EconSouth (Third Quarter 2002)


Cover Story

Are We Running Out of Oil?

Both the availability and the cost of oil concern Americans across the country. Consumers are anxious not only about prices at the gas pump but also about whether oil will be around for the next generation.

Oncreased unrest and instability in the Middle East and in the oil-producing countries of Latin America have again raised concerns about recurring and persistent energy price increases. Oil prices have moved widely over recent years — from below $10 a barrel in 1998 to over $35 a barrel in 2000 (see chart 1), and the threat to future supplies is again becoming a high-profile issue in the United States.

At stake are not only consumers’ pocketbooks but also the health of both the U.S. and world economies, made even more tenuous by the recent downturn in business activity. Beyond these shorter-term concerns is the recognition that available supplies of oil are being depleted as oil use increases. As supplies become scarcer, prices will inevitably rise, and many analysts wonder about the consequences for the U.S. economy.

What’s happened to oil supplies?
Several factors affect both the long- and short-term oil supply conditions, and these conditions, in turn, affect the U.S. economy. The first factor is what the world’s oil reserves look like and what the prospects are for adding to those reserves. The second consideration is where those reserves are and who has access to them. The final component is U.S. refineries’ ability to refine oil and get it to market.

At the end of World War II, known oil supplies stood at about 600 billion barrels, according to the U.S. Energy Information Administration. Following the war, the economies of both the United States and the rest of the world expanded rapidly, and consumption of these known supplies accelerated. However, as the result of new discovery, drilling and recovery technologies, exploitable oil reserves increased even more rapidly than demand. In 2000 a U.S. Geological Survey reported that known recoverable oil amounted to about 3 trillion barrels, a 20 percent increase over 1990 estimates of undiscovered oil (see chart 2).

Crude Oil Spot Price
Chart 1
Source: U.S. Energy Information Administration, dated brent crude oil spot prices

Even more impressive is the fact that an additional three trillion barrels of known supply exist that are as yet unrecoverable given current extraction technologies. To put this number in perspective, consider that — with reasonable assumptions about world economic growth — the known recoverable supplies of oil would sustain the current rate of consumption for somewhere between 63 and 95 years. Of course, the ability to tap these reserves is critically dependent upon who possesses them and how willing the owners are to sell their oil.

Where does U.S. oil come from?
The United States currently imports about 60 percent of the oil that it consumes. About 50 percent of that oil comes from OPEC (Organization of Petroleum Exporting Countries). Persian Gulf OPEC countries account for about 26 percent of U.S. imports, with Iraq supplying slightly under half of the oil the United States gets from this region. Interestingly, oil from Iraq today makes up a much larger portion of U.S. oil imports than it did before the Gulf War. Non-Gulf OPEC countries, and specifically Venezuela, account for about 14 percent of U.S. imports. With such a high degree of dependence on foreign oil, it is no wonder that the United States is concerned about conditions in the Middle East. The nation has a great deal at risk if oil supplies from that region, especially from Iraq, are disrupted for even a short time.

Not only are the United States, Europe and the Far East dependent upon the Middle East for oil, but that area accounts for the bulk of the world’s known reserves (see chart 3). Without a change in U.S. energy usage patterns, dependence on the Middle East for future oil supplies will continue to increase as supplies are drawn down.

Hypothetical Six Trillion Barrel World Oil-in-Place Resources Base, 2000
Chart 2
Source: U.S. Geological Survey (2000)

The ups and downs of oil prices
Currently oil is in plentiful supply (see chart 2), and the world is in no immediate danger of running out of this resource. The United States’ inability to convert crude oil into usable product, however, may have played a significant role in the run-up in domestic oil and gasoline prices during the summer of 2000 and again in 2001.

Refinery capacity has lagged behind demand in the United States, with existing refineries running at full or nearly full capacity since the late 1990s. The roots of this capacity problem were long in the making. Largely as result of the elimination of price controls and allocations in 1981, relatively small and inefficient refineries exited the industry, and refinery capacity in the United States fell dramatically. Capacity utilization of the remaining refineries increased, but virtually no new capacity was built.

Despite the rapid increase in demand for new refinery capacity during the 1990s, the combination of regulations, legal questions and economic considerations limits the attractiveness of such investment for investors and oil companies. The principal response to increased demand has been to increase capacity utilization. In 1998 measured capacity utilization reached 96 percent, a number that may even understate actual utilization given that a certain proportion of capacity is routinely sidelined for maintenance and improvements.

Global Consumption, Production and Reserves of Oil
Chart 3
Source: U.S. Energy Information Administration, Weekly Petroleum Status Report

When U.S. oil prices spiked in the summer of 2001, the situation wasn’t really an oil-supply problem. Even if more oil had arrived on U.S. shores, there was no easy way to convert it into gasoline. And varying environmental constraints on emissions meant that refined gasoline in surplus areas couldn’t always be transferred to where it was needed. For example, oil refined in Texas could not necessarily be shipped to places like Chicago because the Texas refining process might not be compatible with Chicago’s emission requirements. Therefore, because of capacity constraints, last summer’s high oil prices were probably unavoidable.

Unfortunately, current data from the U.S. Energy Information Administration suggest that the capacity utilization problem hasn’t improved. As of June 2002, U.S. refineries were running at 95 percent capacity, which is virtually identical to capacity utilization in June 2001. Operable refinery capacity in 2002 is about 16.8 million barrels of oil input per day, which is only 0.3 million barrels of oil per day greater than in 2001. Inventories are on par with the midpoint of last year’s levels.

A slippery issue
Even a cursory look at the oil supply and refining problems facing the United States suggests that a complex web of structural, production and political issues interacts to affect short-run prices of gasoline and oil-related products. The long-run dependence on the Middle East for oil remains a fact of life. A harmonious settlement of local political problems in the Middle East, as well as improvement of U.S. relations with that part of the world, is essential if shocks to energy supplies are to be avoided.

While there is clearly no demonstrable shortage of oil in the world, it is apparent that by the end of this century, alternative sources of cheap energy need to be found in order to maintain the current U.S. standard of living.

This article was written by Robert Eisenbeis, senior vice president and research director of the Atlanta Fed.

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