WHY WE NEED $70/BARREL OIL

Andrew McKillop

The US economy attained it highest ever postwar growth of real GDP, achieving what today would be the completely unthinkable rate of 7.5%, in the Reagan re-election year of 1984. At the time, in dollars of 2003 corrected for inflation and purchasing power parity, the oil price was over $60/barrel. Before that, in 1980-82, the industrialized world had experienced its deepest recession since the 1930s, with interest rates attaining extremes today associated with the meltdown process in Latin American and African countries unable to achieve ‘structural adjustment’ – US base rates exceeded 22%/year in 1981. Any attempt at raising today’s interest rates to double digit levels in the OECD countries would most surely and certainly entrain complete collapse of world stock market indices, runaway ‘domino effect’ bankruptcy of many major corporations, mass layoffs and unemployment, and grave problems for the financing of structural trade and budget deficits of the US and UK, perhaps leading to uncontrollable flight from the dollar. All European Union countries, and Japan would also face severe national budget financing difficulties, as tax revenues collapsed and spending to limit economic damage, including unemployment compensation, spiralled up as the crisis deepened. Financing of increased state spending through borrowing would then lock on the upward spiral in interest rates, the higher cost of borrowing itself intensifying recession and any inflation that would occur or arise through constantly falling economic growth. Current near-zero economic growth would be replaced by slump.

For a number of reasons, underpinned in final analysis by the approach of the ultimate peak in world oil production, oil prices are rising. However, the interest rate weapon for reducing oil prices through entraining a so-called ‘soft landing’ or controlled fall in economic activity and leading to a fall in oil demand, at this time in early 2003, is out of the question. Raising base rates to perhaps 10% or 12%/year, at this time, would be simple suicide. Thus the much-commented ‘very high price of oil’ in late 2002/early 2003, of about $29/barrel, which is around $15/barrel in dollars of 1984 or less than one-half the actual price level in that year of record US economic growth, will likely be tolerated and accepted by economic and monetary deciders for the simple reason they have no other choice. In addition, this ‘very high oil price’ is believed by most fit-to-print commentators and analysts as likely to fall through 2003, notably because of the possible military invasion and occupation of Iraq. Another source of solace to approved and published commentators is that Venezuela must sooner or later restart oil exporting, whether or not the Chavez regime is ousted. Official or conventional economic ‘logic’ then continues by forecasting that a reduction of oil prices to about $18/ barrel, that is under $10/barrel in dollars of 1984, will itself underpin and accelerate non inflationary growth in the US, European, and possibly Japanese economies. World economic growth, however, is little mentioned by accepted commentators, except to say that ‘high oil prices hurt poorer countries more than rich’.

Through 1986, from December 1985 through August 1986, oil prices were nearly divided by three, that is fell by about 60% in 8 months, to around $11.50/barrel in dollars of 1986, for many light blends. Absolutely no spontaneous, self-reinforcing and of course non inflationary increment to economic growth was recorded in any OECD country. The energy economic myth concerning oil prices, that ‘high prices hurt economic growth’, which has little or no truth, also has no logical corollary in ‘lowered prices favoring growth’. Conversely, unrestricted double-digit growth of stock market ‘value’, without corresponding growth in the real economy certainly has strong impacts. While the 1986 oil price crash was a non event in economic growth terms (as was the fall in prices after Desert Storm in 1991), unrealistic growth of stock market indices directly led to the October 1987 US, and then world stock market crash. Bourses experienced their largest one-week falls in index numbers since the 1929 Wall street crash. Stock market capitalization losses, that is loss of nominal or paper ‘value’ were estimated at around $ 1 850 Billion. This amount of notional ‘lost value’ is well exceeded by nominal losses of around $ 6 500 Billion in today’s dollars from the continuing but slow motion crash that has occurred on world stock exchanges through 2000-2002. The eagerly awaited fall in oil prices through 2003, due to war in Iraq, increased Russian production, and/or reinstatement of Venezuela amongst the oil exporting fraternity, is therefore difficult to see as itself assuring or enabling recovery in economic growth of OECD countries, but may itself contribute to further, and intensified falls on world stock markets, as expected or hoped-for and invested-for growth does not occur. Conventional parlance for this is double dip recession, athough in the case of 2000-2003 we can more easily say treble dip.

