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The Copernican Shale Revolution

Martin Sandbu, Financial Times

Forget what you always thought about oil

Every now and then a text slides across one’s desk that captures the elusive combination of simple and accessible analysis with profound implications. This week just such a text appeared in the form of a speech by Spencer Dale, the former Bank of England policymaker and current chief economist at BP. In very accessible language, Dale succinctly summarises the conventional wisdom on the economics of oil — which he admits he has long shared — only to argue it has been turned upside down by the technological transformation that has made the oil-locked shale exploitable.

Do read Dale’s speech on the new economics of oil in full; it will be the intellectually most fertile 20 minutes you spend on reading economics for some time. But here is a short summary.

Dale outlines four stylised facts that have been widely taken as axiomatic in thinking about oil economics: it is a resource in fixed and therefore depletable supply; demand and supply only adjust to price changes with difficulty, especially in the short run (which amplifies price swings); oil flows from east (the Middle East in particular) to west; and the Opec cartel of oil-producing countries stabilises the oil price.

Dale argues that we need to change our view on each of these. As anyone who bothers to look at estimates of recoverable oil reserves will long have noticed, oil is not in fixed supply in any economically relevant sense. What matters is not how much oil exists in the ground but how much can be extracted, which varies with technological and economic circumstances. Indeed, the more oil has been pumped out of the ground, the more there seems to be left to extract because of technological progress. The sudden (and largely unexpected) economic viability of oil extraction from shale through hydraulic fracturing (fracking) is a big but not the only part of this story.

Shale upturns the other old verities as well (Dale also has a shorter comment piece in the FT which makes these points). As he points out, the cost structure of shale looks much more like manufacturing than conventional oil extraction with its enormous fixed costs. That means (for the economists) a flatter supply curve or (for everyone else) production that can adjust much more easily to price incentives than before.

And all of this affects the geopolitics of oil too. No longer east to west: the huge increase in American production (and a reining in of demand growth) means the US is well on its way to becoming self-sufficient, and has already been overtaken by China as the world’s biggest net importer of oil. […]


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