How cheap is “cheap” oil?

By Roger Andrews

Everyone seems to agree that the world is running out of cheap oil. But how cheap is cheap? Until we know it’s hard to say exactly what the world is running out of, or indeed if it’s running out of it at all.  Clearly what is needed is for someone to put a dollar value on cheap oil, and here I do my best to come up with a number.

Before we can start we need a definition of “cheap”. Webster’s defines it as “worth more than the price paid”, which is probably as good a definition as any, so we will use it. But how do we define when oil is no longer worth more than the price paid, i.e. not cheap? When the world stops buying it. There is of course no exact point at which this occurs; in theory oil will become progressively less “cheap” as the price rises and consumption growth will decrease progressively as a consequence. However, there will come a point at which the oil price becomes high enough to turn consumption growth negative, and for the purposes of analysis I’ve picked this as the “cheap” oil threshold.

Using this criterion we will now look briefly into the question of where this threshold might occur.

First the basic data for reference. Here’s a plot of world GDP, world oil consumption and oil price (West Texas crude) since 1965. Note that GDP and oil price are in current dollars:

Next is a plot showing the percentage of its income the world has historically spent on oil, calculated by dividing the value of the oil consumed by world GDP. Between 1965 and 1974 the world spent less than 2% of its GDP on oil. Between 1974 and 1980 the percentage quadrupled to 7.5%. Between 1980 and 1986 it fell back to 2%. Between 1986 and 2003 it oscillated around 2%, dropping briefly to 1% in 1998. Since 2003 it has doubled to around 4%:

The next plot superimposes world oil consumption on these percentages. Since 1970 there have been three abrupt oil price increases that coincide with significant decreases in consumption. First was the “oil shock” of 1974-1975, which was followed by a brief decline in consumption after years of continuous growth, second was the the oil shock of 1979-1980, which was followed by a more prolonged decline, and third was the consumption decline during the “great recession” of 2008-2009, which coincided with the 2008 spike in oil prices (note that the percentage of world GDP spent on oil is a proxy for oil price over the short-term).

There’s a strong relationship between expenditures and price (R squared = 0.73) over the period before 1986, with the trend line going negative when the world spent more than 5.5% of its GDP on oil, which is our definitional threshold for “cheap” oil. Based on these results we might therefore conclude that before 1986 oil ceased to be “cheap” at around $20/bbl, which is the approximate average price level at which the 5.5% threshold was reached:

But since 1986 the picture has been quite different. The trend line is close to flat and doesn’t cross zero until the world spends ~8% of its GDP on oil, which with the world now spending 4% of its GDP on oil equates to an oil price of about $200/bbl. So according to our definitional scheme and based on the most recent 28 years of data the cheap oil threshold is now $200/bbl.

This crude estimate is of course subject to considerable uncertainty, but if we assume it’s correct then the question becomes; how long might cheap oil last if oil is still cheap at $199.99/bbl? I’ll leave that for someone else to figure out.

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49 Responses to How cheap is “cheap” oil?

  1. Euan Mearns says:

    Roger, this is a slide made by Nate Hagens a number of years ago comparing items that all cost about $100. And so I think in this context we can consider $100 to be cheap.

    • Joe Public says:

      But we buy ‘things’ not for what they are, but for what they ‘do’ for us.

      5 maybe 6 out of the 7 items in the photo are, I suggest, to boost an individual’s ego. Certainly those 6 are not purchased solely for their utility.

      Interestingly, items of similar practical usefulness can be purchased for a tenth the price. But not oil, of course.

    • Roger Andrews says:

      Euan: Nate’s graphic is amusing but misses the point. All of these things cost $100, but how many of them are worth $100? I submit the barrel of oil and that’s it. (Catch me paying $100 for a pair of embroidered jeans.)

      Joe P gets the point.

