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Oil prices and economic growth
The
US economy attained its highest-ever postwar annual growth of real GDP,
achieving what today would be the impossible all-year rate of 7.5%, in
the Reagan re-election year of 1984. At the time, in dollars of 2005
corrected for inflation and purchasing power parity, the oil price range
for daily traded volume light crudes was about 57 - 69 US
dollars-per-barrel (USD/bbl). In late June 2005, oil prices have again
crossed the 60-dollar threshold.
Oil
prices, since June-July 2004, have broken into a system of extreme
volatility with ever higher daily, weekly or monthly peak and average
prices. The previous pattern, through Sept 2003 – June 2004, was of
regular and smooth general upward movement, with far less volatility.
This already suggests that what can be termed ‘incipient
undersupply’ or looming physical shortage is now on the horizon. The
recent book by Matthew Simmons “Twilight in the Desert: The Coming Saudi Oil Shock and the World
Economy” dates Peak
Oil to anytime now, with the bellwether Ghawar and other Saudi giant
fields now entering into decline and triggering at best flat supply, or
even a fall in total supply from the five Mid East countries of OPEC.
According to the OECD’s IEA, the US DoE and other sources, the five
Mid East countries of OPEC have the reserves in the ground to deliver
fantastic output increases by 2020.
Overproduction
by Mid East and other producers is the cause of fast depletion, and the
main driver of this is world oil
demand. World economic growth
in 2004, on IMF data published in early 2005, was the highest for over
15 years, at about 4.8%, despite – or because of - oil prices
attaining 55 USD/bbl in 2004. As oil prices increased, economic growth
rates in all regions of the world (except the Eurozone) also and
significantly increased through 2004. This trend was especially marked
in East Europe, West Asia, and the oil-importer countries of Africa and
Latin America (especially Brazil): economic growth in nearly all non
OECD countries in 2004 strongly rebounded from the lows of 2002-2003,
surprising many analysts. World trade growth in 2004 was also at record
highs.
Due
to this ‘vintage economic growth’, world oil demand growth is also
at ‘vintage’ rates, estimated by the OECD IEA at 2.68 Mbd for 2004.
There should therefore be no real surprise that oil prices, too, are
hitting ‘vintage’ levels. Despite the simple economic facts of
record economic and trade growth and low inflation, however, current oil
prices are described by J-C Trichet of the European Central Bank, by A.
Greenspan of the US Fed, and other major players as ‘extreme.’
Regular claims are made that they will ‘inevitably hurt economic
growth,’ or increase inflation, which will entrain defensive interest
rate hikes. Many analysts in fact believe interest rates can fall
through late 2005.
Increasing
realism – no more ‘supply side answers’
Since
the tripling of oil prices in 1999 from their 14-year low of around 10
USD-per-barrel, followed by another doubling through 2003-2004, we have
become habituated to announcements by OPEC that ‘big production
increases’ can be delivered. Many oil analysts with an eye on media
exposure have come in with pronouncements of the same type, claiming
that ‘new supply’ is coming any day soon. This has not happened, and
the reverse – that is shrinking supply – is increasingly likely. Oil
prices are set to continue their progression, in a context now marked by
extreme volatility.
In
fact, higher and stable oil and energy prices are a necessity for any
progress towards the urgent task of energy transition away from fossil
fuels, starting with oil intensity reduction in the economies and
societies of the OECD group. The arrival of Peak Oil, or the absolute
peak of world oil production, which is almost certain by or before 2007,
will drive home the message that there are no supply side solutions.
Durable
solutions to the growing threat of world oil markets being faced with
long-term or ‘structural’ undersupply, followed within at most 10
years by world gas supply also peaking, must and will include treatment
of the demand side. In this context, real and committed long-term energy
system adjustment, and energy economic adjustment and adaptation
strategies must be dusted off from their ‘antique’ status, and
brought forward. In many countries, in the US case dating back to
president Nixon’s ‘Energy Independence’ plan of 1974, plans and
programs for energy saving, oil intensity and oil import dependence
reduction, and renewable energy development go back more than 25 years,
that is a quarter-century.
In
all cases, these programs were shelved or ‘placed on the back
burner’ when oil prices eased back, or when good rates of economic
growth with higher priced oil were found to satisfy the public and
business. In all cases, public and political concern on the oil issue
fell back to nothing within a few years of any particular crisis event,
such as the Iranian Revolution of 1979.
We
are now facing physical shortage
rather than any short-term political embargo or supply limitation. With
the arrival of Peak Oil, we face the real prospect of permanent oil and
energy shock. In other words, those forgotten ‘emergency plans’ and
programs for energy conservation, efficiency raising, transition to
renewable energy, and restructuring towards a low energy economy,
habitat and society must this time be put into practice, not shelved
when oil prices fall back to some level judged ‘manageable.’ This
will only become crystal clear when oil and energy prices reach some
critical level, or ‘panic point’ for decision makers and the public,
perhaps in the region 75 – 90 US dollars-per-barrel. This may take
some time, and the more time we waste before ‘biting the bullet,’
the worse the adjustment conditions and circumstances will be.
