Editor's Note: James Quinn is a senior director of strategic planning for a major university. James has held high-level financial positions with a retailer, homebuilder and a university in his 22-year career.

Unintended Consequences of Cheap Oil

When oil reached $147 a barrel in the summer of 2008, panic set in among the sages in Congress. Windfall-profit taxes on oil companies and government support for alternative energy were the mantra. Government intervention was going to work its magic.

Instead, the markets adjusted rapidly to a worldwide decline in demand, and the price plummeted to less than $40 a barrel. This drop has put an additional $200 billion back in Americans’ pockets - much-needed relief during a grinding recession. The law of supply and demand worked without government intervention.

According to the pundits, speculators drove oil up to $147 a barrel; once the speculators were forced out, oil prices collapsed. Their view is that this was a merely temporary crisis, and that everything will now return to normal; they could not be more badly mistaken.

When the current economic downturn ends, oil demand will begin climbing again; supply, by contrast, has likely reached its peak. The facts, based on exhaustive research by Matt Simmons:
 

• 60% of the world’s oil is consumed by 10% of the world’s population.
  
  
• America represents 5% of the world’s population and consumes 24% of the world’s oil.
  
  
• Middle East oil use is growing more rapidly than China’s.
  
  
• China now uses 8 million barrels per day versus 3.5 million barrels per day in 1997.
  
  
• China now consumes 2 barrels per person, versus 24 barrels per person in the US.
  
  
• Peak supply of 86 million barrels of oil per day has been reached. Demand will grow to 115 million to 125 million barrels per day in the next 20 years.

The price of oil is now dangerously low. Untapped resources in non-traditional places include: Oil sands in Canada, oil shale in the Western US, and deep-water oil. At $40 a barrel, the cost to extract oil from these sources is greater than the revenue that can reasonably be generated. Therefore, all projects in these areas will be stopped or delayed indefinitely. Drilling rigs are being shut down, employees are being laid off, and all expensive deep-water projects are being abandoned.

Supply has topped out at 86 million barrels per day. Mature oil fields throughout the world are in decline. Projects can take decades to bring on-line. Projects not yet begun will result in supply shortages in the future.