      • Euan Mearns says:

        Some may recall this slide from my post “Energy and Mankind Part 3” (Google title to find the post). Note that 23.5 g of oil has the energy content required to replace a Man working for 8 hours.

      • Euan Mearns says:

        Roger says: “All of these things cost $100, but how many of them are worth $100? I submit the barrel of oil and that’s it.”

        Well, pricing a barrel of oil off the human labour that it substitutes for indicates a value of $933,000 / bbl. I further submit that jeans cost $100 / pair and that their value is determined by what is inside them. It is entirely feasible that Roger may pay $100 for a pair of embroidered jeans and that the value goes down when he puts them on 😉

      • Euan Mearns says:

        “All of these things cost $100, but how many of them are worth $100? I submit the barrel of oil and that’s it.”

        But on a slightly more serious note. What Roger said here is that oil (or energy) is equivalent to real money – we agree on something at last 🙂

        • Euan, now that I’ve taken my embroidered jeans off, what exactly is it that we disagree on here?

          • Euan Mearns says:

            Roger, I don’t think I would use your last chart to constrain anything. The interesting observation is that it is virtually a horizontal line. That leads to the conclusion that there is zero price constraint on demand for oil. $933,000 here we come. Dig a hole in Ghawar and use a chain of human slaves to pass down buckets – which echoes a comment I made on TOD many years ago.

            The limiting factor on oil production will be system chained ERoEI.

          • Euan: I think we’re better off with a gentle downslope. The trend line can’t keep going horizontally for ever. It has to turn down somewhere. Let’s assume that there is a price constraint, but only a weak one. The human slaves will thank us.

          • Euan Mearns says:

            Roger, I think you need to consider the possibility that the relationship is non-linear. If demand growth is strong and this meets static supply growth then the price (% of global GDP) may rise exponentially until a recession is created reducing demand. So the trend may look horizontal but may suddenly turn down.

  2. Euan Mearns says:

    Roger, one interesting angle of your approach here is that you see oil demand going negative at $200. And so this is in effect a peak demand scenario that you paint, a concept I have warmed to over the years. At $200 the world economy is either in such dire straits that demand for everything collapses. Or $200 promotes large scale substitution – nuclear power and electric cars. We have to note that the run in prices from 2002 to 2008 was from $20 to $100 – a five fold increase. $100 to $200 is a mere doubling.

    Perceptions of cheap vary according to which side of the fence you sit. Presently, for many producers, $100 is too cheap whilst for many consumers it is too expensive. I believe the North Sea requires something close to $150 today to survive.

    I note that in the 1980s, the % of GDP spent on oil was 5.5% before demand went negative. Now it is 8%. May I suggest that the shift may be due to energy efficiency gains. As we approach $200 perhaps efficiency stretches the target to 10%?

    • Roger Andrews says:

      Hi Euan:

      How one views oil price increases since the first “oil shock” depends to a large extent on whether one plots oil prices in current dollar or constant dollars. Take your pick:

      I think that the ~5.5% to ~8% increase is partly a result of efficiency gains and partly a result of more people having more money to spend, or at least being more willing to spend it. Whether future efficiency gains will offset consumption growth from China and the rest of the developing world, however, remains to be seen. There are some frightening predictions of the numbers of cars that will be circulating in China by 2050:

      And the fact that the world has been willing to spend anywhere from 1% to 7.5% of its annual income on oil over the past 50 years without batting too many eyelids is, I think, a lesson in itself.

  3. Sam Taylor says:


    Are you familiar with the work of Steven Kopits? He gave a very illuminating talk on the oil supply supply/demand dynamic earlier this year, which you can view here:

    He argues rather persuasively that the demand destruction ceiling is not that far above $100.

    Could you also tell us the R^2 for your final chart? I would have to imagine the error bars on that 8% figure are pretty wide.

