Don't blame Mideast turmoil for oil woes

By Michael Elliott, contributor


FORTUNE -- When you think of life's more pointless exercises -- guessing what Lady Gaga will wear next, trying to read Finnegans Wake -- predicting the price of oil is right up there. I remember oil executives telling me in 2002, when the price was a bit more than $20 a barrel, that it was heading for $16. It peaked at more than $140 in 2008.

Yet despite all the reasons to be suspicious of any forecasts, all it took was for prices to spike in response to the turmoil in Libya -- with the benchmark Brent crude going to nearly $120 a barrel -- for the usual predictions of doom, gloom, and lines at gas stations to be trotted out.

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Time for a reality check. Nobody loves short-term volatility in the markets. (Except traders, of course; they love it.) But the idea that revolution in the Middle East is going to translate, through expensive oil, into a sustained global downturn seems way off. First, Libya accounts for less than 2% of global oil production; second, whoever runs that country will quickly figure out that oil is of no value if it's left in the ground; third, Saudi Arabia can always increase supply, and once prices spiked, started talking about how it might do so; fourth, the old assumptions about a rise in the cost of oil leading to a concomitant reduction in output don't hold as they once did -- the run-up in prices to 2008 coincided with a sustained period of global growth.

The Middle East, truth to tell, is not the place to look for the oil story. Prices, having crashed in 2008-09, have been rising for the past two years. Before the first demonstrations in Tunisia ever took place, prices were already up more than 30% from last summer. The global recovery is being led by emerging markets that are less energy-efficient than developed countries, and those markets will remain that way for decades, as millions of Indians, Chinese, and Africans move from villages to cities and as their nations shift from agriculture to energy-intensive manufacturing.

On the demand side, then, you would expect that in the long term -- say, over 20 years -- the price of oil is indeed going to go up. What about supply? Markets being wonderful things, high prices for any commodity stimulate investment in producing it, but at some level -- whether you believe oil production has "peaked" or not -- the global supply of oil is finite. A lot of new oil discoveries are either in places that are technologically challenging and expensive to exploit -- like Brazil's continental shelf -- or where environmental concerns add to the time and cost of bringing a project onstream (such as the Arctic).

So oil is indeed going to be more expensive, and one day that will make renewable-energy options like wind and solar truly cost-effective.

But even now, oil isn't the only fuel around. Consider gas, which some industry analysts think could be in overabundance, thanks to technological breakthroughs that enable gas to be extracted from shale and the development of enormous infrastructure systems for shipping liquefied natural gas around the world.

The new gas economy is changing both economies and geopolitics in fascinating ways. The new sources have diminished the hold that Russia -- a huge gas supplier -- has on Europe. And it's one of the reasons Australia, which is sitting on bags of gas, pretty much escaped the Great Recession.

True, plentiful gas is not a simple fix for high oil prices. It can't easily substitute for oil in all the ways we use it -- like getting us around. (Though I recently noticed that Los Angeles County now runs almost its entire fleet of 2,200 buses on gas.) So the U.S. is going to depend on foreign oil for years. Imports have nearly doubled since 1980, and though not all oil comes from unstable places -- Canada and Mexico are the top two suppliers -- some does.

But if you really want to worry about energy, you should spend less time thinking about the Middle East and more figuring out how to reduce our dependence on oil. Switch the heating in your house from oil to gas. Don't drive to the train station; walk. You'll feel better twice over. To top of page

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