Oil Wars

If you want to understand the future a look at the price of oil is never a bad place to start. That price is down and pixels are dying in their billions with commentary as to what that means for Russia, Iran, fracking, IS, Canada and your car’s gas bill.

Oil prices have fluctuated significantly for years and I expect they will continue to do so. What interests me is the implication of a low oil price for the longer term prospects of the West. And, in general, there seem to be more positives than negatives.

When oil prices are high there is a rush of investment into oil based enterprises from multi-nationals to frackers. No bad thing but there is always a real danger of over investment leading to the exploitation of very marginal resources. A lower oil price will strand some of that investment and, just as importantly, postpone a great deal of it. Which frees up investment for other, potentially more useful, purposes.

The second thing which happens is that governments become addicted to the joys of relatively painless oil royalties. This looks like revenue but, because it is drawn from a diminishing resource, is actually a rather dangerous drawing down of capital. A lot of oil “revenue” is seen as general revenue and is spent on non-capital expenditures. With a booming oil sector governments are tempted to think the exaggerated revenues are available for general expenses and will continue to be. Which means that government budgets are set based on a purely extractive draw down of a province’s or nation’s capital. This is a poor idea.

Not to take anything away from the bright guys who are fracking and mining their way to oil fortunes, the reality is that extracting oil does not leave much in the way of useful, secondary industry, much less innovation. Which, in turn, means that when the oil is no longer profitable to extract there is no residual, non-oil, economy left behind. If a government spends the oil revenue as it comes in, or worse uses it to secure loans, when the oil revenue dries up there is nothing to cover the spending or the debt.

(The polar case here is Saudi Arabia. If Saudi oil dried up tomorrow, other than terrorist and Islamoloons, what else does Saudi make? Take a look here for the answer. And here is Canada by contrast.)

The “bingo” of high oil revenues has been largely wasted by governments. This is not intentional, it is just what government, confronted with a big pile of money does. From Russia to Iran to Alberta, government grabs the money and spends it on day to day operations. There is virtually no way to stop this so long as we have politicians with month ahead horizons. However, the current crash in oil prices means that there will be less money to squander.

The golden lining of additional pressures on nasty states like Russia, Iran and Venezuela is likely not as significant as the prevention of malinvestment and governmental squander. In time, as various emerging economies continue to grow, demand will drive the price of oil upwards again. With luck investors and governments will not make the same mistakes twice.

(One unalloyed good arising from the collapse of the price of oil is that so called clean energy renewables like wind and solar look even sillier with their present technology. I suspect wind will always make zero economic sense; I have more hope for photo voltaic solar as new materials promise significantly higher efficiency. And those same materials in a different configuration promise radical gains in battery efficiency for that daily occurrence known as darkness. Again, a low oil price will dampen the insane over investment in these marginal technologies.)