Long Term, Cheap Oil Is Bad for the World

Muhammad Sahimi is chairman of the chemical and petroleum engineering department at USC

Crude oil and gasoline prices have soared to a high not seen since the Persian Gulf War in 1990-1991. Oil futures have passed $30 a barrel, whereas they were as low as $9.50 about a year ago. This dramatic rise has been brought about by the success of the Organization of Petroleum Exporting Countries in lowering its oil production by more than 4 million barrels per day since last March.

The simplistic view of a layman in the West is that as much oil as possible must be produced, and it must be sold as cheaply as possible. However, the critical question is whether “expensive” oil is bad for the industrial world. Experts predict a gloomy future if oil becomes too expensive, a world characterized by recessionary economies and social turbulence. I contend that in the long run, expensive oil is good for the world. In fact, cheap oil has deep and troubling political, economic and environmental consequences.

Since most of the world’s oil reserves are in the developing countries, many factors influence their development and marketing. Oil is the nonrenewable national wealth of the oil producers. One should not expect the oil-exporting countries to deplete this resource without getting any lasting benefits in return.


At the same time, the world is witnessing a population explosion--not in Japan, Europe or the U.S. but in many of the oil-producing countries. The annual rate of population growth in Saudi Arabia and Iran, OPEC’s two largest producers, is more than 3%. Since the 1979 revolution, Iran’s population has more than doubled. This explosion profoundly affects the social fabric of the oil-producing countries. Except for Norway, every major oil exporter relies heavily on its revenue from oil sales. If the price of oil stays too low for too long, there will be social instability and even revolution in these countries and mass migration of their populations to the West. The cost of such instability to the U.S., Europe and Japan will far exceed whatever they now are paying for oil.

At the same time, technology and capital reside with the nations that import much of their oil, whereas the oil reserves, population growth and social and political turbulence are in the other half of the planet. What will happen after all the recoverable oil of these countries is gone? If these countries do not receive a fair price for their resource to develop a reasonable political and economical infrastructure, they will need massive aid to survive.

What about the economic implication of cheap oil? Cheap oil bankrupts the small oil producers and oil equipment companies, especially those in the U.S. These companies can make a profit only if the oil price is at least $16 to $18 a barrel. Cheap oil has increased the dependence of the West, and in particular the U.S., on foreign oil imports, resulting in larger trade deficits. More important, it has resulted in the loss--perhaps permanently--of more than 500,000 jobs in the oil and related industries of the U.S. Finally, it is a myth that expensive oil is bad for the economies of the U.S., Europe and Japan. Several studies have indicated that there is a negative correlation between the fluctuations in the oil price and the gross national product of Western countries. From 1982 to 1986, when oil prices were high, the economies of the U.S., Japan and Western Europe were expanding, whereas the second half of ‘80s, when prices collapsed, was marked by recession.

This, however, is only one side of the economic effect of cheap oil. Development of oil reserves is tied to the global economy. Oil-producing countries must maintain a high level of revenue from oil sales if they are to continue developing their infrastructures and industrial basis, and at the same time invest in their oil industries to maintain and develop their resources to meet worldwide demand. All of this means more jobs in the West, since the oil producers rely on the West for the necessary technology. What would happen to the huge chemical industry in the West that uses oil-derived materials if the oil reserves of the developing countries were depleted too fast? Chemical and related industries contribute one-third of the United States’ GNP.

Finally, consider the environmental effects of cheap oil. The main culprit of air pollution is fossil fuels, mainly oil, which in the U.S. accounts for 85% of fuel use. There are hidden costs of cheap oil, which we pay for through air and water pollution, global warming and acid rain.

Cheap oil induces people to overuse it and thus discourages development of alternative sources of energy that are environmentally friendly. It affects the economy negatively. It costs us huge sums in health care. It causes social and political instability abroad. Is this the world that we envision for ourselves and our children?