Market Power

Musings by an academic economist on the power of markets and the power over markets.

Monday, April 11, 2005

Will We Ever Run Out of Oil?

From time to time, I tell my students that as long as market forces are allowed to work, the world will likley never run out of oil. I think it's an intriguing question and it gets them thinking about how market forces work. There are four basic reasons, all based on market forces, for why we won't run out of oil. Each is based on the premise that when the supply of known oil reserves start dwindling, the price of oil will increase.

1. High oil prices provides an incentive to people to reduce their consumption of oil.

2. High oil prices give an incentive for oil companies to start extracting oil from places where oil is known to exist but where extracting it is very costly. As a case in point, some small oil companies are drilling in urban neighborhoods in Houston.

3. High oil prices give an incentive for oil companies to start exploring for new sites to drill for oil. From this morning's Wall Street Journal (paid subscription required):

Few U.S. motorists need give a thought to bomb-wielding terrorists in the Caucasus or the rifle-toting Urhobo tribe in the oil-rich delta of Nigeria.

But to national-security planners, diplomats, oil companies and energy planners, they are becoming critical components in the increasingly difficult and risky game of bringing new oil supplies to market. ...

... The oil supplies expected over the next two decades are coming from or moving through some of the least stable and most corrupt areas in the world.

As a result, long-neglected regions such as West Africa are rising in importance to U.S. policy makers. Emerging countries around the Caspian Sea are attracting new attention, too, as is the tense U.S. relationship with Venezuela's leftist government.

4. High oil prices give an incentive for enterpreneurs to develop alternative forms of energy.

The big kicker revolves around information and impediments to market forces (such as regulation). Do we really know exactly how much oil is in the ground? Maybe not, but incentives and technology are there for firms to know as much as they possibly can. Even if we know how much oil is in the ground, regulations may add so much cost to drilling that it makes no sense to drill for it?

Will we ever run out of oil? Likely, the answer is no. Will we ever stop using oil - quite possibly, yes. Of course, if market forces aren't allowed to work, then all bets are off.