Oil Prices in 2012

The price of oil is setting a new record every week, it seems.  Everybody wants to know what's going to happen in the next few years.  Will it keep rising?  How high will it go?  Of course that's impossible to answer with any accuracy because of poor reserve data, the obscure intentions of oil producers and elasticity effects that lead to demand destruction or substitution. However, it is possible to do simple-minded extrapolations of recent price behaviour to see what might happen if various trends continue.

Just for grins I extrapolated the price of oil (currently trading at about $125 per barrel) out to 2012 using Excel's trend line functions. I examined two cases. The first uses weekly price data from 2002 to the middle of 2006, the second extrapolates the trend  from the beginning of 2007 until mid-May, 2008.  I chose these periods because to my eye they exhibit relatively coherent trends and show significantly different behaviour.

The price data came from the EIA archives.

Here is the actual oil price data for the last ten years:



In the above graph you can clearly see that the two baseline periods -- from 2002 until mid-2006, and 2007 until now -- appear to represent very different price regimes.  Obviously different factors are influencing the price behaviour in each period.

My interpretation is that the earlier period represented a gradual tightening of the oil supply as the developing economies in China and India picked up steam.  The increase in supply failed to keep pace with the rising demand, with a resulting rise in prices.

In contrast, the steep increase since January, 2007 represents a combination of factors:  a flow of money into the commodity markets as the American housing bubble burst; continuing growth in China and India"; and oil supplies lagging further and further behind demand.  However, there is one new factor that appears to be playing a major role: the dawning awareness on the part of crude oil buyers that "Peak Oil" is happening now, and as a result the world oil supply situation is unlikely to improve significantly from this point on.

I first looked at the trend from 2002 to 2006, since that was when there appears to have been the first significant upward break in the overall price trend:



If this trend had held (meaning that the price rise since 2007 had been an anomalous spike, and that the price rise would revert to the previous trend) we could have expected a price of $250 per barrel in 2012.

Now, $250 oil within four years is ominous enough, but at the beginning of 2007 there was another major upward break in the trend that is still continuing.



If the trend since the beginning of 2007 reflects the new underlying reality of the oil markets, we should expect to see oil selling for $900 per barrel by the beginning of 2012. That's less than four years from now.

The thing that's most interesting to me is just how extreme the change in trend has been in the last 18 months. Since the beginning of last year all bets have been off.  If an appreciation of Peak Oil on the part of the world's oil buyers is playing a role in this new price behaviour, we might expect the upward pressure to intensify further as this awareness spreads over the next year.

Given the recent price behaviour, I'd expect to see major effects of demand destruction world-wide within the next two years. That may flatten the curve, but it's clear that demand destruction could kick in well before any effective global energy substitution program can gain traction.

The price escalation may happen too fast for any adaptation to fully maintain the transportation dependent sectors of the global economy.  And what will this chain of events do the global economy? Demand destruction means less industrial output, less economic activity and lower national GDPs. Oil prices will go down because global GDP declines, so the recession-driven reduction in oil prices can't be seen as a positive outcome.

Some of the recent oil price rise may also be due to speculation, and reducing the opportunities for speculation might dampen the price increase without impacting industrial activity. I'm on record as saying I don't think speculation is playing a major role in the recent price rise, but even if half the current trend is due to commodity speculation, we're still left with $500/bbl oil some time in 2012.

Most of the people who are touting "solutions" -- whether it's technological Business As Usual dreams like electric cars or even powerdown proposals like electric rail -- don't seem to appreciate just how close to the edge we really are.

May 22, 2008
© Copyright 2008, Paul Chefurka
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