Why oil is big newsWhat’s going on with oil? The price fell from $110 to $50 per barrel in just eight months (from June 2014 to January 2015), yet this is the stuff that’s supposedly going to run out in a matter of decades, so really it ought to be going up in price. Why does the market have such a problem working out the true value of oil?
The answer is simple – the market is driven by supply and demand, and supply is up while demand is down. All other factors become irrelevant, at least in the short term, which is all the market really cares about. Supply is up because of one thing – US fracking. The US has once again become a leading oil producer, joining Russia and Saudi Arabia at the top of the charts.
Having invested heavily in fracking technology over the last two decades, US oil companies have been rewarded with a glut of oil that is now trading at half the price they were expecting when they poured billions of dollars into the business.
The US oil boom is the main reason why the US economy has seen real growth in recent years, while the rest of the world is struggling along and Europe and Japan are both facing further recessions. As I explain in my book (and elsewhere on this site), all wealth must come originally from natural resources, and oil is the biggest source of all wealth in the world: Because of all the heavy industry involved in the process of exploration, drilling, refining, transportation etc, the US oil boom has led to a revival of manufacturing, helped by the cheap natural gas that gives US industry a big advantage over global competitors, and this has created over a million new jobs in recent years, helping to offset declines in other sectors.
But the outlook is not so good now. Although cheap oil ought to help consumers by cutting fuel costs, most people are still struggling along on wages that haven’t risen for years (for reasons I explain here) so most likely they’ll be glad just to spend less, or even to pay off some debts while they have the chance.
The drop in demand for oil is a good thing of course, as we need to burn less fossil fuel to combat global warming. But the US will find that its boom is short-lived because it’s based on a product that the world is trying to cut down on, both for economic and ecological reasons.
Nobody really believes that we’re entering a new era of cheap oil – the current situation is the result of OPEC, Saudi Arabia especially, trying to force some of the weaker US operators out of business. Many of the fracking companies are losing money at $60 per barrel, having borrowed heavily to invest in new wells. This is a threat to the whole economy, especially the banks that have put billions into these companies, and many of the jobs that have been created recently are vulnerable to the sudden change in outlook, as new investment is shelved.
But there’s a bigger issue behind all this: The current oil glut and resulting price cuts are the opposite of what we should be aiming for as we try to combat global warming. We need to consume less oil, and produce a lot less, so that the price rises to reflect the real long-term cost of burning oil. The fact that global growth is spluttering and reducing oil demand is a good thing for the future of civilization – industry needs to adjust to the new reality and invest in renewable energy rather than more fracking.
However successful it might be as an economic powerhouse, the US is not a good model for the rest of the world when it comes to its reliance on new-found oil wealth. Where it can be a much better model is in the innovation that some US entrepreneurs, and also state legislators, have shown with regard to wind and solar power, and in the development of electric cars and other environmentally-sound technologies.
The following chart shows why the fracking boom is so important to the US economy right now:
The point about the rig count is that, much more than total production, it represents activity and jobs, so this chart shows why oil is such a big part of the US economy right now, in a way that I don’t think is fully appreciated by most commentators. It shows why the US recovery is real and why Europe can’t hope to replicate the US model. The UK ‘recovery’, for example, is really just a resumption of the credit bubble, because the UK relies too much on services, especially finance: GDP figures don’t give the right picture (because they overstate the importance of finance and underestimate the importance of primary industry, such as oil – more on this here).
So the main point about oil is this: It has been the biggest source of wealth by far since the Second World War, both in the US and globally, but the fracking boom will be short-lived and confined mainly to North America. And really, for the sake of our grandchildren, we must learn to live without oil.