The
only other solution – ‘demand destruction’ through economic rout
Without
strategies for an ‘energy lean’ economy and society, there is only
one method and type of economic adjustment to oil prices that can at any
time move very fast to ‘exotic’ highs under the force majeure of
geopolitical instability in the Mid East, in Central Asia, in Africa, or
elsewhere. This economic adjustment would be through using the interest
rate weapon, generating so-called demand destruction through intense
economic recession.
Economic
‘adjustment’ through destroying demand, by self-imposed recession is
a tried-and-tested strategy. The last time it was used widely in the
OECD countries, in 1980-83, the impact was surely to reduce oil prices
(in 2005 dollars from a peak around 110 USD/bbl in late 1979 and early
1980, to around 60 USD/bbl in 1984), but the collateral economic and
social damage was awesome. In addition, the actual oil savings generated
by this self-imposed recession was no more than about 9.6%, measured by
world demand in 1980 against 1982. Actual falls in oil demand were
concentrated in the 3 years of most intense recession (1980-82), with
oil demand continuing to grow again, from 1984, the moment world
economic growth was restored.
Unlike
today, the OECD economy entered this ‘adjustment-by-recession’ with
balanced budgets in most countries, including the USA, in 1979-80. The
financial, economic and geopolitical risks, today, from recourse to
‘the interest rate weapon’ are almost open-ended.
The
simple conclusion is that the interest rate weapon would backfire today.
Things are very different today. No ‘soft landing’ is currently on
offer. The world economy is driven by intense growth in the emerging
industrial superpowers of China and India (and other large population
industrializing economies such as Brazil, Pakistan and Turkey), in a
global economic context of increasing economic growth. In the case of
the USA, generating about 30% of world GNP and taking about 30% of world
oil imports, both public finance and trade deficits are now at all-time
record high extremes.
Hiking
interest rates, in today’s economic and financial context, would
result in near-instant world economic and financial crisis. The interest
rate weapon, today, wielded in the same way that Volker applied it in
the early 1980s would surely entrain complete collapse of world stock
markets, severe financing problems for so-called ‘emerging economies,’
runaway domino effect bankruptcy of many major service and finance
sector corporations, mass layoffs and unemployment in the OECD
countries, and grave problems for financing the structural trade deficits of especially the US and UK. The US would
expose itself to perhaps uncontrolled flight from the dollar as the
interest rate weapon firstly produced stock market collapse, with
inflationary recession as the likely outcome.
An
urgent situation due to past inaction
The
lack of action to stabilize or reduce oil intensity of the economy in
the most oil-intensive economies and societies (USA, Europe, Japan,
Asian Tigers) dates back, now, for more than 25 years. This has resulted
in ever-rising oil import dependence on ever-shrinking numbers of
exporter countries still having large export surpluses above their
domestic demand. The number of countries where oil-intensity, measured
in barrels/capita/year, has fallen since 1980 can be counted on the
fingers of one hand, in all cases for exceptional or special reasons,
such as very big increases in gas supply.
The
current situation is marked by almost unlimited upward potential for oil
demand growth in the ‘emerging industrial superpowers,’ including
China and India, as well as other large population industrializing
countries such as Brazil, Pakistan and Turkey. The close-to unlimited
upward potential for oil import demand of China and India can be
understood by a few simple figures: oil intensity per person in China
and India is respectively about 2.3 and 1.3 barrels/capita/year,
compared to over 25 in the USA and around 12 in Japan and most EU
countries. Car ownership in the USA, Japan and Europe is close to
saturation, at around 550 – 740 cars per 1000 population, but is less
than 25 in China and under 15 in India.
This
makes it certain that we are entering a new context, in which oil price
rises are virtually certain, if there is no quick-acting and deep
economic recession at the world-wide level. And we have the proof, on a
daily base, that despite the somber warnings of ‘recession due to high
oil prices’ current oil price levels, now evolving towards the 60 –
70 USD/bbl range, have done less than nothing to curb world oil demand.
In fact the exact opposite.
High
oil and energy prices quickly raise world solvent demand through
increasing revenues from production and export of ‘real resource’
commodities (energy, metals, minerals and agrocommodities) by mostly
low, or very low income countries. These countries have what is called
‘high marginal propensity to consume,’ that is, they quickly re-inject
their revenue gains to the world economy. Greater use, and purchase of
US dollars for settlement of oil and commodity trading also favors
economic and trade growth, while shielding the US dollar, to some
extent, from rapid erosion of value against other currencies.
