Peak Oil on Artificial Steriods

Bubble, Bubble, Oil and Trouble

The prospective price of oil has been a hot topic in recent weeks. It is the kind of issue which fascinates us at Contra Celsum because it has so many facets. We posted recently that the West has recently taken on the role that OPEC played in the great oil shocks of 1973 and 1974—albeit for different, although connected, reasons. Both OPEC then, and the West now, see themselves as being under real and substantial threats. Both acted (and are acting) to restrict the supply of oil.

In the seventies, OPEC felt that it was being exploited by Western oil consuming nations. So Arab nations (predominantly) formed a cartel, restrained output, and forced the world oil price up. The impact was felt all around the world. It resulted a decade of stagflation in the US and Europe (and other western economies, such as New Zealand). Stagflation is a macro-economic condition of rising prices (inflation) coupled with stagnant or no economic growth.

Stagflation leads to rampant inflation. Universal rising prices are tolerable (although not healthy) where productivity and economic growth is matching or outstripping price rises. Where prices are rising, but economic growth is static or contracting, however, as is the case under stagflation, in the end inflation becomes rampant. That is, economic actors (producers and consumers) engage in adaptive behaviour and adjust their production and consumption decisions to the expectation that costs and prices are going to rise.

On the expectation that prices will continue rising they markedly increase their debt levels (borrow now, and pay back later with cheaper, inflated dollars) thereby pushing up interest rates. They hoard real assets on the expectation that they will match rising prices (gold, silver, real estate, hard commodities) driving up hard asset prices still further. Manufacturers build in greater margins on the expectation that the next lot of raw materials will cost more, thereby pushing up prices still further. Employees, demand and get higher wages, without any increase in productivity or more effort. Rising labour costs result in yet another universal price rise. So the spiral goes viciously upward.

Well, we hear you say, so what? As long as everything keeps adjusting upwards the party can go on for a long time. Not if you are on a fixed income, or have no hard assets, or are renting. For such people, who are usually the most vulnerable in our society, stagflation and rampant inflation is devastating and results in impoverishment. Moreover, inflation means that more and more paper money is in circulation in the economy. To cope with rising prices and economic pain, credit restrictions are eased. But the transmission of the money supply is never uniform. There will always be those who are closest to the money spiggots; they always benefit, but at the expense of those who are furtherest away. Monetary based inflation is theft, pure and simple.

To break stagflation and burn it away required the harsh monetarist medicine of the eighties, with the inevitable accompanying recessions.

There have been plenty of people raising the stagflation spectre in recent weeks. But it takes more than the rise in the price of a commodity to create conditions of stagflation. Rising oil prices are a necessary, but not sufficient condition. The world is now far more of an open global economy than the seventies and while it is possible that stagflation will eventuate, it is not likely. Nevertheless, were trade barriers to be erected once again, were free trade agreements and treaties to break down, were wage and price controls begin to emerge, and were widespread government deficit spending to re-occur, all bets would and truly be off. But we are not there yet—not by a long way.

Meanwhile, will the price of oil come down again? Courtesy of the Hive, we read that a senior economist for Export Development Canada is arguing that the price will drop in the second half of this year back down to around US$80 per barrel. Reason: slowing economic growth will reduce world-wide demand for oil. And George Soros is quoted in another article, also courtesy of the Hive, arguing that the oil price will drop, but his reason is different. He reckons price is now the result of a speculative bubble which will burst. So, which is it to be? Slowing economic growth or the bursting of a speculative bubble? If both are right, the price may drop back to US$40 or US$50 per barrel.

Not so fast. Courtesy of Adam Smith of the Inquiring Mind we have been linked to a very thoughtful piece in the Wall Street Journal. It argues, based on research work being done by the International Energy Agency (IEA), that supplies of oil are going to be far tighter than previously thought. In fact, we are already at conditions of “peak oil”.

The methodology of the IEA until recently has been to forecast world demand for oil, and it has simply assumed that production would rise gently and gradually to meet demand. Now, however, the IEA is looking at supply, and concluding that aging oil fields and diminished investment mean that it is unlikely that world supply will keep up with demand.

But this occurrence of “peak oil” is an artificial creation. There are plenty more supplies of oil in the world. As one analyst put it, the difficulties in oil supply are not buried in oil fields—they are above ground. They are social and political. In the West they are largely the result of greenist ideology.

To be sure, the greenists do not mind that peak oil is being artificially created. They would be quite happy to see not one more drop of oil consumed—for this, they believe, would combat global warming. They are very pleased to see the price of oil so high, and wish that it were higher. They will probably be gratified in the months ahead, unless our Canadian economist and George Soros are correct.

In their zealotry, hard core greenists are happy to see everyone poorer. They write off as mere “collateral damage” the degradation, starvation, and death of millions in the poorest countries in the mad drive to manufacture ecology-destroying biofuels. Like all good utopians, rationalists, and ideologues, the end really does justify the means.

What of the reality, however? Laying aside the lunatic fringe, will greenism triumph? Not when it starts to hurt. All the soft-core greenists, the fellow travelers and the politicians who represent them, are likely to desert the cause pretty quickly. The most likely immediate response to high oil prices: reduced taxes on gasoline. We are bold enough to predict that in the forthcoming election campaign in New Zealand, one of both major political parties will move to reduce the price of petrol at the pump by reducing state petrol taxes. France's Sarkosy has already made such a call—yesterday, in fact. Gordon Brown has proclaimed that high oil prices are his current apocalypse du jour. (Last week it was global starvation as a result of biofuels. Poor Gordon is finding that all the pet leftist causes are creating global crises which he is now left to deal with. Old Blony Tair. You have to give the man credit. He has to be the ultimate exponent of the hospital pass.)

Secondly, expect that when rising oil prices are seen as a threat to national security, the US congress will move rapidly to open up some of its vast oil reserves in Alaska and the western states to exploration and development. Greenism will quickly be seen as a nice-to-have, but only when you are sitting in your warm living room, with lots of affordable groceries in the kitchen. But it will take time to bring the oil onstream.

Thirdly, expect the major developing countries in the Third World, which have never bought into greenist ideology, to move quickly and effectively to assist in exploration and development, in exchange for favourable supply contracts, in the poorer third world. We continue to expect that within ten years the crisis will have passed.

“Peak oil” will seem like a distant memory, a time of temporary madness. What is an open question is whether greenism will have been thoroughly discredited and completely repudiated in the process.

Unlikely, for as Freeman Dyson recently argued environmentalism has now replaced socialism as the established secular religion. High priests and zealous acolytes do not relinquish religious beliefs so easily.