One of the primary concepts I recall from the first class I took in my major course of study at Brigham Young University was the importance of the margin. It is the marginal buyer and the marginal seller who determine the price. The cost of a barrel of oil has dropped precipitously over the past few months. In the short term consumers and manufacturers reap the benefits. But what of the producers, the marginal producers which have production costs that go well beyond $40 a barrel for oil? Yes, as long as the cost of extraction is less than the market price for already existing wells, production will continue; sunk costs are sunk. But what of the investment needed to begin development of the “next well”, the well which will be expected to take the place of the depletion of the wells already in production? It will not be brought on line in time if investors don’t see a profit to be made.
To dig a little deeper, pun intended, it serves to ask why extractors of petroleum would invest in production platforms which lead to overall costs per barrel being upwards of $60, $70, even $100 a barrel if there are a sufficient number of sites producing at $10-$20 a barrel? The answer is, of course, there aren’t. There are a certain number of older, traditional rigs pulling oil out of the ground at very low cost, and making the producers a great deal of money even now, but that type of production cannot fuel the entire economy on its own the way we have arranged that economy…and so we need higher cost non-traditional oil to be brought into production (extraction)…but if the price doesn’t warrant the investment to do so they won’t be brought on line.
The bottom line is that the extreme drop in the per barrel oil price today will result in an even higher price spike tomorrow. The biggest problem with this for the long term is that people are willfully misinterpreting this short term drop in price as a signal that business as usual is possible. Fossil fuels will get more expensive to extract. We extract the highest yielding low cost energy first in the same way you would choose to pick the best quality low hanging fruit from an apple tree first: you wouldn’t start by climbing a ladder to pick a half rotten piece of fruit with beautiful, ripe apples within arm’s reach.
The more I learn about renewables, and how dependent they are on fossil fuels, rare earth metals, and an underlying expansion of the economy, the more I agree with those who believe that conservation is the only path to a green economy. Here in the United States we have the luxury of starting from such an appalling state of inefficiency that becoming more efficient won’t require genius levels of intelligence.
Again, the problem is we are hearing the message we want to hear from the recent drop in oil prices. It is the faint undertow, the water receding ever so slightly more than usual, just before the tidal wave hits. My recommendation: take advantage of this moment to invest every dollar you can in making yourself as energy efficient as possible.
I recommend the following sites to delve more deeply into this topic: