The Oiloholics  

Posted by Big Gav

Energy Bulletin notes that this week's Economist has a number of articles on oil, and declares that it is time for America and China to wean themselves off "oiloholism" (without acknowledging peak oil of course).

I subscribed to the Economist for a decade and always found it worth reading. They've been pushing the same line for over a century and have seen two waves of globalisation pass now, so you'll rarely be surprised by their take on a particular issue (hint: "free trade is good"), but they are generally pretty even handed and often take what I'd consider the correct stand on a lot of issues where many right wingers these days would choose some other rather less sane (or less moral) option.

For example, last year they decried the calcification of US social structures (noting that an american today has less chance of moving from the poorest 10% of the population to the richest 10% than someone in France or Germany does, neither of those being countries that the Economist is given to praising) and also strongly recommended their readers vote against George Bush in last years presidential election (the first time they've ever not backed the Republican candidate).

Bart comments that "Although its slant is cheeky pro-market, The Economist is worthwhile reading for anyone interested in business and economics -- whatever one's political stripes. In the 19th Century, for example, The Economist counted Karl Marx among its readers.".

According to the IMF's model, an increase of $10 a barrel in oil prices should knock three-fifths of a percentage point off the world's output in the following year. Thus the increase of $30 over the past year or so should have reduced global growth by almost two percentage points. However, all such ready-reckoners are based on previous oil shocks, when the main cause of higher prices was a disruption to oil supplies: the OPEC oil embargo in 1973-74; the Iranian revolution in 1979; and Iraq's invasion of Kuwait in 1990.

The current episode, however, has its origin in increasing demand, notably in China, the rest of Asia and the United States. Last year's increase in global oil consumption was the biggest for almost 30 years. The old rules of thumb based on supply shocks do not work for price increases driven by rising demand. If oil prices rise because of a shortfall in supply, they will unambiguously cause GDP growth to fall. However, if higher oil prices instead reflect strong demand, then they are the product of healthy global growth. They will therefore be less damaging.

The downside is that, if prices are high because of strong demand rather than a supply shock, they are likely to stay high for longer. In past oil shocks, a rise in price as a result of a temporary supply disruption caused oil consumption to decline, so that when supply returned to normal prices promptly fell. But if oil prices are being pushed higher largely by rising demand in China and other emerging economies, a sudden collapse is less likely.

This is not to deny the role of speculators, whose bets that prices have further to climb have given the market an extra momentum—perhaps leaving it vulnerable to a future drop. Even so, with demand growing strongly and supply unusually tight as a result of years of inadequate spending on exploration, development and refining capacity, any serious supply disruption would push prices yet higher. The basic fact is that the equilibrium price of oil has risen: analysts at Goldman Sachs expect oil to fetch an average of $68 a barrel next year and $60 for the next five years. In the long run, such high prices will encourage exploration and bring forth increased supply that will eventually dampen prices, but this will take time.

Once an economist always an economist I guess...

3 comments

This comment has been removed by a blog administrator.

"Once an economist always an economist I guess..."

Beautifully understated, Gav. Thanks for your many excellent scans.

I admire the Economist for taking an anonymous approach to reporting. No bylines, therefore no egos to get in the way. I agree though on their free market streak.

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