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PEAK PRICE OIL AND THE ECONOMY (Oct 2004)(re-edited Nov 2008) With every dollar rise in the oil price, an ‘expert’ on the economy and business will be there to pontificate that “High oil prices hurt growth”. No supporting evidence is provided, except to claim that “during the oil shocks of the 1970s trillions of dollars of GDP was lost by the OECD countries”. More rational arguments, eg. that very high oil and energy prices will cause a deflation shock, or inflation shock, or will reduce consumer spending on non energy goods and on services, are not usually mentioned. Much is made of claimed ‘evident fact’ that high oil prices reduce consumer confidence, and investor confidence: today therefore (Oct 2004), with a barrel at over 50 dollars (whatever the dollar itself may be worth !), it is widely claimed that economic players will take fright, stop spending, and drag the economy down. Actual, real world economic trends, such as record industrial growth and capital investment in oil importing China and India, in the new EU nations of E Europe, in Russia, Brazil and elsewhere, the fast growth of world car and airplane, and bulk cargo ship construction, massive growth of the world urban development and public works industry, and so on, are given short shrift. The goal of the ‘Cheap Oil fraternity’ is to highlight the angst and fear generated by high priced oil. These ‘experts’ always end with a sombre warning: unless prices can be brought back down to what they call reasonable levels, things will get worse. In simpler terms, any low price for oil and energy will do. Petro Keynesian Growth Real facts are always lacking in the discourse of the Cheap Oil fraternity. One easily-checked economic fact they will surely economize on is the following: the US economy attained it highest-ever postwar growth of real GDP, achieving what today would be the completely impossible all-year rate of 7.5%, which is about 3 times the US economy’s average annual growth rate through the 1990s when oil prices were low, in the Reagan re-election year of 1984. In 1984, in dollars of 2004 corrected for inflation and purchasing power parity, the oil price for light, low sulphur crudes was around USD 58 – USD 68/barrel. Lower quality, heavier and higher sulphur crudes typically sold at around USD 50 to 55/bbl in 2004 dollars, at that time. This type of simple economic fact has almost ‘samizdat’ status, being close to unmentionable in the popular, and specialized media, exactly like Peak Oil until very recently. Today’s epochal and vast economic growth of India and China, for example, takes place in a framework of steadily rising oil prices – and also causes oil prices to rise. Very simply, the “oil tax” levied on the OECD countries, and increasingly on China, India and other oil-dependent industrialising and urbanizing nations, is recycled into the global economy. Rising oil prices create new and solvent demand in former, or continuing lower income societies and nations, for example exporters of non-oil mineral and agricultural commodities, for which prices are buoyed by higher energy prices. These ‘players’ have a high propensity to consume and therefore, in very classical Keynesian terms, this serves to increase world economic growth. My term for this process – which also generates more liquidity through increased demand for US dollars to settle oil purchases - is Petro Keynesian Growth. But we can however take another tack and argue that conventional or classical economic growth is far from being a synonym for human wellbeing and cultural progress. Climate change impacts of burning about 10 or 11 Bn tons of carbon, in fossil fuels, every year, are quite easy to analyse and forecast. Resource wars, as we know from the tragic case of the Iraq invasion and its military occupation, are most certainly intensified by oil hunger, or greed. The constant pursuit of economic growth and the consumer society almost surely runs against and compromises the sustainable economy and society. The Mother of coming recessions – The 1980-82 recession If we check the ‘oil shock recessions’ as these are called, even in economic journals, where some ‘experts’ sometimes add there are even moral grounds for seeking the manna of cheap oil because “High oil prices hurt poor countries more than rich”, these recessions were each totally different in their depth and severity. The first ‘oil shock recession’ started in late 1973 and was over by early 1975, following a 295% price rise for oil. Apart from a ritual and big fall of stock exchange indices, actual economic activity, and employment were not much affected in most OECD countries. This almost purely financial or stock exchange crisis, to be sure, was retrospectively claimed as due to the first Oil Shock, when in fact this supplied a glorious opportunity to frenetically mark down stock prices. Without the figleaf of Oil Shock, this sequence of ‘classic