It is possible to attribute the extreme, that is highest-ever one-year growth of the US economy in 1984 as due to equally extreme budget deficits operated by the Reagan administration with the aim of securing Reagan’s re-election. Such desire can easily be attributed to the current Bush administration, but conditions for financing yet further increase of already spiralling US budget deficits are distinctly different, and less feasible than those of the Reagan era. Conversely, oil price rises to levels close to those of 1984 are probably inevitable. They therefore should not be thought of as assuring an economic apocalypse, and meriting resistance by extreme measures, notably one, two or more wars simultaneously. Economic policymakers should understand that if or rather when oil prices attain $60-$70/barrel in dollars of 2003 global economic adjustment to higher prices will result in restored economic growth, and will enable certain, long overdue structural economic modifications through energy-economic factor change. In the present context of very low real oil prices, and lowered levels of consumer confidence in OECD countries due to fears of job losses, terrorism, climate change and other worries in what are essentially consumption saturated economies, few other strategies for restoring conventional economic growth in fact exist. Lower interest rates at this time can be discarded as any kind of rational, or even possible strategy for the simple reason that US, European and Japanese base rates are at historic lows, in some cases their lowest for 50 years! Any further cuts in US interest rates, notably, would most surely lead to flight from the dollar and a rapid aggravation of US trade deficits, with increased inflation; conversely, increased trade deficits due to higher oil prices may well be limited if confidence in the dollar can be maintained.

Higher oil prices operate to stimulate first the world economy, outside the OECD countries, and then lead to increased growth inside the OECD. This is through the income or revenue effect on oil exporter countries, then metals, minerals and agrocommodity exporter countries, many of them Low Income (GNP per capita below $400/year). Almost all of these countries have very high marginal propensity to consume. That is any increase in revenues, due to prices of their export products increasing in line with the oil price, is very rapidly spent, mainly on purchase of manufactured goods of all kinds. In the 1973-81 period, in which oil price rises before inflation were of 405%, the New Industrial Countries of that period – notably Taiwan, South Korea and Singapore – experienced very large and rapid increases in demand for their exports. These three countries increased their oil imports, through the 1973-81 period and despite the 405% price rise, by 50% to 80% in volume terms, this demand ‘elasticity’ requiring an explanation by excited commentators who ‘explain’ that higher oil prices ‘hurt poorer countries the most’, and reduce world oil consumption thus also hurting ‘greedy oil exporters’. In global economic terms, very simply, higher priced oil is used by more efficient producers, who do not experience inflation and recession because of their adjustment through growth. Concerning the myth, or propaganda that ‘high oil prices hurt poorer nations’ we can note that through 1973-81 the number of Low Income countries unable to repay sovereign loans, and therefore forced to accept structural adjustment as a condition for financing by the IMF, was almost zero. From 1986 to 2002 the number of Low Income countries (LICs), mostly in Africa, that have experienced so-called ‘structural adjustment’ and then collapsed into civil and ethnic war, has never ceased to rise. Probably 7 – 10 million persons have died through the direct or indirect effects of ‘structural adjustment’ through 1986-2002, mostly in Africa but also in Latin America.

Today’s New Industrial Countries (NICs) include China and India. Both have immense internal or domestic markets, and large potentials for military keynesian spending, that is reinforcing domestic economic growth through deficit financing of modernization and expansion of their military systems, using labour-intensive projects securing rapid growth of employment, or reduced unemployment in regions selected for such programmes. The relative lack of integration of these behemoth economies in the world system, and particularly of India, provides them with some cover or shelter from the effects of world recession, when or if the current, continuous but slow degradation of economic performance in OECD countries tilts to all-out recession. Conversely, whenever any increase in world solvent demand for manufactured goods occurs, these two countries will rapidly increase output. China is without question the world’s leading industrial power for medium- and low-value consumer manufactured goods. Under almost any hypothesis, therefore, fossil energy demand – particularly oil – will increase in China and India, in the short run at rates close to their rate of economic growth.

