Peak oil, cheap oil

Oil is trading at close to its lowest price since 2021 at $67 a barrel, down from a peak of $130/b in 2022. The US Energy Information Administration expects prices to fall further to $51/b next year. This is despite heightened tensions in the Middle East, and the continued threat of disruption to oil supply in the region. Today’s subdued oil prices are in marked contrast to the 1970s when conflict in the Middle East led to a quadrupling of oil prices, triggering a global surge in inflation and recessions in the West.

Why are oil prices so low today?

The outbreak of hostilities between Israel and Iran in June prompted fears that Iran might attempt to disrupt traffic in the Strait of Hormuz and led to a spike in oil prices. Prices fell back following the ceasefire between Israel and Iran on 24 June.

Supply and demand fundamentals also point to lower prices. US tariffs have dimmed prospects for global growth and demand growth in China, the world’s second-largest consumer of oil, remains subdued. Meanwhile oil supply is rising. OPEC+ has been reversing cuts to production introduced in 2022 in an attempt to bolster prices. Analysts expect a glut of oil to hit the market towards the end of the year.

Five longer-term shifts have also helped reduce the vulnerability of western economies to the disruption of energy supplies from the Middle East.

First, OPEC’s hold over the oil market has weakened. Its market share has fallen from 50% in the 1970s to around 30% today as supply has surged elsewhere, particularly in the US. Fracking has enabled the US to more than double its oil output in the last 20 years. It is now the world’s leading oil producer, accounting for one-fifth of global output.

Second, the creation of strategic petroleum reserves since the 1970s has provided a buffer against oil shocks. Members of the International Energy Agency are required to ensure oil stock levels equivalent to no less than 90 days of net imports and to be ready to collectively respond to severe supply disruptions. The UK, for instance, currently has stocks equivalent to about four months of net oil imports.

Third, economic activity has become less energy intensive. Vehicles, appliances and industrial processes are more productive, generating more output for a given level of energy input. Despite a shift towards larger, heavier cars the mpg (miles per gallon) of the average US car has doubled over the last 50 years. In countries with stringent regulations electricity consumption of many household appliances has halved in the last two decades.

Fourth, the composition of economic activity in the West has moved from energy-intensive manufacturing towards services. Even in the US, with its cheap and abundant energy, manufacturing’s share of GDP has fallen from 20% to under 10% today.

Finally, oil’s share of global energy has declined from an average of 42% in the 1970s to 30% last year. Gas, solar, wind, nuclear and coal have all increased their share in the mix. The contribution of solar and wind is relatively small, consisting of a combined 6% of global energy supply, but is growing at a breakneck rate. Solar output has risen by an average of 25% each year since 2018, doubling every three years. Energy output from wind is increasing by 12% a year. By contrast average growth in energy from oil is less than 1% a year.

In the UK solar power output so far this year has exceeded the total for 2024 due to sunny weather and the rapid rollout of panels. Plans for battery storage have surged and planning consents for new renewable capacity have reached record levels.

In the 1970s it was widely thought that the world was likely to run out of oil, causing energy shortages and driving up prices. The so-called peak oil theory did not anticipate new extraction techniques, such as fracking. Nor could it foresee the emergence of the US as the world’s leading oil producer or the reduced role of OPEC and Middle East oil producers in global energy supply.

Hydrocarbons, including oil, are still critically important for global growth. But the fact that the oil price remains subdued in the face of geopolitical instability speaks to a shift in the global energy landscape. It has been made possible by gains in energy efficiency, new technologies and the exploitation of new sources of supply. This adaptability bodes well for the transition to renewables.