Whistling
in The Dark– The New ‘Relaxed Attitude’ on
High Oil prices
By Andrew McKillop
By late 2007 oil prices had surely not heard the signal of “seasonal
downturn in demand”. They therefore did not respond to the usual talk-down
mantra of high stocks, falling demand, OPEC pumping almost all it can, not
too much geopolitical stress (except for about 1.6 million dead in Iraq since
2003), and warm enough weather – at least in the northeast of the USA – to
imagine that Winter will not come. This would allow a remake of the 2006
oil sell-off, culminating on January 18, 2007 with a low of about $49.50-per-barrel
for WTI grade, February delivery.
Such was the acclaim and applause this happy feat generated that for weeks
finance blogs were stuffed with talk of “30-dollar oil” coming
back almost anytime. This of course would be a really precious aid for the
inflation fight, help the consumer faithful to buy another car, and also
harm those terror organizations of the Arab world, and hostile Venezuela,
Russia, Iran, Nigeria, and so on, which thrive on high-price oil! Whether
cheap oil would also help mitigate climate change was usually not commented
by the blogsters, busily talking up cheap oil, because cheap oil is so good.
Times
Change
By late 2007 this cheap oil euphoria was somewhat lacking in the financial
blogosphere, In the mainstream press and media it was replaced by articles
and panel discussions well evoked by the following title and lead-in:
How Economy Could Survive Oil At $100 a Barrel -
Compared to 1980, U.S. Is More Able to Handle Once-Unthinkable
Rise
By Peter FRITSCH and Kelly EVANS, Wall
Street Journal, September 29, 2007
The world economy has managed, with some indigestion, to swallow the rise
of oil prices past $80 a barrel. How well could it survive $100 a barrel?
The answer is quite well -- so long as several conditions still hold true.
The price rise would probably have to be gradual. Inflation couldn't get
so bad as to force big interest-rate hikes. Oil-rich nations would need to
pump their profits back into U.S. and European economies.
All of this has happened so far. The happy confluence may continue, though
fears remain strong that high energy prices will tip the U.S.into recession.
A host of factors, including tight oil supplies and a weak U.S. dollar, suggest
that oil prices have further to rise. Some analysts continue to believe that
oil is destined to reach an all-time high, as measured in today's dollars,
of more than $101 a barrel. The record was set in 1980. On Friday in New
York, the benchmark crude-oil futures price closed down $1.22, or 1.5%, to
finish at $81.66, a little more than $2 off the all-time high, not adjusting
for inflation.
101
Dalmatians or Dollars a Barrel ?
As measured in today’s dollars, and in fact, there was nothing like”$101
a barrel” in 1980. One simple reason is that no electronic or other
futures trading of oil existed in 1980 - the US Nymex started in 1983, exactly
when oil prices started their long, long slide to almost nothing, that is
about $10 a barrel for the February 1999 Brent contract on the ICE market.
Not surprisingly, the existence of 24-hour electronic trading was for a long
time offered by New Economy zealots as yet another proof how good their medecine
is – through driving down commodity prices, and especially oil prices.
With no daily or by-the-second price quotations in 1980, no fixed and set “oil
price for 1980” can be given. This problem is complicated by the methods
used for oil price settlement in 1980, compared with today, as well the vast
problem of what price deflator or purchasing power correction is
going to be used to work out the maximum oil price attained for specific,
individual shipments and cargoes in 1980 but expressed in 2007 dollars.
Answers to this question in fact range from about $85 to $130 a barrel, enabling
journalists to take their pick, for the biggest hit of sensation. Carefully
omiting any then-and-now price comparisons for anything else – residential
real estate, shoes and toothpaste, the family oil burner car and ride-on
lawn mower, veterinary services, hairdressing, mobile phone service costs
and charges, or whatever - high oil prices of 1980 seem an awful lot higher,
when nothing is used to compare them, except a more or less randomly picked ‘US
dollar deflator’ for 1980-2007.
Plenty of thorough and serious studies by economists in fact show that real
energy prices are still about 25% below those of 1980 in most OECD countries,
when compared to real earnings and the purchasing weight of each item – from
energy to rent and food – in average persons’s budgets. If that
seems amazing, step outside in any big city of the Global Economy world,
and count the 2-ton, 500 HP 4WDs you can see in 10 minutes, or run a quick
check on airplane traffic or container shipping growth rates. The real
wage effect explains this: even at today's nominal record prices, oil
consumers in the OECD countries spend less than 5% of their disposable incomes
at the pump, against nearly 7% in 1980.