Oil
prices will remain high
For
many reasons, underpinned in final analysis by the approach of the
ultimate peak in world oil production capacity and output, oil prices
will remain on a volatile, erratic but fundamentally upward trend. As
noted above, the interest rate weapon for reducing oil prices through
entraining a recession in reality, while its promoters would talk about
a so-called ‘soft landing,’ should be out of the question at this
time. Thus we have a de facto
context where ‘current high prices’ will necessarily be tolerated
and accepted by economic and monetary deciders for the simple reason
they have no other choice in the short- or medium-term.
This
reinforces the arguments already set out, above, for other – both new
and old - energy economic strategies and responses being utilized.
We
should not expect any immediate change-around in the basic supply/demand
situation. World oil demand has already increased by over 10 Million
barrels-per-day (Mbd) through 1999-2004, and now stands at around 83 or
84 Mbd. The underlying rate of world oil demand growth is likely well
above 3% annual, which is far above the ‘reference scenario’ used by
all energy agencies, and by the world’s major oil corporations and
major investment players, until the last 6 months-1 year. This alone
will guarantee supply shock, through underinvestment and delayed
investment, and intensifies the likely problems we have to face as we
move rapidly towards Peak Oil.
Oil
demand growth trends are well over 5%/year for all of East and South
Asia, above 4%/year in East Europe, and probably close to 3%/year for
the USA. The net result of this is that world oil demand will continue
to grow by around 2.5 Million barrels/day each year. This is close to
double the rate of the early 1990s. Concerning imports, world oil import
demand will remain well above the consumption growth rate number (due to
depletion) and can be estimated at a trend rate of close to, or above 3
Million barrels/day each year. Depending on region and country, this
will set local pricing and price trends, and natural gas-versus-oil
tradeoffs.
At
present the only bottom line of which we can be sure is that almost no
credible scenario re-enables oil prices at the 1990s ‘target price’
of USD 18-per-barrel, or OPEC’s so-called ‘preferred price’ of 22
to 28 USD-per-bbl, which by late 2004 it, and all the world’s major
oil corporations, had preferred to forget about.
No
easy alternatives
The
underlying basis for this new situation is world oil production capacity
being unable to track surging demand, oil depletion accelerating,
discoveries lagging far behind annual consumption, and the lack of both
initiatives and activity to reduce oil intensity of the economy.
In
real terms oil prices are still below their highs of the 1980-83 period.
The real limiting factors on faster economic growth in most OECD
countries do not include oil prices, but personal debt, delocalization
and de-industrialization, aging populations, fears of job losses,
terrorism, climate change and other worries in what are essentially consumption
saturated economies. There are ever fewer possible strategies for
restoring high levels of conventional economic growth on a long-term
base in the aging democracies of the OECD group. So-called
‘de-growth’ towards a sustainable economy and society are in fact
the sole logical responses to this predicament.
The
climate change issue, which will not go away, reinforces all arguments
in this paper as to the need for energy economic restructuring, with
initial goals being oil intensity reduction and energy conservation.
This
strategy will include ‘de-growth,’ and if intensively developed can
quite rapidly reduce oil intensity of the OECD countries. This in turn
will buy time for the giant industrializing economies of Asia, who for
some time will be forced to increase their oil burn. Unless the OECD
countries rapidly adopt oil saving and oil intensity reduction policies
and programs (which can be modeled on Kyoto Treaty provisions), the
potential for terminal energy crisis, or unlimited growth of oil prices,
will remain a distinct possibility. The
alternatives are somber but clear.
Conclusions
For
various economic doctrinal and economic mythical ‘reasons’ Cheap Oil
is seen by decision makers in the richer nations as the ‘passport to
economic growth.’ This is a pure fantasy.
Cheap
oil and energy underpin the service oriented ‘globalized’ economy
which drives the urban-industrial reference format, model and framework
for economic development and social progress anyplace in the world. This
in turn is a powerful motor for continued and strong demand growth for
fossil energy, worldwide. Upward potential for personal consumption of
fossil fuels is essentially unlimited in this context.
Physical
depletion is either rejected or ignored as a price setting factor for
oil and gas. Concerning oil there is mounting evidence that net
additional production capacity is decreasing every year and may soon
fall below the product of new capacity demand + annual lost capacity. By
2007-2008, and perhaps before, structural supply deficit will be a
reality on world oil markets. Before that, loss of export capacity
through accidents, stoppages, sabotage or war will produce recurring
price ‘spikes.’
Conventional
or classic economic growth will be enabled and facilitated at the world
or ‘composite’ level by rising oil prices, even to 60 – 70 USD/bbl.
Also
because of depletion, but in addition because of environment and climate
limits, energy transition away from fossil fuels must and will happen.
Price signals, in the existing economic system and framework, are needed
if this is to start, and to build from the immediate near term. Existing
and developing frameworks provided by the Kyoto Treaty offer some
potential for adaptation and direction to the task and goals of energy
transition.
© 2005 Andrew McKillop
Editorial Archives
This
article based on my article of same title published in ‘Arab Oil &
Gas’
Vol.
XXXII - N° 766 - 16 August 2003
(Arab
Petroleum Research Center, Paris)
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