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VoxEU Column Energy Environment Global economy

The two oil production revolutions and what they mean for the price of oil, politics, the economy, and the environment

After decades of oil price rises, new extraction techniques for shale and conventional deposits mean that recent dramatic price falls will be here to stay. This column argues that, even with oil at $50 a barrel, global producers will invest to catch up with US-led technological innovation and so add 40 million barrels a day to production by 2035. This will revolutionise domestic energy policymaking, environmental commitments and global geopolitics.

Oil price developments over the past 40 years have been truly spectacular. In constant money, prices rose by almost 900% between 1970-72 and 2011-13 (UNCTAD 2015, UNSTAT 2015). Compare this to other exhaustible commodities, and we find that a metal and minerals price index rose by only 68% in real terms in the same period.

In our view, political rather than economic forces have shaped the inadequate growth of upstream oil production capacity, which is the dominant factor behind the long-run upward price push. The resource curse, represented by domestic and international conflicts over the oil rent, is probably the most important explanation for this extraordinary historical price increase.

But the recent fall in oil prices is also probably here to stay, thanks to increasing production. We discuss these trends more fully in a new paper (Aguilera and Radetzki 2016).

The shale and conventional oil revolutions

Beginning less than 10 years ago, the shale oil revolution – employing innovations in horizontal drilling and hydraulic fracturing – has reversed the long-run declining oil production trends in the US into rises of 73% between 2008 and 2014 (EIA 2015). Shale oil costs become competitive when the oil price is $50 per barrel. An exceedingly high rate of productivity improvement in this relatively new industry promises to strengthen the competitiveness of shale output even further.

The US lead in the shale revolution has many explanations, including large-scale and long-lasting conventional oil exploitation, a well-developed infrastructure, many small adventurous prospecting and production enterprises, a sympathetic public approach to the industry, and the incentive to landholders that they own underground resources.

Also, most environmental problems related to shale exploitation are likely to be successfully handled as the infant 'wild west' industry matures, and as environmental regulation is introduced and sharpened.

The US does not have outstanding shale resources. A very incomplete global mapping suggests a US shale oil share of no more than 17% of a huge geological wealth, which is spread widely. Shale technology is mainly non-proprietary, and given the many advantages accruing to producing nations, it is inevitable that the revolution will spread beyond the US.

With a 17% share of global shale resources, the US in 10 years expanded its output by nearly 4 million barrels per day (mbd). We assessed the prospects of non-US shale oil output in 2035, arguing that that the rest of the world will by then exploit its shale resources as successfully as the US has done in the revolution’s first 10 years. Assume, then, that the rest of the world is equally as successful as the US was between 2004-2014 in exploiting its share of the resources between 2015-2035. This would yield rest-of-world output of 20 mbd in 2035. That is similar to the global rise of all oil production in the preceding 20 years.

The advancements in horizontal drilling and fracking can also be applied to conventional oil extraction. Several basins in the US and other countries are already doing this, which we call the 'conventional oil revolution'. We also assume that conventional oil in the rest of the world is able to benefit from the application of shale extraction methods, just as US conventional oil has begun to do. This would yield another 20 mbd by 2035.

The oil output increases are bound to have a strong price-depressing impact, either by preventing prices from exceeding recent levels ($53 per barrel for Brent crude in 2015), or by pushing them back to these levels if they rise in the short term. We estimate prices of about $60 in 2035, but an increasingly likely scenario predicts a price of $40. This will influence economics, politics, diplomacy and military strategy.

Implications for the macroeconomy, environment and for politics

The global spread of the production revolutions, and the price weakness that we predict in the next 20 years, will, on balance, be an advantage both to the oil industry and to the world economy. Successful shale and conventional oil developers could reap benefits similar to those seen in the US in recent years.

Producer nations that fail to compensate for the effects of the oil price decline by expanding output would experience a negative effect on public income. On the other hand, we conclude that the effects of the resource curse will get smaller as prices decline.

For climate policy, the two revolutions will cement and prolong global fossil fuel dependence, with implications. At the same time, the US experience shows that the expansion and cheapening of natural gas means we will use less coal in power production, reducing CO2 emissions. Efforts to develop renewables, however, will become more costly, requiring greater subsidies.

It is  hard to fathom the changes to international political relations. Growth and geographical diversification of supply would not only suppress prices, but would also promote competition among suppliers and make it more difficult for producers to use energy sales in pursuit of political ends. Therefore we argue that importers will put less effort into political intervention and control of oil. For instance, many will question the diplomatic and military presence of the US in the Middle East as the country’s dependence on oil from the region reduces.

References

Aguilera, R.F. and M. Radetzki (2016), The Price of Oil, Cambridge University Press.

EIA (2015), Annual Energy Outlook, Energy Information Administration, Washington DC.

UNCTAD (2015), UNCTAD Stat, United Nations Conference on Trade and Development.

UNSTATS (2015),  National Accounts Main Aggregates Database, United Nations Statistics Division. 

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