stock exchange crisis’ again happened in 1987. In both cases, economic growth rates fell, but in neither case by as much as during the 1980-82 recession. We can for example note that by 1975, most OECD countries were experiencing economic growth at 3.5% or 4%/year (in real terms, after inflation), much higher than typical OECD growth rates, since at latest 1990. Following the 1987 stock exchange crash, after a ‘ritual’ period of economic stagnation of no more than about 9 months, another, but rather weak period of economic growth was born, in the OECD countries. Cyclic analysis and intepretation of these recessions, including 1980-82, are at least as convincing as arguments for an Oil Shock trigger. The 1980-82 recession was vastly deeper. This was the real ‘Mother of Recessions’, during which unemployment shot up in all the OECD countries, and the economy actually contracted, year-in and year-out for nearly 3 full years. Not unsurprisingly, world oil demand actually fell for 3 consecutive years – for the first time in the entire period 1945-2004. World oil demand fell by about 9.6% in cumulative terms, through 1980-82. By the rate of business failures, bankruptcies, rise of unemployment and other indicators, the 1980-82 recessions was the sharpest since the 1929-31 period, when the world entered the 7-year Great Depression. The ‘oil linkage’ or ‘trigger factor’ is more than somewhat tenuous, concerning prices. Oil prices in 1979-81 increased about 115% in nominal terms (before inflation correction), attaining over USD 90/barrel (perhaps more than 100 USD/bbl for certain contracts) in 2004 dollars, but the gold price, in 2004 dollars exploded to about USD 1400/Troy ounce ! Compared with 1973-74 and the very rapid 295% increase in nominal prices, the 115% rise through the 3 years 1979-81 was apparently sufficient, we are told, to produce or generate a much deeper, and longer lasting recession. We can compare this price rise with what has happened through 1999-2004: during this period, oil prices have increased about 400%, with an increase of around 50% in the period January-October 2004, and by about 900% in the period 1999-2008. This has however occurred in the absence of extreme high interest rates (the case in 1980-82); and without the extreme geopolitical tension, given daily media attention bordering on hysteria in 1979-81, due to the Iranian revolution and the Soviet invasion of Afghanistan which, among others was opposed by Osama bin Laden and Afghani Taliban with Saudi Arabian funding, CIA training, and US supply of weapons and support. Above all, on the monetary front in 1980-82, there was very rapid US dollar devaluation or loss of world purchasing power, and extreme inflation – high priced oil was popularly deemed the ‘natural’ culprit and cause. In fact, high priced money, that is double-digit interest rates, and a very weak US dollar were arguably the main real causes of recession and high inflation. This will be proven, again, at anytime that interest rates in the USA, Europe and Japan are cranked up “to counter oil price rises”, or for any other reason. The missing element for the shift to pure and outright crisis is extreme inflation – which further ‘erosion’, or collapse of the US dollar can almost any time bring about, to which we can add, for the Eurozone-15 countries and EU-27, the impacts of a possible collapse in the value of the Euro. Real world Energy economics Through 2004, until at least the first Quarter of 2008, world oil demand consistently increased, if at quite erratic and variable Quarterly rates. The basic lesson to be learned from this fact, in a context of constantly rising oil prices, is that oil price elasticity is very low, for the simple reason that it is very hard to substitute, specially for the transport, mining, fishing, agriculture, plastics, petrochemicals and related industries, and is cheap relative to almost any renewable energy source. Even at prices well above 100 USD/bbl, and most surely at prices current in 2004-2007, the world economy showed no sign whatsoever of strong and sustained falls in oil demand, nor serious and consistent real-world effort to substitute oil burning, whatever the media interest in climate change. In fact, for much of the period, we had what can be termed reverse elasticity: oil demand increased as prices rose. This returns us to the ‘first inter-crisis period’, of 1975-79, with oil prices in today’s dollars that were often close to USD 60/barrel, and growth rates of world oil demand ‘close coupled’ to economic growth rates, that is about 4%-per-year. For the OECD bloc or group, typical oil consumption growth rates, in volume terms during this period were about 3.5% to 4.5%-per-year. In other words, not only had the OECD group adjusted to quadrupled prices in 1973-74, but imported and used considerably more oil, each year. In addition, in the majority but not all of the OECD countries, inflation was not particularly