12 Nov 08 Eddie's Blog Global

Falling oil prices

I have recently seen comments by various economists and politicians that low oil prices are good, that they are to be welcomed. It is worth debating this claim.

So firstly, why do some people believe that low oil prices are good? Low oil prices reduce inflation for so long as they are low. This allows central banks to reduce interest rates (if other causes of high inflation are also absent). Reduced interest rates are a necessary condition for economic growth. Most economists consider that the current round of low interest rates in USA, Japan and GB will lead to economic growth in those economies.
We shall see.
Low interest rates are a necessary but not a sufficient condition for economic growth. If people have no confidence in the immediate economic future there will be no growth even with low interest rates. During the 90’s Japanese interest rates were zero and there was stagnation for the entire period.

So back to relatively cheap oil and whether it is good or bad.

The fundamental question that needs to be asked is why has oil come down in price? The oil supply and demand situation is very finely balanced. In fact given normal growth rates in the West and very high growths in the BRIC countries there is not enough oil to meet demand. Consequently the price went up.
As we said in a recent blog oil is being depleted at 9.1% per year. With an expenditure of $360Bn per annum on exploration and enhanced extradition the depletion rate can be reduced to 6.4% per year (IEA).

So a high oil price is an expression of reality.
It is a good signal to the world that we all have to change our ways. It is an appropriate signal to Governments that new forms of energy must be brought on stream at a quicker rate than they had planned. It is a signal to the consumer that we need to buy more fuel efficient cars and spend some of our disposable income on insulating our houses.
It is a signal to investors that investing in sustainable forms of energy is a winning way forward.

So what does the current low price do?

We know that T. Boone Pickens has postponed his investment in the world’s largest windfarm in Texas.

We know that pressure to buy fuel efficient cars is reduced and that GMs impetus to develop the volt hybrid will be reduced.

We know that exploration for new natural gas in the US is reduced. It needs a price in the $7.50 - $8.50/million BTUS for new gas exploration to happen. At a current $6.50 this comes to a halt.

Oil consumption will increase at a time when logically it should be reducing to reflect its depleting nature.

The most obvious loser is the environment. The rest of us lose as well. Oil is only at a low price because of recession in US, Europe and Japan. It will hunt up again when growth resumes.

This low price is one half of the reason for oil price volatility. I have often written that this is the most short-term destructive, the most corrosive aspect of our dependence on fossils.

No Government, no company or no household can plan its energy future in the face of such volatility.

The producing nations are right to reduce supply. They are like the rest of the world’s nations. How can they budget for their infrastructure, education, policing, health services when their income next year could be half or double what is was last year.

We in the West can live with high oil prices. We need to live with them. They make us do the right thing.