What goes up will go up some more; that is the new chapter that economists should add after watching the Oil price graph assault gravity every other day. The price of a barrel of oil has doubled since last year and 42% more than it was in December. For the first time in history, the price per barrel of oil reached the symbolic level of $135, continuing the 20% advance recorded at the beginning of May. According to the International Energy Agency (IEA), the global energy sector is evolving into a “New World Energy Order”, where demand and supply equations are changing and new active players are emerging. The US, Europe and Japan are no longer the drivers of energy demand growth as the demand side now tilts to China, India and the Middle East. These are the nations who decide how much the world will need from energy suppliers as well as the composition of energy demand including oil, gas and coal - in the last three years, the three areas represented 80% of the increase in oil demand. By 2010, China is set to surpass the US as the largest energy consumer in the world. It is projected that nearly 40% of the growth in global energy demand until 2030 will come from China and India. In the US the hurricane season which starts on June 1 is expected to be a rough one, threatening refineries and pipelines in the southern US, which could send gas prices, already nearly 20% above what they were last year, soaring even higher.

Amidst all this Oil companies are reaping a windfall from soaring petroleum prices driven largely by heightened demand from China that started in 2003. But a combination of geology and changing geopolitics means that increasing the energy supply is not as simple as pumping more of the same old crude. With rising prices making Oil a more valuable commodity than ever, petroleum-rich countries such as Russia and Venezuela have tightened control over their nations’ reserves by essentially raising the rent on US-headquartered oil companies- “resource nationalism” they call it. After several years of re-establishing state control over Russia’s oil business (and driving out western capital and technology), production is falling. Interestingly this is not the problem of reserves, but economics. Money is what keeps Russia stable (after a long time) and Putin popular, but the state has been taking too much. Meanwhile, China, India and the Middle East are subsidizing domestic oil products by $50 billion annually, so that the consumers would not feel the global hiccups. However, the consumers have not changed their consumption pattern.

The situation in Russia perfectly illustrates what goes wrong when petroleum and politics mix. If governments dictate “fairness” through nationalization, increased taxes or higher royalties, oil production falls and prices rise. When governments step back and allow the oil business to do its job, production increases and prices fall. Simple old economics you say. But the fact is that around 75% of the world’s available oil reserves are totally controlled by national oil companies and are not accessible to outsiders.  Mexico nationalized its oil industry in 1938, booting out the US and European oil firms. Mexican oil production is now declining sharply, driving world prices upwards. Moving on to Saudi Arabia, home of the world’s largest conventional oil discoveries, nationalization of private western-interests began in 1973. Because of huge reserves, Saudi production is only now beginning to decline. However Saudi and UAE have promised to pump in more into the world.

Global oil production capacity is peaking in the short to medium term and only a few countries in the Gulf Cooperation Council (GCC) can increase their production capabilities - which will only happen in the long term.  Oil production is tight as most oil producing countries, including the 13-member Organization of Petroleum Exporting Countries (OPEC) and non-OPEC, are producing at their maximum capacity. Non-OPEC countries have limited abilities to increase production.  US’ government estimates show that OPEC is pumping 33.1 million barrels of oil a day and has 2.2 million barrels of unused capacity. Of that, 1.78 million are said to be in Saudi Arabia, but there are doubts as to how much of that capacity really exists. The country is run by its ultra-conservative royal family, which is notoriously secretive about the oil on which its power depends. It has good political and economic reasons to exaggerate its reserves. The Saudis any which ways would not want to loose them on the world and in the process bring down the price of oil – the finite commodity that underpins their entire economy. The truth is that the demand in the world for oil is rising far quicker than production, which has been sluggish for the past few years. Despite predictions of a steady growth in production, the world now produces almost exactly the same amount of oil as it did in 2005.

With 50% of the world’s oil now used up, production is not getting any easier owing to higher input costs – which were driven by high oil prices at the first place. While the cost of steel and raw materials rose, the cost of extracting oil also followed it skywards – by 6% since January 2008 and by 100% since 2000. With governments in Russia and Middle East difficult to deal with, and fears that all easily extractable oil has been tapped (although an almost limitless amount of oil can be extracted from bitumen, shale and even coal through elaborate processing, which costs $70 a barrel) we are staring at a situation where prices will not fall dramatically any time soon.

With China and India’s consumption rising by 7.5% and 5.5% per annum respectively, their fuel consumption is expected to rise by 60% by 2020. State subsidies from China, India and the Middle East of $50 billion a year keep prices low and do little to encourage frugality. Meanwhile speculators and traders are having a field day pushing oil prices further up. With troubling supply data and an ever increasing and unrelenting demand from emerging economies on the back of rising income levels, a figure of $250-$280 a barrel is what the target would be in the medium to long term.

The inexorable finale is that oil prices will remain high forever. The only long-term solution is to find alternative methods of energy and fuel. Sky-high prices have made it increasingly economically sensible and viable to extract more unconventional forms of oil, in particular the asphalt-like tar sands (also known as oil sand, or extremely heavy crude oil) plentiful in northern Alberta, Canada.