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Energy Voices: Insights on the future of fuel and power

Oil prices are still high. Ten reasons that's a problem.

Oil prices are still high, Tverberg writes, and will continue to be so if we expect to have more tight oil and more oil from other unconventional sources. Tverberg offers 10 reasons why high oil prices are a problem.

By Gail TverbergGuest blogger / January 23, 2013

In this March 2012 file photo, PetroChina oil rigs are seen near the banks of a snow covered lake in northeastern China's Heilongjiang province. New oil sources may help supply somewhat, Tverberg writes, but the high cost of extraction and resulting high oil prices are not likely to go away.

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A person might think from looking at news reports that our oil problems are gone, but oil prices are still high.

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Gail Tverberg, an actuary with a background in math, analyzes energy and financial matters from a perspective that the world has limited resources. For more of Gail's posts, click here.

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In fact, the new “tight oil” sources of oil which are supposed to grow in supply are still expensive to extract. If we expect to have more tight oil and more oil from other unconventional sources, we need to expect to continue to have high oil prices. The new oil may help supply somewhat, but the high cost of extraction is not likely to go away.

Why are high oil prices a problem?

1. It is not just oil prices that rise. The cost of food rises as well, partly because oil is used in many ways in growing and transporting food and partly because of the competition from biofuels for land, sending land prices up. The cost of shipping goods of all types rises, since oil is used in nearly all methods of transports. The cost of materials that are made from oil, such as asphalt and chemical products, also rises. 

If the cost of oil rises, it tends to raise the cost of other fossil fuels. The cost of natural gas extraction tends to rises, since oil is used in natural gas drilling and in transporting water for fracking. Because of an over-supply of natural gas in the US, its sales price is temporarily less than the cost of production. This is not a sustainable situation. Higher oil costs also tend to raise the cost of transporting coal to the destination where it is used. 

Figure 2 shows total energy costs as a percentage of two different bases: GDP and Wages.1 These costs are still near their high point in 2008, relative to these bases. Because oil is the largest source of energy, and the highest priced, it represents the majority of energy costs. GDP is the usual base of comparison, but I have chosen to show a comparison to wages as well. I do this because even if an increase in costs takes place in the government or business sector of the economy, most of the higher costs will eventually have to be paid for by individuals, through higher taxes or higher prices on goods or services.

2. High oil prices don’t go away, except in recession.

We extracted the easiest (and cheapest) to extract oil first. Even oil company executives say, “The easy oil is gone.” The oil that is available now tends to be expensive to extract because it is deep under the sea, or near the North Pole, or needs to be “fracked,” or is thick like paste, and needs to be melted. We haven’t discovered cheaper substitutes, either, even though we have been looking for years.

In fact, there is good reason to believe that the cost of oil extraction will continue to rise faster than the rate of inflation, because we are hitting a situation of “diminishing returns”. There is evidence that world oil production costs are increasing at about 9% per year (7% after backing about the effect of inflation). Oil prices paid by consumers will need to keep pace, if we expect increased extraction to take place.  There is even evidence that sweet sports are extracted first in Bakken tight oil, causing the cost of this extraction to rise as well.

3. Salaries don’t increase to offset rising oil prices.

Most of us know from personal experience that salaries don’t rise with rising oil prices.

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