Will oil prices hold at current high levels? According to a recent study, we are in an oil-price super-cycle that won’t crater any time soon.

Abdel M. Zellou, a PhD candidate in mineral and energy economics at the Colorado School of Mines, Golden, studied crude oil supercycles as part of his thesis, under the direction of professor John Cuddington. There is both acceptance of and skepticism about such supercycles. Zellou sought to identify the conditions necessary for a supercycle to arise and to gauge the evidence of such cycles through history.

A supercycle is a long cycle in real commodity prices lasting 20 to 70 years. Driving these cycles are industrialization and urbanization, which increase demand for energy commodities and metals.

About 100 years ago the U.S. went through this process as it shifted from agricultural to manufacturing to today’s service economy. The BRIC economies—Brazil, Russia, India and China—are going through this process now.

Fossil fuels, including oil, natural gas and coal, have contributed some 80% of total world energy supply for the past 70 or more years.

“The projection is that the percentage will be that high for the foreseeable future,” Zellou told a Petroleum Club audience recently in Denver. “We’re in business for a long time.”

Supercycles result from a demand and supply response. The ingredients in demand are an increase in GDP per capita; a structural transformation; a resource-intensive manufacturing sector; supply that is inelastic in the short run and elastic in the long run (for metals, the supply response is about five to seven years); a response in mineral supply capacity when expected future prices exceed long-run marginal cost; and market-clearing.

Zellou’s models identified three supercycles and one uncertain period in oil prices; they also identified a downward trend for coal prices, and an upward trend for oil. The first cycle occurred from 1850 to 1884, followed by an uncertain period from 1884 to 1966. A second supercycle stretched to 1996. We are currently in a third supercycle. “This is good news for you (producers),” Zellou said.

Other good news: “If you look at the trend, long-term oil prices are going up and have risen by 125% over the past 65 years, or by 2% per year in real terms,” he said. “This is good news in the sense that prices are rising. But, it is also bad news, because there is a battle between the scarcity of the resource—as we burn it, prices increase—and technology.

As we invest in 3-D seismic, horizontal technology and such, that decreases the cost of extraction, and prices should decrease.

If this isn’t happening, we are losing that battle—we need to do more in technology and become even better at extracting oil,” he said.

What role could alternative energy play in the supercycle?

Zellou said, “We talk a lot about alternative energy and I’m all for it, but it’s important to be fully aware of the high share fossil fuels has taken for the past 100 years, and it’s still going to be providing 80% of supply for the next 20-plus years. We need to deal with that in the most efficient way that we can.

“The best way to divvy up and grow the pie is to work together—that’s something that is sometimes hard to pass along as a message,” Zellou said.

When will this supercycle peak? Zellou’s personal take is, “It depends.” But he doesn’t see this cycle breaking anytime soon.

The current upward cycle is an expansionary phase that began in 1996 and today is propelled by the growth of the BRIC economies, led by China. Given that faster growth shortens the cycle, will the current supercycle be clipped? If China’s fast-paced, 10% annual growth is taken into account, and the past supercycle of 20 to 30 years is cut in half, that “brings us to today,” he said.

“Therefore, you may think we are at the peak. But, being at the peak doesn’t mean that prices drop like crazy. You still need a lot of time for that cycle. It may take five to 10 years or so to get back even to trend prices.”

China has a long way to go to reach a peak in GDP per capita intensity of use, making Zellou optimistic. And don’t forget Africa, he advised. “Actually, Africa is the fastest-growing part of the world over the next 30 to 50 years.

“So, the struggle is not prices, it is brains to extract oil at the lowest cost, and with the lowest risk.”

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