The U.S. is set to overtake Saudi Arabia as the world’s largest oil producer. But don’t expect that to translate into lower prices at the pump.

Posted on November 19, 2012 by Richard


The International Energy Agency on Monday said the U.S. is on track to become the world’s biggest oil producer by 2020. By 2035, the agency said in its annual World Energy Outlook, the U.S. could get close to the elusive goal of energy independence, at least when it comes to oil.

But oil prices, the IEA said, will continue to rise, hitting $125 per barrel in inflation-adjusted terms — more than $215 per barrel in nominal terms — by 2035. U.S. consumers, the agency makes clear, won’t be shielded from those price increases, even if the country doesn’t import a drop of foreign oil.

Why doesn’t more production mean lower prices? Two reasons: supply and demand.

Oil is a global commodity. What matters for prices is total supply and total demand — not where the oil is produced or consumed. That means that even if the U.S. relied only on domestically produced oil, prices would still be dictated by global market forces.

In terms of supply, politicians tend to distinguish between foreign and domestic oil. But for prices, a different distinction is more important: OPEC and non-OPEC.

OPEC is a cartel, meaning its members collude to try to keep prices high. When prices start to fall, OPEC countries agree to cut back on production in order limit global oil supplies, pushing prices back up. Higher prices, however, induce more drilling in countries outside of OPEC, such as the U.S., which limits OPEC’s influence. The more of the world’s production that comes from outside of OPEC’s clutches, the harder it is for the cartel to control prices.

Increased domestic oil production, then, matters mostly because it adds to non-OPEC oil supply. The trouble is that even as the U.S. is pumping more oil, many other countries are pumping less. The IEA expects a surge in non-OPEC production this decade due to newly tapped deep-water and shale resources in the U.S., Canada and Brazil, but after that the world will rely increasingly on oil from OPEC countries, especially Iraq.

The other half of the equation is demand. The U.S. and other western countries are using less oil due to improved fuel efficiency, increased use of renewable fuels and other factors. But soaring demand in China and other developing countries more than offsets that decline. The IEA expects global oil demand to hit 99.7 million barrels per day in 2035, up from 87.4 million barrels per day in 2011.

If the IEA is right, the equation is simple: More demand plus less (non-OPEC) supply equals higher prices. But higher prices aren’t inevitable. Under an alternative scenario looked at by the IEA in which countries adopt policies to limit consumption of oil and other fossil fuels, prices would stay flat or even fall over the next two decades.

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