High Oil Prices: Why the US Is Doing Less Badly Than Some Other Countries

At this point, supply and demand is not working well to increase world oil supply. Even if the price of oil rises, world oil production doesn’t increase by very much.  In the words of economists, supply is relatively inelastic (even including biofuels and natural gas liquids).



Figure 1. World oil production based on EIA data (broadly defined, including biofuels and natural gas liquids) compared to exponential trend line fitted to 1983-2005 data. 2011 estimated based on data through November 2011.

Between 1983 to 2005, world oil supply rose by 1.64% per year. If world oil supply had continued to rise at that rate, oil production would have been about 5 million barrels a day higher in 2011 than it actually was. The fact that oil production has remained relatively flat is the primary reason oil prices have continued to rise, except when punctuated by recession.

The amount of the shortfall is huge. It is far more than the amount of oil taken off line by Libya, and more than Saudi Arabia’s supposed spare production capacity. Given the high price of oil, most of the missing oil seems to be oil that we do not have production capacity for.

Even if the hype about possible increases in US oil supply are is true, a major gap still remains. For example, doubling the Bakken production would add only about 500,000 barrels a day of crude oil, or about 10% of the shortfall. Part or all of this increase would be needed to offset declining production elsewhere around the world.

While the primary reason that oil prices are high is the 5 million barrel a day shortfall in production, there are issues as well. Much of the easy (and cheap) to extract oil has already been extracted, so higher prices are needed to cover extraction costs. In addition,  oil exporters depend on oil revenues to fund social programs and food and oil subsidies for their own people. F

There are current issues as well. Loose monetary policy makes alternative investments unattractive, and leads to more investment on commodities.  Worry about the Iran situation can add a further risk premium.