The REAL Reason Why the US Should Wait Generations Before Drilling

“Drill-baby-Drill” was the mantra of Sarah Palin’s speeches when she had all that momentum leading up to the dreaded Katie Couric interview where it became evident she was quite clueless in virtually every aspect of foreign policy, governance, finances and energy.  Alaska being well-known for little else brought drilling back to the national spotlight and political debate during the 2008 race. There are basically two main camps in the US at present:

• Drill Now! Proponents believe that by drilling our own oil both on land and offshore, we can “reduce our dependence on foreign oil from countries that hate us”.

• No More Drilling! Proponents here generally consist of liberals and environmentalists that don’t want to see the tapping of domestic resources continue given the environmental side effects of extracting and processing oil.  Republicans and most businesses prefer unabated drilling with the notion that it will bring down the cost of oil (increasing profits to most businesses), create jobs, create more political stability in the US, etc.

While it’s true that we import much of our oil from countries that basically hate us, it’s not that simple.  I mean, if that were completely true, why wouldn’t we just import “only” from countries that don’t hate us?  Well, I guess those are few and far between in the oil exporting community, but if we relied on say Canada, Nigeria (doesn’t really have a government to speak of), Great Britain’s offshore finds and other developing economies rather than the Middle East, Venezuela and to a degree, Russia, we wouldn’t be giving money to the “bad guys”, right?  Not really.  Oil is fungible.  It is the most efficiently traded commodity on earth and it’s denominated in US dollars (hence why it makes sense to hedge your own energy costs with inflation on the way and a declining dollar).  If we stopped importing from Saudi Arabia, we’d end up paying roughly the same elsewhere (after switching costs) if enough supply even existed elsewhere, and some other country would just slurp up the slack and buy from them instead instead of their current source.  It’s like the incredibly silly gas boycotts young impressionable people seem to fall for every couple years.  They don’t work based on very common, basic economic principles.

Local Benefits vs. the Greater Good

Why do some Americans want more drilling while others don’t?  Alaska, for instance, derives incredible revenues (by taxing the drillers) for their oil reserves.  These funds help sustain a state which, aside from tourism and energy, has little more to offer.  There will never be an economic center in Alaska, nor will the next Research Triangle Park or Silicon Valley be initiated there.  Oil is Alaska’s lifeblood financially speaking.  Meanwhile, events like the Exxon Valdez and other spills endure as reasons not to drill in the U.S.  Let the bad guys do the dirty work is the concept.

The Real Reason We Shouldn’t Drill for Oil Now

I have an entirely different rationale for why we should add as little new drilling capacity in the US as possible.  It is based on long term strategic concepts.  The Us tends to act on short term thinking.  Our politicians enact policies that benefit their political career and they tend to not act in the best interest of the country as a whole (I mean, how else could you explain the recent healthcare negotiations where votes were “bought” with state-centric bribes) – so we’re talking the next election cycle.  Countries like China enact policies that play out over decades.

We should not drill here because oil will eventually become very, very valuable.  I’m not talking the $140 per barrel we saw in 2008, but rather, an order of magnitude more valuable in present day dollar terms.  Why?  We’re not going to “run out of oil” as the peak oil proponents would have you believe – ever.  What will happen – and follow me here – is we will asymptotically approach barriers throughout humanity that will render oil too expensive to be worth extracting.  Right now, oil is so damn cheap to extract and refine into various distillate products, that even the poorest countries on earth, the poorest people, can afford it.  And in the US, we use so much of it that with 5% of the global population, we consume a quarter of the world’s oil!  People pay more for bottled water than they do for refined gasoline.  As much as people whine about high gas prices, when you think about what it takes to discover, extract and process oil, and the utility it provides, it’s really quite cheap.

Well, what’s happening is that oil is so cheap, that the replacement rate in all of the world’s largest finds cannot keep up with the extraction rate.  Basically, we’re part of a runaway equation whereby the global society is consuming oil faster than it can be replaced.  No amount of technological improvements or new finds can rectify this situation because a new find takes over a decade to fully exploit and the “developing markets” are now developing faster than anyone imagined – and that translates into energy consumption.  Peoples that once never consumed fossil fuels are now doing so at increasing rates and the US itself hasn’t slowed down much.  As more countries start to behave more like the US, the spiral continues. (peak oil predictions)

This, in turn, will eventually translate into an ever-increasing price of oil as it becomes more expensive to extract with newer, more innovative, more expensive extraction techniques.  This more expensive oil will result in newer, “greener”, “sustainable energy” technologies to become financially viable.  The reliance on these newer technologies will gradually slow the consumption and rise in cost of oil.  This will be a dance that plays out over decades, more like generations.

How We Win – Monopoly is Beautiful

Imagine if we held onto our cheap oil – the stuff that’s easy to extract in its current form.  While the rest of the world plunges into either darkness, expensive oil, or comparatively expensive sustainable methods, we’re sitting on massive, easy to extract virgin oil reserves?  We would be the envy of the world.  While Saudi Arabia, Iran and Iraq disintegrate into complete wastelands due to their lack of other natural resources or any viable goods/services to export in a capitalistic global society, and every other large reserve globally has been tapped, the US could slowly start tapping oil at today’s relatively low production costs.  With our reliance on the newer green/sustainable technologies vastly supplanting reliance on oil, the remaining legacy machinery, vehicles and industry that were relying on expensive oil could still have relatively cheap oil flowing from none other than the US.

This is a greatly simplified view of how the global oil market would play out in this scenario, so take a look visually at a hypothetical example.  Using today as a baseline 100% oil reserve, you’d see a gradual rise in price in equivalent current $USD as the world’s remaining reserves are gradually depleted.  Several decades out, when it becomes evident just how scarce oil is and how expensive it is to extract the remaining difficult finds, the price begins to spike.  Somewhere along that curve, the US opens the floodgates.

Chart 1 – This is What a US Monopoly on Oil Would Look Like

In summary, oil reserves decline, oil becomes very expensive.  Other technologies move in supplanting some use while price stays high.  Somewhere along that curve of pricey oil, the US finally opens up the spigot (before it’s too late and oil becomes totally obsolete) and allows metered drilling.  The US enjoys a virtual monopoly on the world’s oil supply.  While it is drilled by private industry, the US derives massive tax benefits from the high price and cost of new licenses/royalties.  Look at how Norway operates now.  Imagine that ten-fold. No more national debt.

Industry and the Taxpayer enjoy windfall revenues.

For what?

For being patient.

Thoughts?

Tagged as: oil price