The Price of Oil and Economic Growth

29 September 2004, Wellington

The Price of Oil and Economic Growth

The revolutionary can only regard his revolution as a progress in so far as he is also an historian. Collingwood (1956)

US$50 a barrel oil.

It may have come as a surprise to many (particularly market analysts) that the price of oil didn’t just magically stop at US$40 a barrel. As we push beyond the $50 per barrel barrier the G-7 finance leaders seem to have given up demanding the impossible – that OPEC deliver oil at $30 a barrel or less. There seems little point. OPEC simply do not have the remaining capacity to flood the market with cheap oil – those days are gone, forever.

Nevertheless we are yet to see New Zealand or indeed any OECD nation descend into oil-price-shock-caused recession. Quite the contrary, US Federal Reserve has recently raised interest rates for the third time and signalled more to come. Global economic expansion continues despite costly oil.

The G-6 have withstood a 40% jump in oil price but still forecast a 3.5% growth rate. Eurozone nations are expecting 2% economic growth. Our nearest neighbour Australia is expected to enjoy boom times, around 3.7% growth in 2005 on the back of tax cuts and rising exports.

Although New Zealand’s strong growth is expected slow slightly to 2.3% by March 2005 according to Dr Cullen, Reserve Bank Governor Alan Bollard raised interest rates 5 times this year pushing the New Zealand dollar 13% higher against the Greenback – we win the prize for the best currency performer on the world stage.

A tentative conclusion one might draw from this data is that the price of oil certainly around US$50 a barrel does not make a jot of difference to economic growth. In fact initially the opposite is the case argues Andrew McKillop*

“Higher oil prices increase world economic growth by raising ‘real resource’ prices, through what we can call ‘the revenue effect.’ The pro-growth impact of oil does not stop there, because fast increasing values of world merchandise trade due to higher ‘real resource’ prices directly leads to fast growth of world liquidity”

McKillop argues, contrary to the IEA (International Energy Agency) that extreme oil prices don’t necessarily hurt even very poor countries citing economic and social indicators of such countries during the 75-84 oil shock years.

US$100 a barrel oil and Peak. Just after the 70’s oil shocks high interest rates were used to combat the high oil prices and as demand and growth waned the world including New Zealand crashed landed sometime in the 1980’s to cheap (less than US$20 a barrel) oil. If we continue to see economic growth in the face of higher oil prices, and that seems to be where all the indicators point presently, we might expect oil within coming years under increasingly tighter supply constraints to extend out beyond $100 a barrel with minimal economic impact.

Effectively this would translate to 50%-75% rises in real resource costs since the year 2000 with little effect on economic growth and or continuing oil demand. History reminds us that it took exorbitant interest rates to curb inflation and high oil price/demand after the late 70s oil shocks, consequently resulting in an extended period of recession thus stifling any microeconomic adjustment.

When, or indeed if such levels of interest rates are used this time to bring under control extreme oil prices, and beyond US$100/bbl we can be almost certain that significant interest rate hikes will be used, the crash landing will not include a return to cheap oil for any extended period as in the late 80’s. We will enter a recession from which it is unlikely that we will ever fully recover.

The price of oil will have significant impacts on the level of production that coincides with peak oil. The IEA (International Energy Agency) claim that we should not expect to see Peak before 2020. However the IEA have grossly underestimated demand (increasing by 2.8%-3.3%, twice the IEA estimates) and largely discounts current depletion figures (around 1.5Mbd lost to depletion each year).

McKillop (amongst many others) argues absolute production peak could be around 90Mbd (currently we consume 82.5Mbd or thereabouts). On current demand curves we’d expect to see that kind of production around 2007 with prices well in excess of US$100/bbl. After peak oil actual supply will fall by around 3–3.5% for some years after which it will accelerate to much higher levels. Structural oil supply deficits will quickly become apparent beyond 2007. With New Zealand existing at the end of most supply chains, we might expect earlier signals.

Given almost any realistic analysis it is difficult to continue to hold “growth as usual” scenarios as oil is certain to continue to display extreme price spikes over the coming years. Peak oil is all but dismissed by the IEA, OECD and UN as well as the New Zealand Government. However this claim stands in stark contrast to rapidly depleting fields in the UK, US and Norway (the 3 largest OECD oil producers) where almost a million barrels per day of production was lost between June 2003-June 2004.

If no action is taken to transition to a non-oil energy economy by 2007 we are likely to see many aspects of our economy in the process of extreme break down, double-digit interest rates, hyper-inflation, wholesale collapse of the property market, a high rate of business failure, high unemployment, economic, political and social instability – a forthcoming recession from which there will be no escape.

* Andrew McKillop: OECD report forecasts strong economic growth, low inflation. From Vheadline.com., Sept 22, 2004. http://www.vheadline.com/readnews.asp?id=22878

Powerless NZ 29 September 2004 PowerLess NZ is a growing group of scientists, energy analysts and concerned citizens whose principle objectives are to alert both Government and the general public to New Zealand’s looming energy crisis. Our aim is to support development of renewable energy resources at both a private and public level, as well as encourage a firm move away from dependence upon fossil fuels. More information about global peak oil and resource depletion can be found at http://www.oilcrash.com/

ENDS

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