Oil prices tumbled in the second half of 2014, losing more than half of their value from their peak. It was the industry’s worst year since 2008, and the tumble continued into 2015. The speed and severity of the decline took most analysts by surprise. Last May, Citigroup raised its forecast for Brent crude to $109 per barrel from $103 for 2014 and to $105 from $95 for 2015, stating that “earnings headwinds in the sector look considerably less than they have for some time.” Oil prices began to tumble a month later.
The price drop may prove short-lived. Various supply and demand factors have come into play over the past several years, with new crude coming from America’s shale deposits, Canada’s shale sands, Brazil’s deep-water drilling and elsewhere even as economic growth in China and Europe slows. Now, high-cost sources of supply may be shaken out, whereas the world economy may benefit from cheaper oil. Last October, Citigroup predicted a $1.1 trillion annual boost for the global economy. While more cautious now, forecasters therefore see a return to $80 per barrel oil some time later this year.
However, the oil market has gone through a structural change and the era of expensive oil is over. Oil prices are now going to be weak for a very long time—if not for good.
Economic history is a story of the development of technology and its impact on the production of goods and services.
The most primitive economic activity was hunting-gathering, and all proceeds from the labor went to the hunters and gatherers themselves. Once agriculture and animal domestication emerged around 12,000 years ago, producers started to use tools, an early form of technology. A portion of the harvest had to go to producers of tools, and the more complicated they became, the more farmers had to pay for this technology.
Today’s agriculture is highly productive. American farms produce 260% more output than in 1950. During the same time period, the agricultural workforce dropped from 12% of the total U.S. workforce to less than 2%. This increase in yields and productivity has been achieved by a massive deployment of advanced technology, such as better fertilizer, hardier seeds, smart combines for more targeted planting, and information links to global markets.
Without technological advances, food prices would have been extremely volatile and prohibitively high; worse, Malthusian predictions of massive food shortages would have long ago come true. As things stand, food prices are remarkably stable and food is affordable for most of Earth’s population, except in the poorest nations.
The story of the economic evolution of agriculture is highly relevant for another commodity industry, oil. Demand for oil is a relatively recent phenomenon, dating back to the end of the industrial revolution in the mid-19th century. Oil has been a dominant commodity only for around 120 years, since the development of the chemical industry and the invention of the internal combustion engine. For most of that period, oil producers were the equivalent of hunters and gatherers, pumping oil out of the ground wherever it was plentiful, easily accessible and relatively cheap to produce.
Oil prices remained remarkably stable for a long time, despite growing demand. During the first 70-plus years of the 20th century, crude oil averaged less than $25 per barrel in today’s dollars. Even the 10-year spike after the 1973 Arab oil embargo and the 1979 Iranian Revolution didn’t move the average price for the century much higher. Moreover, by the close of the century, crude fell to $10 per barrel, well below its historical average.
But then came the 21st century, which opened with a 15-year stretch of record oil prices. Even though $147 oil was seen in mid-2008, peak annual averages were actually registered after the global financial crisis, in 2011–13, when crude averaged around $110 per barrel.