According to many analysts, and as discussed by Campbell and Korpela in this book, there are increasing reasons to believe that maximum possible world oil production increases through the 2003-2008 period may be no more than 0% - 0.75% per year. World oil demand increases through 1990-2000 for the slow-growth economies of the OECD, and fast-growth economies of the NICs averaged about 1.8% per year. This Peak Oil situation, in theory, should entrain very large or nearly unlimited increases of oil prices, perhaps after a delay of several years, with or without various military adventures, and whatever is done with ‘strategic’ petroleum reserves. Taking current world regional per capita oil consumption rates, and economic output per barrel or barrel equivalent of commercial energy, the effectively price elastic OECD North, and price inelastic NICs and LICs can be compared and contrasted. That is, relatively large and rapid falls in oil demand in the OECD North, and increasing demand in the NICs and LICs can be expected whenever oil prices break through the current, artificially low range of scarcely one-half the 1984 barrel price in real, puchasing power corrected terms. Apart from terms of trade and price effects entrained by much higher oil prices – that is most metals, minerals and agrocommodities tracking or exceeding oil prices in terms of their relative or absolute price levels relative to manufactured goods and services imports and purchases – oil prices at up to $70/barrel in 2003 dollars will ensure easier financing of infrastructure projects in LICs. They will also enable poor countries to break free from their indebtedness to the North’s financial institutions, and again have real freedom of economic policy choices.

It is in no way obligatory that fossil energy intensive infrastructures and development, with harmful environment impacts, should be the automatic norm. LICs, from a base of low energy infrastructures, ‘extract’ considerably more economic wealth per barrel of oil or equivalent of commercial energy than either OECD countries or the NICs. By conserving this energy-economic advantage, and addressing their real needs rather than that of the so-called Global Market, these countries will be in a stronger position than the OECD North to face the coming era of energy penury. Their very low per capita consumption of commercial energy – entire continental oil demand of Africa is about 3 Million barrels/day or less than a third of either EU-15 or US oil imports – in fact indicates that LICs will, should or could increase their oil consumption for some time.

Conversely, in the OECD North and particularly the USA, oil price rises to $60-$70/barrel will firstly provide the ‘wake up call’ not only for their stagnant economies, but for needed restructuring of the economic system and cultural values. Apart from handwringing and tubthumping, and of course military adventures, there will be little margin of action and few options open to political and economic decision makers. As noted above the ‘interest rate weapon’ at this time is more than a double edged sword; cranking interest rates to double digit levels will almost certainly bring about another 1929 crash and Great Depression. Within about 12 months from what will certainly be called an Oil Shock, increased solvent world demand will trickle up to the OECD North, in the form of increased demand for higher value manufactured goods and sophisticated services supplied by the industrialized countries. The weak-only world oil production increases permitted by a situation of Peak Oil will act to lock on oil prices at higher levels – we will unlikely ever again hear, and even less believe in the myth that the world is awash with oil. Maintained higher levels of world oil and energy prices, and prices for energy-intensive metals, minerals and plantation agrocommodities will then operate to enable and facilitate the long-delayed, but inevitable structural changes of firstly OECD North economies, and restructuring of their social and cultural value systems. These of course include fundamental change of habitat and transportation systems towards more collective and energy efficient modes and methods for satisfying real human needs, de-urbanisation, and entirely different agriculture and land use systems. Maintained, and then increasing fossil energy prices will supply much-needed market signals to the self-styled ‘market conscious’ decision making elites of the rich countries - energy systems, by necessitity and by urgence will shift to energy conservation and renewable-based approaches.

These and other changes can be accepted or can be rejected. Current leaderships in the advanced industrial countries would appear to have scant regard for the reality of Peak Oil, or the environmental consequences of near total reliance on depleting, fossil-based energy. However, military adventure is itself very costly in energy-intensive materiel and equipment, and of course very harmful to the environment as well as human beings. Sooner or later, therefore, it will be understood that the idea of potential military solutions to geological problems of fossil energy depletion is so absurd, so shamefully stupid that it must be completely forgotten. International cooperation, an almost forgotten term from the 1970s and early 1980s, when oil prices attained about $85/barrel in dollars of 2003, should rapidly be reinstated as the way forward to preparing all persons for a future in which nearly all of our current and easily producible supplies of oil and gas will be exhausted by about 2035. Major human migrations will most certainly have to take place, as current economic, urban and industrial systems are dramatically restructured or abandoned. Without much higher oil prices in the present this progression cannot begin – thus increasing difficulties of, and reducing timeframes available for the obligatory and inevitable restructuring which will happen, nolens volens.