The market sets
high oil prices to tell us what to do
By Martin Wolf
Published: May 13 200819:09| Last updated: May 13 200819:09
Oil at $200 a barrel: that was the warning from
Goldman Sachs, published last week. The real price is already at an
all-time high (see chart). At $200 it would be twice as high as it was in any
previous spike. Even so, it would be a mistake to focus in shock only on the
short-term jump in prices. The bigger issues are longer term.
Here are three facts about oil: it is a
finite resource; it drives the global transport system; and if emerging
economies consumed oil as Europeans do, world consumption would jump by 150 per
cent. What is happening today is an early warning of this stark reality. It is
tempting to blame the prices on speculators and big bad oil companies. The
reality is different.
Demand for oil grows steadily, as the vehicle fleets of the
world expand. Today, the UShas 250m vehicles and Chinajust 37m. It takes no
imagination to see
where the Chinese fleet is headed. Other emerging countries will follow Chinas
example.
Meanwhile, spare capacity in members of the
Organisation of the Petroleum Exporting Countries is currently at exceptionally
low levels, while non-Opec production has equally consistently disappointed
expectations. (See charts.)
It looks increasingly hard to expand supply
by the annual amount of about 1.4m barrels a day needed to meet demand. This
means an extra Saudi Arabiaevery seven years. According to the
International Energy Agency, almost two-thirds of additional capacity needed
over the next eight years is required to replace declining output from existing
fields. This makes the task even harder than it seems. As the latest
World Economic Outlook from the International Monetary Fund adds, the fact
that peak production is reached sooner, because of todays efficient
technologies, also means that subsequent declines are steeper.
This is not to argue that speculation has
played no role in recent rises in prices. But it is hard to believe it has been
a really big one. True, the dollar price has risen sharply, but that is partly
the result of the decline in the dollars relative value (see chart). As I have
argued before, if speculation were raising prices above the warranted level,
one would expect to see inventories piling up rapidly, as supply exceeds the
rate at which oil is burned. Yet there is no evidence of such a spike in
inventories, as Goldman Sachs and the IMF point out.
Similarly, it is not even true that the
investment needed to boost the constrained production capacity has been
lagging. The WEO shows that nominal investment by national and international
oil companies more than doubled between 2000 and 2006. But real investment
hardly increased, because of a global scarcity of rigs and associated skilled
labour services. Against this background, it seems far more likely that such
speculation as there is has been stabilising, rather than destabilising: in
other words, it is moving prices in the right direction, in order to reduce
demand.
Will the high prices succeed in doing this?
Certainly. Demand has to match supply for a simple reason: we cannot burn oil
that does not exist.
The price spikes of the 1970s were followed
by big absolute falls in demand and output (see chart). This was partly because
of the recessions and partly because of rising efficiency. Both forces should
work again this time, but to a much smaller extent. The slowdown in the
USeconomy is indeed likely to be significant.
Slowdowns will also occur in western Europe and Japanand even in the emerging
world. But the
latter will still grow rapidly. Overall, the world economy and so world oil
demand is likely to continue to grow reasonably briskly. Similarly, the
improved efficiency of use of petroleum, as people switch to more efficient
vehicles, notably in north America (where the room for doing so is so large),
will be offset by the rising tide of demand for motorised transport in the
worlds fast-growing emerging countries.
On balance, it is quite unlikely that
aggregate demand for oil will collapse, as it did after the two previous price
spikes, just as it is unlikely that massive net new oil supplies will come on
stream in the near future. This does not mean that prices will remain as high
as they are today for the indefinite future: such stability is improbable. But
it means we should expect a sustained period of relatively high prices even if
peak oil theorists are proved wrong. If proved right, this would be true in
spades.
So what should be the response to these
simple realities? Here are some obvious do nots and dos.
First, do not blame conspiracies by
speculators, oil companies or even Opec. These are the messengers. The message
is one of fundamental shifts in demand and supply. If speculators push prices
up in response, they are helping the adjustment. Even if Opec keeps output
back, it is preserving a valuable resource for the future.
Second, do not blame the emerging countries
for their growing demand. Citizens of rich countries must adjust to the higher
prices of resources that the rise of the emerging countries entails. The only
alternative is to attempt to destroy those hopes. That would be a blunder and a
crime.
Third, understand that prices at these
levels are now playing a big macroeconomic role. At $100 a barrel the annual
value of world oil output would be close to $3,000bn. That is 5 per cent of
world gross product. The only previous years in which it was higher than that
were 1979 to 1982.
Fourth, adjust to high prices, which will
play a big part in encouraging more efficient use of this finite resource and
ameliorating climate change. The current shock offers a golden opportunity to
set a floor on prices, by imposing taxes on oil, fossil fuels or carbon
emissions.
Fifth, do try to reach global agreement on a
pact on trade in oil based on the fundamental principle that producers will be
allowed to sell their oil to the highest bidder. In other words, the global oil
market needs to remain integrated. Nobody should use military muscle to secure
a privileged position within it.
Finally, do become serious about investing
in basic research into alternative technologies. Energy self-sufficiency is an
implausible goal. Investing for a post-oil future is not.
We are no longer living in an age of
abundant resources. It is possible that huge shifts in supply and demand will
reverse this situation, as happened in the 1980s and 1990s. We can certainly
hope for that happy outcome. But hope is not a policy.
The great event of our era is the spread of
industrialisation to billions of people. The high prices of resources are the
markets response to this transforming event. The market is saying that we must
use more wisely resources that have now become more valuable. The market is
right.
**
Martin Wolf is associate editor and chief economics commentator at the Financial
Times, London. He was awarded the CBE
(Commander of the British Empire) in 2000 for services to
financial journalism. Mr Wolf is an associate member of the governing body of
Nuffield College, Oxford, honorary fellow of Corpus Christi College, Oxford
University,
an honorary fellow of the Oxford Institute for Economic Policy (Oxonia). He was
made a Doctor of Science (Economics) of LondonUniversity, honoris causa, by the
LondonSchoolof Economics in December
2006.
Copyright The
Financial Times Limited 2008
http://www.ft.com/cms/s/0/219fcbde-2108-11dd-a0e6-000077b07658.html
[Non-text portions of this message have been removed]
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