CASE STUDY

Case Study



Case Study

Answer 1: OIL as a Scarce Commodity

Oil is a fossil fuel, 150- to 300-million-year-old “solar energy” buried underground. Up until the Industrial Revolution, most of the world's energy was supplied from renewable sources. But with the Industrial Revolution and the depletion of wood in England in the early eighteenth century, the transition to technologies that run on nonrenewable sources of energy occurred as production and transportation began to rely increasingly on coal. Earlier in the twentieth century, we observe another shift to a new nonrenewable resource pioneered first by the introduction of battleships that run on oil to the Royal Navy and then by the mass production of cars in the 1920s. Today, our highly industrialized, and predominantly capitalist, world economy continues to be heavily dependent on this nonrenewable energy source.

This state of dependence inevitably begs the question of the exhaustion of this nonrenewable resource. How far is it? How much oil is in the ground? What is the rate at which new oil reserves are found? How difficult is to extract them? How reliable is the reserve-to-production ratio that indicates the length of time the remaining oil reserves will last if the production will continue at the current levels? What is the rate at which the consumption of oil is growing? Although, the answers to these questions are heavily contingent upon the assumptions that one is willing to make in calculations. If one were to accept the “optimistic” predictions of the International Energy Agency regarding the possibility of reaching peak production sometime between 2013 to 2037. It will probably be safe to assume that the current reserve-to-production ratio of 42 years will not improve drastically in the coming decades.

In 1945, the real price of oil was only about $11-$12 per barrel. After all, we learn in our most basic economics classes that as technology improves, we are able to manufacture easier and easier and the prices should reduce, not increase. The answer is that the demand for oil is so great that technology has to improve continuously in order to meet the demand. However, the demand for oil is increasing faster than technology is able to keep up.

What does this have to do with scarcity? As demand increases, oil becomes more and more scarce, since production is not able to meet the demand. In order to mitigate demand, prices must rise. The indicator describing the scarcity of any product is its price; therefore, when prices rise we know that supplies are most likely to be low. There are exceptions to that rule, but in general this is how it works.

In the past, the answer is that the majority of the oil in the United States is acquired from the Middle East. Since many countries have reduced output while combating revolts and uprisings, supplies are dwindling and thus prices are rising. If the price remained low, then the world's demand would burn every drop of oil and there would be gas shortages just like we saw in ...