    • Sam: Kopits draws two conclusions that I think put the issue in its true perspective:

      Demand-constrained models dominate thinking about oil demand, supply, prices and their effect on the economy

      The data have not supported these models in recent years; the data do fit a supply-constrained model

      I plan to put up another post on this, if Euan doesn’t fire me in the meantime, that is. 😉

      The R^2 for the final chart is 0.04 – very low because the line is close to flat, and yes the errors are pretty wide as a result (I estimate between $150/bbl and infinity). However, the fact that the line is so close to flat is an indication it itself, suggesting as it does that the world is still a long way away from losing its thirst for oil.

  4. bobski2014 says:

    Looking at Figure 1 I couldn’t make out how GDP could grow exponentially, while consumption appeared to be approximately linear.
    Am I right in thinking that this is an expression of consumption being in physical units (bbls) while GDP is being measured in current US $ which does not necessarily equate with the production of more “stuff” ?

  5. Ralph W says:

    Oil is cheap when it can be used to generate a good economic return for the investment in its purchase. So $20 oil is not cheap if you are using an SUV to daily drive 40 miles to do a job that pays $10 a hour. Hence US total miles traveled by such cars are falling. However, $100 oil is cheap if you are a farmer in developing country using it to pump water for your crops, or driving your crops to market 20 miles away, providing you are getting a good price for those crops, and given the continued population rises in many parts of asia, those prices are sustained.

    First world oil efficiency is very poor when compared to the economic activity generated. Hence the stalled economic growth in OECD nations. The US has benefited from cheap NG for a few years now, but that is an economic bubble close to bursting. New oil developments, be it shale oil, deep water or tar sands are all marginal at best at $100/barrel. Investment by the oil majors is falling, and once the shale bubble bursts so will investment in fracking. In practice the subdued demand in Europe, and impending recession in China as economic reality catches up with their infrastructure building bubble, will cause oil prices to decline just far enough to trigger major collapse in oil company finances, and we will see sharp declines in global oil production in the next few years.

    Then peak oil will be indisputable.

  6. A C Osborn says:

    As Euan alluded to at August 20, 2014 at 9:20 am the main use for oil is Transport, which for general use (not Sea or air travel) compared to 50 years ago is between 50% and 100% more efficient. That has gone a long way to offsetting the increase vehicles in use and thus demand.
    Oil is not used very much for Energy generation and shouldn’t be, as Electric Hybrids get cheaper they will use even less fuel than today’s average vehicle.
    Currently the USA vehicle fuel prices are extremely low compared to the Eu countries, how much longer can those prices stay low allowing them to continue driving Gas Guzzlers?
    The USA oil consumption can be significantly decreased just by engine downsizing.
    Does anyone have a scale of which areas use most fuel, ie
    Land Transport
    Air Transport
    Sea Transport
    I can see that eventually the primarary use for Oil will be Lubrication as other sources of energy replace oil for transport, think Amonia/Hydrogen Fuel Cells, small cold fusion devices etc. Thus demand for oil will fall dramatically.

    • Joe Public says:

      “Currently the USA vehicle fuel prices are extremely low compared to the Eu countries, how much longer can those prices stay low allowing them to continue driving Gas Guzzlers?”

      Depends upon how greedy the government chooses to be.

      As per the Torygraph:- British drivers pay a higher rate of tax on fuel than any other motorists in the European Union, according to a new study. For every litre of unleaded petrol bought in the UK, 61 per cent of the pump price goes to the government as fuel duty and VAT along with 59 per cent of every litre of diesel.

      • Ralph W says:

        UK tax on fuel has been declining in percentage terms since 2001, when the lorry drivers blockaded refineries and forced Tony Blair to drop the fuel tax escalator introduced by the Tories. No chancellor has dared permanently reinstate the index linking of the tax, let alone the escalator component since.

        This is still a large tax income, and it has enabled other UK taxes to be lower in proportion for the same level of government spending. High UK and European fuel tax has done wonders to improve fuel efficiency of our vehicles and soften the price shocks of sudden oil price rises.

