Free Markets VIII – Running Out of Oil

One of the common misconceptions is that economies have a fixed amount of various commodities. Take oil, for example. We have been hearing for decades that we will soon run out of oil, but it simply isn’t true. There is plenty of oil in the ground yet. What is true is that the easy-to-retrieve oil is fast running out, and we are having to look for oil in more and more remote places, or extract it from things like tar sands with expensive processing, and that is pushing the price of oil up steadily.

It’s price signals again. As the cheap-to-produce oil runs low, the price of oil rises and that makes it economically attractive to find and pump more expensive oil from places like the deep sea. or to use expensive processing to extract oil from tar sands, or to look for ways of producing oil from algae or the like. When oil was cheap, none of these things were worth doing. As oil becomes more expensive, they suddenly become economically viable sources.

And of course as oil prices go up, consumers begin to think more carefully about their use of it. Frankly oil is far more valuable as a chemical feedstock than as a fuel. It’s like burning good walnut in your fireplace – yes it does keep us warm, but that walnut would be a lot more valuable to us made into fine furniture. So as oil become more expensive, we consumers get smarter and more careful about using it.

What is true is that there is a relatively fixed amount of a commodity in an economy at a given price. If demand pushes the price up there will be more of the commodity because there will be an incentive at the new higher price to find or create more of the commodity. The world’s supply of oil is really dependent upon its price.

So what will really happen is not that we will run out of oil, but that the price of oil will continue to rise as it becomes more and more expensive to extract it, and because it is more expensive consumers will become more and more careful how they use oil. At some point (perhaps soon) it will become too expensive to simply burn as a fuel, and so we will have to find alternate energy sources while we use the remaining very expensive oil for more valuable uses.

Here again is where politicians who don’t understand economics can make things worse. Reacting to price rises by “fixing” the maximum price of oil or gasoline is exactly the wrong thing to do, popular as it might be with voters. That simply makes it economically unattractive to extract the more expensive oil, and so soon produces a real shortage.