Monday, October 30, 2006

Oil Prices and Supply

First off, if you drive a car that gets less than 20 MPG, you have no cause to protest high prices. You are the problem.

The current high prices at the gas pumps are driven by factors that work all the way back to really basic supply and demand issues. People often say that oil is a finite, non-renewable resource. I'll buy the non-renewable part, but not the finite part. OK, oil is technically not infinite, but practically speaking we will never run out of oil.

The issue is how fast can it be produced? Today the world is producing about 85MM barrels per day. By all accounts that is with all production going full out.

Here's what will happen. When demand for oil and the world's ability to supply it are out of balacne, prices go up because demand is pushing the limits of supply capacity. Two things will happen in response. Consumers will make choices that will curtail their usage of enrgy--short and longer term structural changes; producers will ramp up efforts to deliver more.

Either that will be enough to ease the supply demand balance, or it will continue to happen for a while. In either case, ultimately the price stabilizes until there is another imbalance. If it the two effects are enough to ease the prices a bit, consumers have less incnetive to save and producers have less incentive to spend money to develop more resources.

There are a few things that you can be certain of in the absence of government interference n the free markets.

We will continue to use our technically finite supply of oil.
People will adjust their lives to compensate for the increasing cost of energy.
As cheaper alternatives appear, they will replace oil in our energy mix.