        Globally land transport is the largest single use of oil, but land, air and sea generally use different fractions of the same barrel of oil, with ships using heavy ‘bunker oil’ and cars lighter petrol. Trucks, some cars and jet aircraft use middle fractions to make diesel or jet fuel.

        Per tonne mile, sea transport is by far the most fuel efficient, as the bigger the ship, the more efficient it gets. Further efficiency gains are largely limited to reverting to wind power to supplement fossil fuel, and sailing more slowly, as fuel cost increases with the square of speed.

        Air travel on a mass scale is not possible with any other fuel, and as the supply of middle fraction distillates will decline fastest once we go over peak, aviation is liable to collapse as an industry.

        Land travel needs to be divided into domestic and haulage. Haulage is largely diesel powered and already close to efficiency limits. Domestic is largely petrol, has a higher degree of discretionary consumption, and has significant efficiency savings possible by simply driving smaller cars more slowly and more carefully. I’m sure half of US petrol consumption could be cut if the US drove european small cars and were less aggressive in their style.
        If we were prepared to sacrifice some crash safety and cut speed limits, even Europeans could halve their petrol/diesel consumption.

        • Lars Evensen says:

          Ralph W,

          interesting summary, but could you explain why “the supply of middle fraction distillates will decline fastest once we go over peak”?

          I am curious, this sounds very odd to me. Isn`t a barrell of oil still a barrell with the same distillates even after the peak?

        • Euan Mearns says:

          Lars, global oil production is marching away from light sweet crude towards heavier grades. Brent (light sweet) is gone. The Clair, Bentley and Mariner fields I was talking about the other day are all heavy crude. The new fields coming on in Saudi are heavy crude. Heavy crude is depleted in the gasoline and diesel / kerosene fractions (distillates). And so the world is going long on tar and short on gasoline. The heavy crude can be refined into lighter fractions using hydro crackers – but it is expensive and energy intensive. The UK lacks capacity to refine heavy crude and thus all the new oil we produce will be exported and we will import light sweet from wherever we can get it – Russia and Norway.

          Different countries in fact are set up to use different proportions of gasoline and diesel – it depends how their refineries were set up decades ago. Refining is dying in Europe as new refineries are built else where – China, Russia and Saudi Arabia. New refineries will be fit for purpose while decades old European refineries no longer are. Thus we are heading towards a world where Europe will cease to import crude but much higher priced refined products instead.

          • Lars Evensen says:

            Euan, thanks. I didn`t think about that. You mention Russia. With the situation in the Ukraine I suppose European governments are playing with fire since the Russians after all supply the EU with 3,5 million b/d or so of light, sweet crude. In the news it`s mostly about Russian natural gas, almost noone talks about their oil.

            Also I suppose what you are basically saying is that the new heavy oil fields being developed in the UK do little to enhance your energy security since it cannot be refined at home.

          • Ralph W says:

            Very light oil (US shale oil) is also increasing. This is so light it is more or less condensate – too light for diesel and marginal for gasoline. The US refineries are built more for heavy oils, which they import from Canada, mexico and Venezuela, making gasoline from their own use and diesel which they export to UK/Europe. The shale oil is too light to be used efficiently in the local refineries so the drillers want to export it to Europe where they would get a better price for it. Currently crude oil exports are banned in the US. This leads to media hype about US being a potential oil exporter, when the reality is they are still the world’s second largest importer after China.

    • Roberto says:

      «Small cold fusion” does NOT exist!


      • A C Osborn says:

        I do not mean Cold Fusion per se but the devices that are currently being built that use LENR, like Rossi, Brillouin, Focardi and the Papp engine. All of them are supposed to use alternate fuel systems/technology.
        They are limped together under “cold fusion” even though that is not the process that they actually use.

        • Roberto says:

          I correct myself… “LENR does not exist”.
          The major experts in LENR came to VERN and did not convince a single physicist.
          Mother Nature has decided differently.


