to bring down oil prices, a number of market-driven solutions will likely replace internal combustion engine cars in the next couple of decades.

The U.S. automotive industry should gear up today to be a market leader in these emerging transportation technologies. Otherwise Detroit will suffer even more from competition by Japanese and other companies and will lose more jobs and industrial base.

The famous Austrian economist Joseph Schumpter has called it "creative destruction." In the case of oil, the inexorably rising price for transportation fuel may eventually destroy those high priced established producers which enjoy some degree of monopoly power.

High oil prices are driving science and research and development to produce better and cheaper sources of transportation fuels and new engine designs, which may eventually offer alternatives to conventional oil and reduce its price.


Ariel Cohen, Ph.D., is senior research fellow in Russian and Eurasian Studies and International Energy at The Heritage Foundation.


What’s New?

Trump’s first 100 days: the foreign policy report card

The Huffington Post By Ariel Cohen May 8, 2017 Many in Washington feared Trump would sell out to Russia. That never happened. Sanctions against Russia…

U.S.-Europe Rift: Is the West’s Survival at Stake?

Huffington Post Dr. Ariel Cohen June 19, 2017 Is the current conflict between the Trump Administration and the European leaders, including with German Chancellor Angela…

Follow Us

  • Twitter: dr_ariel_cohen