The coming triple-digit oil prices: most think tanks and government experts predict a price decline in coming decades. They're dead wrong.

• Author: Verleger, Jr., Philip K.

The global economy has experienced wrenching change in the twenty years since the first issue of The International Economy was published. The Soviet Union collapsed, Mexico experienced a second debt crisis, the currencies of four Asian countries collapsed, and many economic customs were drastically altered following the September 11,2001, terrorists attacks on New York and Washington.

Oil markets experienced even greater turmoil. Supplies were disrupted when Iraq invaded Kuwait in 1990. Production in Russia collapsed following the Soviet Union's disintegration. The Asian financial collapse brought crude oil prices back to 1973 inflation-adjusted levels, devastating industry investment. The war for Iraq's liberation may have permanently immobilized perhaps 5 percent of potential global crude production capacity. Hurricanes indiscriminately shut oil and gas production as well as refining capacity. Uncertainties regarding future global warming regulations delayed needed investments in additional capacity. Spreading nationalism in countries endowed with 70 percent of known hydrocarbon reserves further frustrated global efforts to boost supplies.

The chaos has led to very volatile day-to-day, month-to-month, and year-to-year oil price fluctuations, as can be seen from Figure 1. This graph charts oil price movement from 1987, when the first issue of TIE was published, to the end of August 2007. Within a year of TIE's appearance, prices dipped to $10 per barrel, a level most experts thought had been banished forever. Famously, in 1979 Daniel Yergin and Robert Stobaugh assured the public of the certainty of higher prices, stating "higher real oil prices seem assured for the future, with the only questions being how soon and how high." (1)

Less than four years later, the world confronted very high prices once more when Iraq invaded Kuwait. But again, the high prices were transitory as crude collapsed to $10 per barrel in late 1998 after the Asian and Russian financial crises.

The energy price cycles experienced during TIE's first twelve years occurred because the world's energy industry had excess capacity. This capacity was used to moderate price increases associated with supply disruptions such as Iraq's invasion of Kuwait or the suspension of exports from Iraq following the Gulf War.

Today the situation has changed radically. Global demand has grown dramatically with China's emergence, while capacity expansion has lagged. This makes Yergin's 1979 statement more plausible. Prospects for a prolonged period of lower oil prices in the coming decades are very low absent a severe recession or depression. Indeed, looking forward, it appears that triple-digit oil prices may become a regular feature of the global economy within three or four years, and soon the first digit may become something other than one. Without drastic changes to energy policies, oil-exporting countries that only eight years ago earned less than $200 billion per year may realize annual revenues as high as $2 trillion.

Six factors drive the change in the global energy system: economic growth, underinvestment, nationalism, investment uncertainty, nationalism in countries endowed with resources, and scale. First, global economic growth would boost energy and particularly oil use at near-record rates if supply were available. Second, twenty...