          • A C Osborn says:

            Perhaps you would like to take it up with these NASA scientists then?

            Why don’t you tell them that they are wasting their time.

          • A C Osborn says:

            Perhaps VERN should get together with the people listed on page 4 of this article instead?

          • roberto says:

            Dear A C Osborn, reply to 3 messages here above:

            1) Over matters of designing and running rockets and space shuttles I’d take NASA over CERN any day, but on matters of judging nuclear reaction cross-sections I’d take the world-reknown CERN over NASA any day, if I were you… (my apologies for mis-typing VERN in place of aCERN earlier…).
            The goths of LERN has come to CERN about 2 years ago (you can easily find the full video and all presentations) during a full day, and they have not convinced a single one of the many physicists who were cramming CERN’s auditorium;

            2) Mitsubishi’s filed a patent? So what? There’s plenty of patents who have never generated a single working device or process;

            3) The list of supporters of LENR is long, but the only two real “bigs” are Schwinger, a theoretical physicist who died 20 years ago… and Brian Josephson, another theoretician who also supported Benveniste’s “water memory” and explanations based on paranormal effects… ’nuff said…



      • A C Osborn says:

        There is also another development that defies what was current science, it is called the EMDrive, first developed by the englishman called Roger Shawyer in 2001, the science has been confirmed by China & NASA, there is a very similar device (dare I say copy) by Guido P. Fetta, the CEO of Cannae LLC, called Cannae drive.

        • Ralph W says:

          They are ALL smoke and mirrors. Take that from a science graduate. There are NO easy sources of energy waiting to be tapped.

          • A C Osborn says:

            So the EMDrive is smoke & mirrors, try telling that to Scientists who have already graduated.
            It provides thrust without a Propellent, something that is considered impossible as it supposed to defy the conservation of momentum, a fundamental law of physics

          • roberto says:

            @A C Osborn:

            I don’t know what your background is, but mine as a physicist, after having read the paper you’ve linked, tells me that these guys have not broken ANY known physical laws or principle.
            They simply find that if they put 1 W of microwave power they get 1 mN of thrust… hardly a breakthrough capable of changing things around much.


          • A C Osborn says:

            So you do not recognise “No Propellent” as a breakthrough then?
            The system is Closed, so there should be no Thrust.

          • A C Osborn says:

            PS, my background is just a lowly Engineer, but I have an interest in all things Scientific, especially anything that goes against Concensus thinking. There have been too many breakthroughs in Science, Engineering and Medicine that contradicted the mainstream Concensus of the time, so I follow most thinbgs that take my interest.
            Do you think Svenmark’s Cosmic ray theory is correct for instance?

          • roberto says:

            @A C Osborn:

            “Do you think Svenmark’s Cosmic ray theory is correct for instance?”

            May be, may be not… I don’t know ity enough to take a stance… I apply the rule “take a position on scientific matters only after you’ve studied them enough to understand the issues at stake”.

            Anyway, concerning cosmic rays, there’s still a lot to learn and a lot to explain… four instance here at CERN we have the control room of the AMS-2 experiment…


            … and the CLOUD experiment too…


            … but I would hardly call myself an expert in cosmic rays of climate-inducing aerosols.
            Fact is that Mawwell’s equation are known since more than one century and tested to spectacular precision… so there’s not much more left around to discover with/about them.


  7. Glen Mcmillian says:

    Any discussion of the point at which oil becomes so expensive that the either the economy crashes oerdemand contracts without a crash is almost pointless unless a time frame is mentioned.

    For what it is worth I personally believe that one, two hundred dollar oil in the short term would be a stake thru the heart of the world economy and two, that given time enough- perhaps twenty years for a ” scientific wild axx guess”- we can adapt to two hundred dollar oil without lowering our life style very much except maybe in a few respects such as flying to grandma’s house.