Deeper
Problems for the No Worry School
This is only one small fault in the syndrome represented by the above sample
Wall Street Journal article extolling the new “relax and keep spending” attitude
to oil prices that, for example, are way above the short peak of prices reached
in 1990. At the time, the world’s right thinking (and far right thinking)
press, of course including the WSJ, trumpeted the US-led invasion or liberation
of Kuwait as a forceful and quick way to bring the oil markets “back
to their senses”, these markets having talked up oil prices to the
stupendous level of $40 a barrel ! Today we have $85 a barrel.
As the media now tells us, this is partly, maybe wholly covered by the
Wall Mart effect, despite Alan Greenspan opining in the same media that
it could be waning. Greenspan, we can note in passing, has given his blessing
to $80, and maybe $85 oil by shrugging his shoulders and saying it is ‘not
a problem’ when asked his view on it by former super-hawk on cheap
oil, and war to achieve it – DanielYergin – at Greenspan’s
publicity launch of his out-of-retirement book ‘The Age of Turbulence’.
Greenspan was always enthusisastic about the Wall Mart effect even
if he regularly whined about oil prices far below $40 a barrel during his
near-eternal reign at the US Federal Reserve. This happy effect of Globalisation
can be put so: For every extra dollar, and even more so for each extra euro
that “goes straight to Arab terror-supporting regimes”, as a
famous Wall Street Journal editorial of 2003 called OAPEC, after being taken
from drivers' pockets at the pump, there is now a countervailing deflationary
flow. This is low-cost consumer goods exports from China, India and
elsewhere that put roughly $1.50 back in the pocket of OECD and world consumers,
in the form of cheap goods, even if they also put quite a few workers, in
traditional engineering and industry on the street and into make-work, low
wage unskilled jobs, serving burgers, sweeping waste, trading subprime loans
and opening doors.
The bottom line is not so good for the ‘Relax and spend’ school.
Even with the energy subsidy of abandoning production of energy-intensive
consumer goods at home, and importing them from the emerging economies, oil
demand remains so ‘surprisingly’ high in the OECD countries partly – or
mainly - because oil is still cheap. When we turn to natural gas,
and even more extremely coal, prices are still incredibly low, in
fact begging the question as to how its possible to have inflation at all
with such fantastically cheap energy ?
Biofuels
and Solar – the New Snakeoil
For all the well-muted and non-public concern about ‘sky high oil prices’,
which very surely steels the nerve of political leaders, of the big oil consumer
nations, to keep their occupation troops in Afghanistan, if not Iraq, to
at least control the world’s heroin trade if not the oil trade - the
world today is better equipped to swallow expensive oil than in 1980. At
the time, helping to seal his electoral fate, Jimmy Carter wearing a nice
thick pullover was installing solar panels and a wood-burning stove in the
White House. Today he could have a landfill biogas powered, or a maize-ethanol
burner handy for visiting Russian leaders, who might prefer simply to swig
back the miracle fuel, and then gawp at state-of-the-art solar photovoltaic
goodies delivering electricity – in the daytime – at around 25
US cents per kWh.
The main reason why renewable energy “doesn’t work” today
is exactly the same as in 1980 – it costs a lot more than ‘expensive
oil energy’, and even worse impinges on lifestyle. When we
add in another big reason why oil is expensive, we find yet more plausible
to believe no energy transition to renewables will happen until well after
an economic meltdown firstly happens: current oil prices are driven by the
world’s strong economy, not by an oil embargo or war in the Middle
East. This in fact is radically, even totally different from the 1979-1981
oil crisis, price spike, and spiral into world economic recession – “world” at
the time not including China, India, Brazil, Pakistan, Turkey, Indonesia,
and other big and growing economies. To be sure, atavists in the G W Bush
regime could have their sinister fun and start a war against Iran, to replicate
the crash of 1979-1981, this time with $150 oil – or maybe Osama bin
Laden’s favorite oil price ‘to punish the West’ of $144
per barrel.
