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We Will Never Run Out of Oil

The Oil Supply - The Doomsday Scenarios are Flawed

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For as long as I can remember, I've been hearing that the world oil supply will run out in a few decades. I remember quite vividly growing up in the early 1980's hearing that there wouldn't be any oil left by the time I learned how to drive. Fortunately these predictions never came true, but the idea that we will exhaust all the oil under the surface of the earth is a persistent one.

Predictions that we will run out of oil after a certain period of time are based on an ignorance of the economic way of thinking. The typical way to estimate the number of years it will take us to run out of oil is to consider the following factors:

  1. The number of barrels we can extract with existing technology.
  2. The number of barrels used worldwide in a year.
The most naive way to make a prediction is to simply do the following calculation:

Yrs. of oil left = # of barrels available / # of barrels used in a year.

So if there are 150 million barrels of oil in the ground and we use 10 million a year, this type of thinking would suggest that the oil supply will run out in 15 years. If the predictor realizes that with new drilling technology we can gain access to more oil, he will incorporate this into his estimate of #1 making a more optimistic prediction of when the oil will run out. If the predictor incorporates population growth and the fact that demand for oil per person often rises he will incorporate this into his estimate for #2 making a more pessimistic prediction. These predictions, however, are inherently flawed because they violate basic economic principles. By using economic principles, we will see that:

WE WILL NEVER RUN OUT OF OIL

At least not in a physical sense. There will still be oil in the ground 10 years from now, and 50 years from now and 500 years from now. This will hold true no matter if you take a pessimistic or optimistic view about the amount of oil still available to be extracted. Let's suppose that the supply really is quite limited. What will happen as the supply starts to diminish? First we would expect to see some wells run dry and either be replaced with new wells that have higher associated costs or not be replaced at all. Either of these would cause the price at the pump to rise. When the price of gasoline rises, people naturally buy less of it; the amount of this reduction being determined by the amount of the price increase and the consumer's elasticity of demand for gasoline. This does not necessarily mean that people will drive less (though it is likely), it may mean that consumers trade in their SUVs for smaller cars, hybrid vehicles, or cars that run on alternative fuels. Each consumer will react to the price change differently, so we would expect to see everything from more people bicycling to work to used car lots full of Lincoln Navigators.

If we go back to Economics 101, this effect is clearly visible. The continual reduction of the supply of oil is represented by a series of small shifts of the supply curve to the left and an associated move along the demand curve. Since gasoline is a normal good, Economics 101 tells us that we will have a series of price increases and a series of reductions in the total amount of gasoline consumed. Eventually the price will reach a point where gasoline will become a niche good purchased by very few consumers, while other consumers will have found alternatives to gas. When this happens there will still be plenty of oil in the ground, but consumers will have found alternatives that make more economic sense to them, so there will be little, if any, demand for gasoline.

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