OF all the hurdles to be negotiated by the economy this year, one of the most interesting will be that of high oil prices. Last year, no matter how hard you looked, it was difficult to detect much of an oil-price effect on the world economy, though Gordon Brown blamed it for some of Britain’s slowdown. It was, as I wrote in September, a dog that didn’t bark.
But now some interesting dilemmas are emerging. After the price per barrel of crude fell towards the end of last year into the mid-$50s, from a Hurricane Katrina peak of $70, they have crept up again. An oil price in the low to mid-$60s appears to be the new norm, and it would not take much of a supply or weather shock to push it back up to, or beyond, last August’s record.
The dilemmas are these. If global growth does not slow — and it is put at a robust 4.2% this year by Goldman Sachs — does this mean sky-high oil prices are here to stay? Could it be that the promise of extra oil supplies to dampen down prices will turn out to be a mirage, particularly now that members of Opec (the Organisation of Petroleum Exporting Countries) seem happy with a high crude price?
There is, on top of this, a longer-term dilemma. Even those who were once sceptical are convinced climate change is occurring; the only questions are of degree and the extent to which it is man-made. Part of the economic solution to climate change is that demand slows in response to high prices. If it doesn’t, we could be in more trouble than we think.
The historical backdrop to the current oil price, which I have drawn comfort from before, is as follows. We have data on oil prices going back to the early 1860s. In inflation-adjusted terms oil has risen above $40 a barrel only rarely and not stayed there for long.
Leo Drollas, chief economist at the Centre for Global Energy Studies (CGES), points out that the history can be split into two distinct periods. Up to 1973 the average price in 2005 dollars was about $20 a barrel. Since Opec first exercised its power that year and the world entered an era of high inflation and economic turbulence the average has been nearer $40.
Could it be we are now in a third leg of the oil story and $60 will become the new benchmark? Not only is the global economy robust but it is tilting towards economies such as China and India with a higher energy intensity and powerful economic growth. Meanwhile, there is no sign of demand restraint in energy-greedy America. Even in Britain, the fifth successive monthly trade deficit in oil announced last week was testimony, not only to the North Sea’s decline as an oil province, but also strong UK oil demand.
Tie that in to supply worries — will the attempt to clamp down on Iran’s nuclear ambitions result in that country cutting off oil exports? — and it looks like a high-price cocktail. Iran produces 5% of the world’s oil. Cut that off and the price could hit $100. Nor, some argue, are these supply concerns temporary.
Last week the UK Society of Investment Professionals ran a debate on the question: Has oil production peaked? Speaking for the motion was Jeremy Leggett, author of Half Gone: Oil, Gas, Hot Air and the Global Energy Crisis (Portobello Books). He said worldwide oil production is about to hit a plateau and produced some impressive statistics.
The world’s biggest oilfields, the giant Saudi and Kuwaiti fields, were discovered in the 1930s and 1940s. The year in which most oil was found in the world was 1965. The last big oil province to be discovered was the North Sea in the 1970s. The last year in which more new oil was discovered than was being used annually was 25 years ago.
Leggett, a geologist by background, argued that the world will reach its oil production peak in 2008, plus or minus two years. He has, in addition, put his career where his mouth is, as chief executive of Solar Century, which claims to be Britain’s leading solar photovoltaics firm (producing energy from sunlight).
Against him was the CGES’s Drollas. He took the view that the peak in conventional oil production is still some way off, probably around 2022, and that if you add unconventional oil to the equation (oil from tar sands, shale and so on) it will be well after that. The world has plenty of oil reserves; the key is whether the producers are prepared to allow them to be exploited.
Saudi Arabia, for example, which could pump more crude now and bring the price down, seems to have shifted its stance from doing its utmost to keep the oil price down at sustainable levels to enjoying high prices while they last. Its ageing leadership appears to have become more short-termist in outlook, the domestic political benefits of exploiting high prices being worth more than international diplomacy.
So where does that leave prices? Drollas’s view is there will be serious “demand destruction” at $60-a-barrel oil, in other words demand will slow sharply, and that Opec’s challenge this year will be preventing a drop in prices to significantly below $50. The large speculative element in oil-futures trading means any price reversal could be dramatic.
BP, like Drollas, argues that it is too soon for there to have been a serious demand effect. Oil demand is inelastic but only in the short-term. It does not take too long before high prices change behaviour. And high prices will also bring forward extra supply. Non-Opec supplies from areas like the former Soviet Union and Africa will rise by at least 1m barrels a day this year.
The Paris-based International Energy Agency, which releases new oil-market forecasts this week, is upbeat about the prospect for demand. Drollas is much more downbeat — believing that even if the world economy grows robustly it will economise on its use of oil.
I still believe, looking at the history, that not enough has changed to shift us into an era of oil above $60 a barrel. I think that we will head back below $40. But the path to lower prices won’t be a smooth one.
PS: We won’t know until this Friday what the official statisticians’ verdict is on Christmas spending but, according to the British Retail Consortium, stores had a rip-roaring time. The BRC, which not long ago was warning that a high-street slowdown was leading the economy into recession, reported that total sales value last month was 6.2% up on a year earlier. On the “like for like” measure, sales rose by 2.6%.
We shouldn’t assume this means the official retail-sales measure this week will be up strongly; on past form it could show a fall. The BRC has made the point that there hasn’t been much post-Christmas follow-through. But the numbers were much stronger than anybody expected.
What does the evidence so far tell us about the prospect of a February rate cut? The housing market is picking up, with approvals and prices stronger in the past two months. The weakness of consumer spending feared by some members of the monetary policy committee is open to debate. Higher oil prices, discussed above, will hurt short-term inflation prospects. The numbers, then, have been moving against an early cut, as the markets have sensed, though we will know more after this week’s barrage of figures.
The other early pointer is that Britain’s economy is not rebalancing. If November’s £6 billion record trade deficit in goods, announced last week, is anything to go by, we are heading in the wrong direction. In the first 11 months of 2005 the trade deficit in goods was £58.5 billion, indicating a full-year figure of well over £60 billion. That’s more than £1,000 per person. Worrying.
