The Global View

Will oil prices hit record highs – or crash – in 2012?

Will 2012 be the year we see oil prices rise to crushing record highs? Or will the cost of crude collapse as doomsayers’ predictions about the death of the euro, the bursting of China’s real-estate bubble and other economic calamities come true?

We can’t tell you. With so many uncertainties and complexities in the oil market, no one can … so beware anyone who says otherwise.

There are, however, some things that can be said about oil price trends with a fair amount of certitude:

  • Oil prices and “the rest of the economy” are inextricably linked. Oil, after all, drives much of the global economy, powering the cars, trucks, trains, ships and planes that make long-distance commerce possible. When oil becomes too expensive — as we saw when prices reached a record of $145 a barrel in mid-2008 — economic health declines dramatically.
  • Conventional oil production as we’ve known it is over. Around the world, the amount of oil extracted the old-fashioned way, via conventional drilling, has been essentially flat since 2005 … as a number of energy experts and officials pointed out in a letter to US Energy Secretary Steven Chu this past October.
  • The plateau in conventional oil production has been masked by the rise in production of unconventional liquids such as oil from tar sands. While those unconventional sources might be abundant, developing them isn’t cheap. As this chart from the Oil Depletion Analysis Centre shows, the likely cost to increase production from Canada’s tar sands is in the range of $70 to $90 per barrel, while expanding US offshore drilling requires a price of $70 to 80 per barrel. For comparison, conventional OPEC supplies carry an incremental cost that starts at $40 per barrel.
  • The above-ground factors that affect oil prices — things unrelated to actual reserves, like political instability and weather — can be highly unpredictable. When these types of things go bad, oil can quickly become much more expensive. With the US alone racking up a $52 billion tab in weather- and climate-related disasters this past year, the continuing problems with Fukushima, this month’s long-awaited departure of US troops from Iraq, a power transition in North Korea and lots of saber-rattling between Iran and the west, the outlook for a quieter, more stable 2012 isn’t especially encouraging.