The Economist: 'Feeling peaky?'

[Paul Mobbs]

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http://www.economist.com/node/21553034

Feeling peaky: The economic impact of high oil prices

The Economist, April 21st 2012


AS THE developed-world economy tries to gain momentum, it faces a 
persistent headwind. The oil price remains stubbornly over $100 a barrel, 
acting like a tax on Western consumers. Some blame the high price on evil 
speculators—Barack Obama unveiled plans to increase penalties for market 
manipulation on April 17th. But there is a simpler explanation: that supply 
is inadequate to keep up with rising demand.

The concept of peak oil—the idea that global crude production may be at, or 
close to, its limit—is far from universally accepted. One leading asset 
manager talked recently of the world being “awash with energy” because of 
the exploitation of American shale gas. Nevertheless, oil is still the main 
fuel for cars and trucks. And crude output (as opposed to alternatives such 
as biofuels and liquids made from gas) has been flat since 2005.

A number of countries (including Britain, Egypt and Indonesia) have turned 
from net oil exporters into importers in recent years. And although rich 
countries have curbed their energy-guzzling a little, demand continues to 
surge in emerging markets.

This has left the oil market very vulnerable to temporary supply 
disruptions, such as the war in Libya. Speaking at a conference in Dublin 
this week, organised by the Institute of International and European Affairs 
and the Association for the Study of Peak Oil and Gas, Chris Skrebowski, a 
consulting editor of Petroleum Review, argued that spare capacity in the 
oil market could be eroded by 2015.

The peak-oil concept was devised by the late M. King Hubbert, who correctly 
predicted in 1956 that oil output in the lower 48 states of America would 
peak by around 1970. At the conference Michael Kumhof, an economist at the 
International Monetary Fund, presented the findings of a forthcoming working 
paper which showed that adding the idea of a “Hubbert peak” to energy 
production greatly improved the ability of a model to forecast oil prices. 
Based on an expected 0.9% annual increase in production over the next 
decade, the model predicts that real oil prices will nearly double over the 
same period.

The economic damage caused by such a rise is predicted to be modest, 
perhaps 0.2% of global GDP a year. In the past changes in oil prices have 
had a limited long-term impact, since any losses to oil importers are 
matched by gains by oil exporters. To the extent that high oil prices 
played a role in the recessions of the early 1980s and 2008-09, the main 
reason is that oil-producing countries tend to have a lower marginal 
propensity to consume their income, denting global demand.

Nevertheless, Mr Kumhof worries that if oil prices are high enough, the 
economic impact might increase substantially. On the most extreme 
assumptions, it could be 2% a year.

Even if the world can find more oil—in the Arctic or tar sands, say—the 
longer-term question is whether the era of “cheap energy” is over and how 
the world can adjust if it is. Developed economies are built on easy access 
to cheap energy, importing goods that are transported from around the 
world, with consumers driving many miles to work in air-conditioned offices 
and then flying off to sunny climes for their annual holidays. Persistently 
high oil prices would clearly lead to substitution (electric cars, natural-
gas-powered trucks) but the transition costs could be significant.

Furthermore some potential substitutes for, or new sources of, oil (such as 
biofuels and tar sands) are a lot less efficient, in the sense that they 
require significant amounts of energy simply to produce. To the extent that 
this equation (energy return on energy invested, or EROI) is deteriorating, 
that must surely have an effect on economic growth.

“What is the minimum EROI that a modern industrial society must have for 
its energy system for that society to survive?” ask Carey King and Charles 
Hall in a recent paper*. The academics’ answer: “Complex societies need a 
high EROI built on a large primary energy base.”

This issue is not much considered by mainstream economists, who are too 
busy focusing on monetary policy, the impact of fiscal austerity or the need 
for labour-market reforms. But just as the industrial revolution was built 
on coal, the post-second-world-war economy was built on cheap oil. There 
will surely be a significant impact if it has gone for good.


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(Edward Burrough, 1659 - from 'Quaker Faith and Practice')

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