But if this does not happen we still get to $100 per barrel simply
through supply / demand fundamentals.
This strong global economy, pushed by what we can call Petro Keynesian
growth, permits and enables a certain range of solar-renewable gadgets
to at least be funded on paper, as tradable stocks in “dynamic young
enterprises”. These provide a nice smokescreen of earnest and massive
effort, and of course are subject to massive risk of early failure.
This was already happening in late 2007 with the pride of G W Bush’s
Renewable Fuel Scheme (RFS), that is ‘first generation’ maize-bioethanol
companies, set up in a flurry of investor euphoria from around 2003. By September-October
2007, a slew of these ‘young hopeful’ enteprises were close to
worthless, suffering Northern Rock style stock losses.
Massively over-concentrating resources in one sector or other, at the whim
of market sentiment whipped on by the rumour mill of financial media, then
abandoning these magical ventures, when they fail, in fact adds another strand
to the growth economy: the alternate energy sector. As a way to
waste time, as well as financial and material resources this method cannot
be beaten – but it will not facilitate energy transition – to
a real world future of 2035 sketched out, for example, in my book ‘The
Final Energy Crisis’ (2nd edition coming soon).
Counting
Down and Counting Back
The crash of 1979, and the 1980-1983 recession were in fact, as discussed
elsewhere in this book, almost nothing at all to do with oil. Sky-high interest
rates killed growth and raised inflation due to money also becoming
a lot more expensive. None other than Ben Bernanke, Greenspan’s successor,
now publicly says that – only 25 years too late. The panicky transition
to mature service based economies typified by the derisory ‘Thatcher
Revolution’ in the UK was a failure in energy-saving terms:the moment
oil prices were driven down by a short-term and final bulge in supplies,
the consumer herd cast their longing eyes on ‘Chelsea tractors’,
those 2-ton, 500 HP, 4WD apocalypse wagons that litter city streets anyplace
- and rightly called light trucks in the USA. None other than Sir Richard
Branson and other would-be grinning billionaires are struggling to keep on
bringing cheap air flights to the masses, Branson proclaiming on Bloomberg
TV, Monday 15 October, 2007, that the USA could import “at least 50%
of its car fuel needs as fuel ethanol from Brazil, Argentina”. And
maybe the Moon also, eh what Sir Dicky ?
In fact fuel ethanol in Brazil, according to the chief economist of Datagro
Brazil, Plinio Nastari, supplied about 13.5% of Brazil’s road transport
energy needs in 2006, even if it did cover about 45% of all gasoline-powered
private car energy needs. But on Bloomberg TV anything goes, and Sir Dicky
also promises biofuel powered jumbo jets, so we don’t ask difficult
questions…
Getting There from Here
This will be through creating legislative and international frameworks for
real energy transition, because leaving it all to the infinite stupidity
of ‘the markets’ only the worst can be expected.
At the Italian Parliament, Rome, on October 30, in a special one-day conference
on Alternate Energy I am taking about just exactly that – Energy Transition – so
maybe one day I might make it to Bloomberg TV, sandwiched between the ads
for soft energy and cute finance strategies ?
Why legislation and multilateral agencies for energy transition will be needed
is very simple: we will have to get oil intensity and natural gas intensity
(demand per capita) down at really heroic rates, pretty soon. All too soon,
in several countries –simply ranked by their oil intensity - there
will be ugly consequences when sufficiently high oil prices hit
consumers' pocketbooks – and this will be aggravated in the US, in
the UK and in several other OECD countries, where an effective housing slump
is already hurting the economy. Consumer spending, as we know, is effectively
the only ‘engine of growth’ in the full blown, far-gone, late
consumer societies, which in theory should invest perhaps 25% of their GDP
in new energy infrastructures while they rapidly cut oil intensity
and gas intensity.
Under current leaderships, and with oil at a modest and relaxed $80 a barrel,
there is little chance of that – but how about $90 a barrel ?
Andrew McKillop is
Senior Energy Strategist in Juno Mother Earth Asset Management.
Petroleumworld not necessarily share these views.
Editor's
Note: This commentary was originally published in Juno
Newsletter, Oct. 05, 2007 by Juno Mother Earth Asset Management.
Petroleumworld reprint this article in the interest of
our readers.
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