At the end of trading on Monday, the benchmark price for crude oil futures stood at $73.33 a barrel. That's a long, long way from the $10-a-barrel price of 1999, and it makes it all the more amusing to return to that year and read an Economist cover story on the destabilizing possibilities of $5-dollar-a-barrel oil.
It's awfully tempting to make fun of the Economist's lengthy analysis back then of why low oil prices were likely to stick around for a long time, now that $100-a-barrel oil seems a good bit closer than the return of $10-a-barrel oil. Those silly Brits. Didn't they ever hear about peak oil? Today, with oil prices pushing higher every day, the predictions of peak oil doomers seem ever more prescient.
But maybe we should take the opposite lesson from this cautionary tale. Which is that it is all too easy to extrapolate future trends from contemporary reality. The collapse of prices amid a global glut of cheap oil in 1999 ensured the conventional wisdom that the status quo would continue. Now the opposite appears true: Oil is expensive and will only get more so, as demand continues to rise, and production plateaus.
There's an alternative theory, discussed in detail by petroleum economist Philip K. Verleger in the winter 2006 issue of International Economy. Although Verleger's article has the doomer-friendly title "Hundred Dollar Oil, Five Percent Inflation, and the Coming Recession," Verleger never mentions the words "peak oil." He attributes the spike in oil prices (and, relatedly, U.S. gasoline prices) to a set of different, potentially temporary factors.
The most important factor is not the lack of supply, but the lack of refining capacity. And not just worldwide refining capacity, but refining capacity capable of producing specific grades of oil and fuel mandated by environmental regulations in the U.S. and Europe. "The energy industry in the United States and much of the world today lacks the capacity to transform energy supplies into the product volume needed and demanded by consumers. This capacity constraint could limit economic growth for several years," writes Verleger.
There are several reasons for this, argues Verleger. In addition to environmental regulations, refinery capacity in the U.S. was slammed by last summer's hurricanes. The recent run-up of gasoline prices in the U.S. has been jump-started by many of the remaining refineries' decision to finally take care of deferred maintenance. There's also, says Verleger, the problem that the refining business normally isn't very profitable, so there has been little incentive to expand capacity.
In my view, Verleger's policy prescription to fix this, which is to suspend environmental regulations, is shortsighted. We're all probably better off if high gas and oil prices make renewable energy technologies more feasible, even if there is some short-term economic pain associated with that. But at the same time it would be foolish to rule out the possibility that a worldwide expansion of refining capacity might relieve some of the pressure on the current oil supply/demand equation, which in turn might lead to a dramatic about-face in the oil markets. One reason why oil prices keep rising is the classic self-fulfilling prophecy of speculation-driven booms. The more people who bet on the price of a commodity rising, the faster it will rise.
Until it doesn't. And then the descent becomes as fast as the ascent.