With the price of crude oil up from $29 a barrel in 2000 to over $40 now, the world economy is experiencing its fourth oil price shock in the last 30 years. In nominal terms, this is the highest price ever, but in real terms the price of oil remains well below the 1981 peak, when it was equivalent to $72 in 2004 dollars. In the previous shocks, prices came down again, in each case in the wake of a global recession. What will happen this time?
The answer depends on our old favourites, supply and demand. The bulk of the world’s oil reserves is concentrated in two regions: the Persian Gulf and the Caspian Sea Basin. These are the most unstable regions of the world.
Supply can only be increased rapidly from Persian Gulf sources, where production is well below capacity. But the Middle East is a powder keg. Before the second Gulf War Iraq produced 3m. barrels per day. Now it is down to 1m. The Saudi regime is insecure. Terrorism has plenty of opportunities to interrupt supply. The Caspian region is also politically volatile. In short, there is a high correlation between areas of conflict and concentration of lootable natural resources.
Neither in 1980 or 1990 was the political future of supply subject to such uncertainty as it is today. An important cause of the recent rise of prices has been fears that oil supply could be disrupted by terrorist acts in the Middle East, and the conflict surrounding Yukos. Security and cheapness of Middle East supply depend on the US establishing a permanent and effective protectorate in the region. But there is no guarantee that this is possible. This would in itself suggest that the price of oil is unlikely come down quickly from its post-Iraqi levels.
The main change on the demand side since the early 1990s is the explosive growth of China and India. China, the sixth biggest economy in the world, and the world’s second largest consumer of oil, has been growing at 8 per cent a year on average since 1990. Aggressive Chinese stockpiling has been adding to the pressure on prices.
In the USA, Europe, and Japan economic growth is picking up after the recent recession. Rich countries’ consumption is on an ever rising curve, with energy saving technologies being offset by more extravagant petrol use: witness the popularity in the USA of the gas-guzzling ‘Hummers’ (HUMVEE Sports Utility Vehicles).
Thus oil demand is set to grow at an unsustainable rate. Since the first oil price shock in 1973-4, the world economy has been subject to a destabilising oil price cycle. Rapid growth pushes energy prices higher. High oil prices push the world into recession, leading to a fall in prices. The fall in oil prices pushes world growth and prices higher, re-starting the cycle.
The consensus view is that we can avoid this boom-slump pattern in future. If oil prices stay at their present level, world economic growth will be slowed somewhat, but not enough to trigger a global recession.The poor of the world will be hardest hit, but there is nothing new in that.
This benign scenario overlooks the problem of exhaustion. Reserves of oil and natural gas are set to run out in 60-100 years. Well before that, we will experience energy shortages.Nuclear energy may provide a medium-run alternative, but its development encounters huge political obstacles. The only long-term solution is to slow down energy consumption.This will mean a huge change in our habits. A start can be made by eliminating petrol-driven cars. But try selling that policy to the Moscow car owner!