    My seat of the pants instincts tell me that our chances of a successful adaption to another doubling of oil prices will depend on the price of oil rising slowly but steadily so as to give people and businesses plenty of warning and plenty of time to adapt new ways and habits.

    There can be no question whether doubling our efficiency of use can be accomplished. The technology exists and is in widespread use already today.

    Trains can take the place of long distance trucks and cars can be lightened and made smaller easily enough.Pure electric and plug in hybrid cars and light trucks will be very common because battery prices will come down. The high power battery market is still wearing short pants.

    People will drive less and share rides more often and live closer to work. Work will move closer to people in some cases. There is real reason why a barbershop or one horse plumbers business cannot be run out of the garage at a Mcmansion. A lawyer, accountant , or engineer can work from a home office at least part of the time.

    Oil furnaces can be replaced with heat pumps.

    Consumer and industrial products made from oil can be recycled and or simply made to last in the case of consumer goods.Packaging will continue to get lighter and thinner and deposits can be required so that bottles are refilled.

    The possibilities are endless.

    GM crops will require substantially less fertilizer and fewer trips thru the field with farm machinery for a given yield.

    The question is whether we will change our ways fast enough to stay ahead of rising prices and rising population and demand in the developing world.

    • Euan Mearns says:

      For what it is worth I personally believe that one, two hundred dollar oil in the short term would be a stake thru the heart of the world economy and two, that given time enough- perhaps twenty years for a ” scientific wild axx guess”- we can adapt to two hundred dollar oil without lowering our life style very much except maybe in a few respects such as flying to grandma’s house.

      Glen, this is pretty well how I see things. We just lived through Act 1 of peak oil and it was exciting to follow it on The OIl Drum. Act 2 is being written. There will be some exciting scenes along the way. But with adaptation, and time to adapt, its possible the actual event of the global peak in oil demand comes and goes without too much notice being paid. This could of course be because the world has gone to Hell in a hand cart.

      There is still plenty interesting stuff to discuss and report on in the energy / resource / population / economic / political world. But I don’t think waiting for peak oil, like waiting for the financial crash, or waiting for global warming is the answer.

      When I first started posting on The Oil Drum I used the monicker Cry Wolf

      • Sam Taylor says:


        I can’t say I’m looking forward to Act 3 all that much. I rather suspect it’ll turn out to be a tragedy. Peak oil is but one arrow in a rather full looking quiver, these days.

        Ah well, not much one can do.

      • Roger Andrews says:

        A little bit of good news. The world now creates almost twice as much wealth from a barrel of oil as it did before the first “oil shock” in 1973 and the trend continues upwards:

        • Sam Taylor says:


          I’d be interested to see how much debt we create per barrel as well. And then global debt/gdp ratio. I suspect the latter is declining rather rapidly. I suspect that rather a lot of that gdp is in the form of electronic money, which will never be realised into any objects of real value.

          • Sam: I don’t think oil creates debt. I’m not even sure oil creates wealth any more. The way it works these days is that world economy expands, driven by whatever, and oil production struggles to keep up. In short, wealth now creates oil.

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  9. Rui N Rosa says:

    Roger and Euan:
    Very important subject. Just read and it comes back to fundamental issues rather complex too.
    Not making it too complicate, I thought that Incorporating in your analysis natural gas too, might improve and clarify a bit. Natural gas growth as primary energy source, already at 2/3 of oil, and in specific/ complementary applications, might improve the analysis and results.
    Another point is that valuing at spot price is not imparcial. Most oil and gas is consumed domesticly not internationally traded. How to value it (in monetary terms)? May be by accounting the oil and gas industry assets, sales or whatever.

    • Roger Andrews says:

      Rui: The problem with incorporating gas in the analysis is that the price varies enormously from place to place, as Euan’s graph shows:

      Do you have any information on how much of global oil production is sold domestically and how much exported?

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