strong, and not considered a problem during this ‘inter-crisis period’. Economic growth in the OECD countries, in 1975-79 with oil at around USD 50/barrel, was up to 3 times current average economic growth rates. For the G-7 biggest economies of the OECD group, average growth of real GDP was 4.2% in 1978. In the Cheap Oil 1990s, through 1991-95 for example in which the oil price in 2004 dollars was often below USD 25/barrel, the G-7 group’s average annual growth of real GDP was 1.6%. One usually ignored reason for continuing, if underlying growth of oil and energy demand is the demographic factor. Taking the long period 1965-2007, world population has almost exactly doubled, from about 3300 Million in 1965 to over 6600 Million in 2007. Year average daily oil demand has increased more than 2.6 times, growing from about 31.25 Mbd to around 87 Mbd. Concerning inflation, the usual add-on rationale for why higher priced oil is so bad for the economy, those ‘experts’ usually quoted by the media will carefully avoid to mention (or perhaps do not know) that well before the first Oil Shock, in the early 1970s, inflation rates were three or four times higher than official CPI figures in most OECD countries, today. Yet in the early 1970s oil prices were under USD 9-per-barrel in dollars of today. What happened in the early 1970s, notably ‘the abandon of Bretton Woods’ or fixed exchange rates and gold-US dollar pegging, was due to huge and unmanageable US debt with the rest of the world, in part, ironically, caused by the ‘Bretton Woods system’ of fixed US dollar-gold exchange, at around USD 38/Troy ounce of gold. Today’s gold price, in late 2004, is about USD 450/Troy ounce, and in 2008 gold briefly attained USD 1000/ounce. The first major rise in oil prices through 1973-74 only served to ‘detonate’ already existing economic, fiscal and monetary pressures, and starkly reveal the weaknesses inherent in the postwar, OECD-centric, cheap oil-based economy. Extending this to about 2.5 Billion Chinese and Indians, as we can demonstrate in under 1 minute with a piece of paper and pencil, is completely and totally impossible – due to resource and environment constraints and limits. Taking the average ‘demographic rate of oil demand’ in the OECD countries, about 14.3 barrels/capita in 2007, the complete impossibility of this being extended to a hypothetical ‘liberal economic developed world’, needing around 60 Billion barrels/year, leaps from the page. In the short-term future (by about 2010-2015), and after the deflation shock following the collapse in 2007-2008 of the current oil-fired model of so-called Universal Prosperity, based on trading mostly-virtual debt-linked financial instruments, there is a rather large prospect of hyper-inflation following, like day follows night. A world currency crisis of unmanageably large proportions is becoming a real world possibility, at the 2010-2015 horizon. The myth of ‘delinking’ The mantra of Al Greenspan then Ben Bernanke, of the US Federal Reserve, and J-C Trichet of the ECB is that the economies of the richworld OECD group of countries have been ‘dematerialized’, reducing or even eliminating their need for oil, and generating endless, and nearly effortless ‘productivity gains’. Consequently (the myth continues) high oil, energy, minerals or food prices can be weathered. Economic growth is now ‘delinked’, specially from oil. Through outplacement or delocalisation, that is de-industrialisation inside the OECD bloc, but fast industrialisation outside it, apparent oil and energy intensity of the OECD economy has decreased. Oil and energy intensity of actual consumption has however not changed at all. The average owner of a 2-ton, 4WD, 500 HP private car, burning 15-30 litres of gasoil or gasoline per 100 kms can advise whether their lifestyle is ‘oil-linked and oil-dependent’ or not. Each year, an average motorist in the USA consumes about 14 barrels of oil, in Europe about 8.5 barrels. The world car fleet, in 2007, is variously estimated at around 800 – 900 Million units, growing (until late 2008) at around 55 Million units per year. The same basic dependence on oil applies to average and ‘static’ urban citizens of ‘delinked’ OECD economies, throwing away several kilograms of plastics, paper and metals each week, and eating food whose energy cost is often 1 kg of oil or oil equivalent for 1 kg of food purchased and consumed. Checking the labels on the throwaway plastic packaging on their food, the ‘dematerialized’ citizen will often find their food has been transported hundreds, even thousands of kilometres. Maintaining and operating the urban service economy and its consumer lifestyle, where careers and lives are built on low energy occupations such as flipping hamburgers or trading financial derivatives, even with nearly all lower value, but highly oil-intensive manufacturing activity outsourced to Asian Emerging Economies, imposes high and constant oil and energy