Why Oil Prices Will Drop

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Not very long ago, energy companies were slashing their exploration and drilling budgets, refusing to finance any project unless it could generate crude for $15 or $20 a barrel. But since 2003, when the price of crude rose above $30 a barrel, the industry has relaxed its financial assumptions and beefed up capital spending. In the past four years, Exxon Mobil, the world's largest oil company, has invested more than $60 billion in exploration and development. Between now and 2010, the company plans to begin pumping oil or gas from no fewer than 20 new projects.

Besides Canada, the oil majors are also returning to areas that weren't economically viable when oil was cheap, including the Arctic Ocean and the deep waters of the Gulf of Mexico. The industry's efforts aren't confined to searching for new reserves. It is also investing heavily in high-tech imaging machines and steerable drills that raise yields from existing reservoirs, where historically only the most readily available crude, typically 30 to 40 percent of the total, was recovered. (Extracting the rest was considered too costly, so it was left alone.)

When experts claim that oil is running out, what they really mean is that cheap oil is running out. About this, they may be right. Outside of Saudi Arabia, Iraq, and a few other countries, it is no longer possible to recover large quantities of crude for a dollar or two a barrel. But there are plenty of places where oil can be produced for $20 or $30 a barrel, let alone the $100 range where it has been trading recently.

And the list of potential substitutes for crude is long. Natural gas can be converted to a liquid fuel that produces few pollutants. Venezuela has big reserves of tar sands, as does Utah. Neighboring Colorado has oil trapped in shale, which industry engineers are trying to extract by slowly heating the rock under the Green River Basin. Corn, sugar, and potatoes can be distilled into ethanol, a perfectly good transport fuel, as can wood chips, straw, and other biomass. And as demand for ethanol has surged in recent years, farmers throughout the Midwest have taken advantage of generous federal subsidies to convert their fields to corn, the price of which doubled in the past 18 months. (When oil prices fall, such crop switching may prove to be a costly mistake.)

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