consumption. Apparently ‘low energy’ facets of the New Economy, such as portable computers and mobile telephones in fact generate heavy infrastructure needs, and large energy demand – Internet servers in the USA, for example, consumed about 12% of US total electricity production, in 2007. Typical growth rates for oil consumption in the ‘postindustrial’ countries are around 1% by volume for a 1.5% growth of real GDP. Where ‘re-industrialisation’ of the economy is taking place, particularly in the new East European member countries of the EU, national oil demand was increasing at 4% or more per year (until 2nd Quarter 2008). Taking all the OECD countries, including the USA and Japan (the two-biggest oil importers of the planet) average oil intensity, or consumption per capita per year, was about 14.3 barrels in 2007, and about 10.6 barrels for the ‘dematerialized’ societies of the EU, the same year. Breaking this fundamental dependence on oil, gas and coal burning will most certainly be the greatest challenge of coming decades – and cannot start without the recognition and acceptance of current massive oil intensity in the so-called ‘postindustrial’ economies, and the necessity to start reducing this. Until today, this has only been possible through economic recession, loss of employment and livelihood, and all the other sequels of ‘classic liberal’ recession and slump. For so-called ‘knowledge based’ societies this is a shamful reality. The 1980-83 Recession This recession, which finally ended only in late 1983, can easily be called the ‘Mother of Future and Coming recessions’ for the simple reason that – due to approaching Peak Oil – any return to, or maintenance of world oil demand growth from about 2009-2010 can only lead to yet more oil price shocks. The most recent record price, of about 147 USD/bbl for US WTI on the Nymex, in Q2 2008, can – or most likely will – quite rapidly be succeeded by yet more extreme high prices, very shortly after any type of conventional economic growth is restored in the OECD and Emerging economies. On the geopolitical front, to be sure, the Iran nuclear weapons crisis is ready and waiting, the Iraq and Afghanistan wars can very easily run out of control, and the GCC countries of the Gulf region may be attacked, damaging oil instructures, as well as causing loss of life and wellbeing. Myth has it that the rise of oil prices in 1979-81 was ‘responded to’ by gouging interest rates to their highest levels since the 1930s, producing an economic recession not at all unlike the entry to the Great Depression of 1929-31. In fact, this use of the ‘interest rate weapon’ was primarily decided because of high inflation, itself in part triggered by falling confidence in the US dollar, and by massive, accumulated US trade and budget deficits – exactly as today. Interest rates only fell slowly through 1981-84, as did oil prices (which remained above or close to USD 60/barrel in today’s dollars through the period). Unsurprisingly, this had powerful downward impacts on business activity, employment, consumer spending and investment. Justifying this riot of recessionary medecine was easy – the one word ‘oil’ was used. To what relatively small extent oil price rises had caused the inflation upsurge through 1979-81 is hard to say, but ferocious interest rates hikes without question prolonged and intensified high inflation. This was through raising not only the cost of goods and services, but also the price of money used to pay those goods and services, service debt, and borrow for business expansion. This was therefore an inflationary recession that was intensified by high-cost money, and which only at the bitter end turned deflationary. Today in late 2008, the exactly opposite sequence is becoming ever more probable, that is a deflationary recession, turning inflationary. Monetarist doctrine holds that reducing either the quantity and/or ‘velocity’ of money in circulation is the secret of inflation control, but this nice idea was hardly proved effective by actual results from applying extreme interest rates. Annual average rates for M1 and quasi-money growth in the G-7 countries of about 11%-13%, in 1978, only fell to about 10%-12% per year in 1981-82, after 3 years of ‘interest rate medecine’. Since 2000, and especially since 2005, this ‘propensity to print money’ has never been stronger, and its inflationary effects have only been attenuated by carefully disguising official CPI data, and by ‘imported deflation’ in the shape of cheap industrial consumer products, produced in Chinese and Indian sweat shops. In most major OECD economies during the 1980-82 recession period, unemployment rates above 10%, sometimes 15% of the adult population became the norm. World trade not only ceased to grow, but achieved (if that is the right word) its first ever year-on-year contractions since the only previous period of such violent contraction in the world economy, following the 1929 Wall street crash. By comparison, today in 2004, and until late 2007, with oil at USD 50 - 90/barrel, world trade was growing at around 10%-12% each year. Most important for the coming future Oil Shocks, or shocks, oil prices fell back to less than USD 65/barrel in today’s dollars by late 1983, (similar to today’s price in November, 2008) for the simple reason that no physical shortage existed. In the near-term future, by about 2010, this will no longer be the case. Falling oil prices and ‘New’ Economics One way to proceed is to examine what happens under regimes of low priced oil. The answer is that, ironically or not, but very logically world oil demand growth rates tend to fall or to stay low when oil prices fall or stay low. Through 1986, from December 1985 through August 1986, oil prices were nearly divided by three, that is fell by about 65% in 8 months, to a low of about USD 18/barrel in dollars of 2004. Lighter blends, at the time, still held up to about USD 20-per-barrel, but the 1985-86 price collapse was to set a 13-year pattern of underpriced oil, and all other commodities mirroring the spikes and peaks of the previous 13 years. Most important for ideologists who spout that “High oil prices hurt growth” , the 1986-99 period is marked by weak and falling average economic growth rates in all OECD countries (with very few exceptions, one being oil and gas exporting, capital surplus Norway). At the time of the 1985-86 Anti Shock, loud were the pronouncements that this would usher in a new period of Belle Epoque growth, a reference to the economic growth attained by OECD countries in the 1948-75 period. Very briefly, as noted above, typical economic growth in OECD countries was about 4% annual on a real GDP basis in 1975-78, with so-called ‘high priced oil’, and world economic growth achieved record highs in 2005-2007 with oil prices rising to over USD 90/bbl. The macroeconomic mechanism is easy to explain. Falling energy prices necessarily cut prices for all other energy intensive, nonoil commodities. This is both deflationary and removes liquidity from the global economy. At the same time, if there are massive rises in interest rates on loans to oil and nonoil commodity exporter countries, as in the 1980s, these countries are forced and obliged to ‘export or die’, and become what Neoliberals call ‘price takers’ of ‘Sunset Commodities’ that are of low utility for the ‘advanced’ or ‘dematerialized’ economies that somehow manage to consume vast quantities of oil ! Not surprisingly, investment in, and development of the real resource sector collapsed in the 1980s and 1990s, ensuring future shortages of supply capacity. This sequence can easily reproduce itself again, in a context, we can note again, where world population has increased by about 3300 Million since 1965. To be very sure, ‘liberal economic’ notions that cheap, or cheaper oil can only restore economic growth have been totally contradicted by economic reality in the Cheap Oil interval of 1986-99. No spontaneous or self-reinforcing increment to economic growth was recorded in any OECD country following the 1985-86 Anti Shock. Through 1986-99, economic growth rates in all OECD countries fell, often by one-half comparing 1970-80 with 1985-95. Outside the OECD bloc, and excluding the Asian new industrial countries, the combination of rising populations and falling revenues – reinforced by the debt weapon used by the OECD countries to lever out cheap oil supplies from mostly poor nonOECD exporter countries - has created a multiform and perhaps inextricable economic crisis that continues to this day. While this crisis, caused by the use of pauperization as an instrument of policy towards about one-half of the world’s population, was been able to pry out cheap resources for the aging, near stagnant economies of the self-proclaimed First World, this policy has many intrinsic weaknesses. Impoverished societies are not only the seedbed of fanaticism and fundamentalism – against an enemy that is easy to define – but the civil and ethnic strife entrained by increasing and unremitting poverty leads to the destruction of installations and infrastructures delivering cheap resources for the richworld. The free play of ‘exuberant’ markets has in 2007-2008 begun to lose its status as an unquestionably wonderful ideology, due to this anarchic and chaotic non-regulation of the economy delivering only a ‘Fool’s Cycle of Prosperity’. After the paper boom, the crash is inevitable, each time more intense and harder to escape from. During the so called Clinton Boom of about 1992-99 almost any equity holding could return 10%-per-year. Based on a real economy growing at about 1.5%-per-year no genius is needed to point out the inevitable sequel. The 2000-02 stock market slump wiped about USD 6 000 Billion off nominal ‘value’ from paper holdings. In 2008 outline estimates by the IMF of the ‘lost value’ of so-called ‘toxic assets’ are in November is estimated at over USD 2000 Billion, with world stock market capitalization losses probably above USD 15 000 Billion, to date. Blaming this on oil prices is, at the least, rather difficult ! Oil demand will Grow Under any hypothesis except full scale and long term economic depression, which will need a round of interest rate hikes to perhaps double digit levels in the OECD countries, oil demand will tend to return at any time that economic growth returns. The sequels of many years of ‘benign’ neglect to pauperization of already poor countries, especially those that produce and export oil, gas, minerals and agro-commodities can at any time lead to civil or ethnic strife, riot and rebellion, causing shorter or longer cuts in ‘lifeline supplies’ of no longer cheap raw materials to the supposedly ‘postindustrial’ consumer democracies. In the special case of oil, prices may well rebound to above USD 100/bbl even in 2009, and almost certainly in 2010. While this of course will be hailed as ‘Oil Shock’ this price level is only a little above the inflation and purchasing power corrected oil price level of 1984, the year of all-time record economic growth in the US. The oil price potential, like world demand potential is almost unlimited, and upward. As we have found in 2007-2008, oil prices beyond about USD 125/bbl surpass the pain threshold and start to induce price elastic effects, and increased inflation in the world economy. Demand will likely, or only decrease at prices above this ‘pain threshold’, of course through ‘classic liberal’ economic recession, with an ever present menace of slump into long-term depression. For the oil (and other commodity) exporter countries, the Commodities Boom of about 2003-2008 allowed them to recover most of the purchasing power lost during the Cheap Oil interval of 1986-99, but this process was of course achieved through classic boom-bust market mechanisms which intrinsically exaggerate both upward and downward movement, and require ‘clear and unambiguous’ trigger signals – such as civil war, political coups, complete stoppage of exports, climatic catastrophes (such as Hurricane Katrina), and other ‘interesting economic news’ on which entirely speculative and anarchic market trading depends. While public opinion in the consumer democracies is apparently uninterested by the ‘need’ for market traders to trade rumours of crisis, war and devastation to inflate prices, then deflate them again, this process has in 2008 been clearly revealed as extremely inefficient, apart from its moral unacceptability. During the Cheap Oil interval, ‘classic liberal mechanisms’ delivered consumers all the cheap energy they desired. The delivery of shortage and penury, by just the same market mechanisms, has led to rediscovery by public opinion and political leaderships of the consumer democracies that State-level, multilateral mechanisms of control and regulation are not ‘antique’ and useless means for ensuring stability. Conclusions The likelihood that due to Peak Oil, from at latest 2010, oil prices will easily exceed 100-125 US dollars/barrel, even in the case of weak and hestitant global economic recovery from crisis. Persistent physical oil shortage is almost certain by 2010, especially net export supply volumes. This itself will powerfully draw attention to study and action for firstly slowing the growth of oil and gas demand, then reducing demand for these fossil fuels. Action in the so-called ‘postindustrial’ but extremely high oil intensity OECD countries will be obligatory. Only at genuinely ‘extreme’ oil prices, well above USD 125-per-barrel, will there be any return of ‘elasticity behaviour’, with strong potentials for uncontrolled economic crisis driving another fall in fossil energy demand, firstly in the OECD countries. The real need is for Energy Transition, with transparent Multilateral frameworks, including organized and efficient economic and energy system restructuring, especially in the OECD economies and societies, but also worldwide. Laisser-faire scenarios will necessarily include a new ‘Great Depression’ , quite soon after the current crisis, to a backdrop of already serious tension and low-level but increasing international conflict and warfare focused on the Middle East (‘war against terror’ and ‘war for oil’). De-globalization, or increased self-reliance will necessarily feature in longer-term restructuring of the world’s energy and economic systems. The sooner that internationally agreed targets, frameworks and structures for managing energy transition can be set, the greater is the chance of avoiding endgame energy resource conflicts, and achieving long-term sustainability. The likely, or near certain return of Oil Shock by 2010, due in final analysis to emerging supply deficits and refusal to target the reduction of oil intensity in OECD countries, will be a ‘salutary crisis’ if this brings coherent action to head off irremediable crisis.
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