1. THE GLOBAL ECONOMY UTTERLY DEPENDS ON CHEAP OIL
The unfolding social and political unrest in the Middle East/North African (MENA) region are emblematic of changes that will be visiting the rest of the developed world in the near future. Yes, dictators, corruption, and weak justice all play into the MENA situation but underlying those insults is a deeper structural flaw that rests on the relentless math of energy depletion and its relationship to economic growth. The short version of the story is this: the global economy utterly depends on cheap oil to function. Without cheap oil, the economy will not work quite the same as it did before.
We have irreversibly slipped into a world of ever-increasing energy costs and those, predictably, are dragging down the weaker players first. By failing to appreciate the fundamental and irreplaceable role of energy in fostering economic growth, the world's high priests and priestesses of monetary and fiscal policy have placed the developed world in the exact same situation as the MENA countries.
No, printing more money and manufacturing more debt to promote more consumption will not help anything. In fact these efforts are harmful because they distract us from what's really at the heart of the issue; instead we should honestly admit to ourselves that we have a gigantic energy-based economic and monetary predicament on our hands. One that requires a clear-eye diagnosis, and adult-sized conversations about what sorts of intelligent responses make sense here.
Assuming the west fails to heed the warnings and lessons being served up by the MENA region, the predictions are easy enough to make. Fiscal and monetary crises will sweep inwards from the weaker regions towards the center. Markets will violently gyrate but ultimately destroy wealth. We still have time, but not a lot, especially considering that the leadership of the developed world is, for the most part, operating with the wrong narrative in place. The right one would consider energy and other critical environmental resources equally alongside economic goals.
2. OIL SPIKES UNDERCUT ALTERNATIVE ENERGY PROGRAMS
Since 2008, oil demand in the developed countries of the OECD has declined by 4 million barrels/day. Over the same period, oil demand in the rest of the world has risen by 4 million barrels/day. In 2011, the world has returned to the precarious balance of oil supply and demand that we faced in 2007 and 2008, when rising demand and stagnant production sent prices soaring to nearly $150.
The uprising in Libya, removing 700,000 b/d from the market, yet sending crude oil prices up 15%, reminds us both of how fragile that balance is as well as of how little has changed since 2008 in terms of our preparedness for such price shocks. If unrest were to spread to the core of the Middle East producing area in Saudi Arabia, disruption of exports from there could produce a price spike unlike any experienced in the past. And with the spike would come another economic crash.
The events since January highlight important vulnerabilities: one is the mismatch between the long lead times of our programs to develop alternatives to oil and the rapidity with which crude oil supply can be disrupted, sending markets into turmoil and undercutting the same programs attempting to mitigate such impacts. A second is reliance on strategic and critical inputs that are sourced from a small concentration of producers. As the US looks to move away from oil for transportation, it is at the same time moving to import dependence on other critical inputs such as lithium for batteries and rare earths for hybrid-car motor magnets from a small concentration of producers. This leaves our energy system open to the same types of supply and price shocks as we are witnessing today.
Since 1995, David Fridley has been a staff scientist at the Energy Analysis Program at the Lawrence Berkeley National Laboratory in California. He is also deputy group leader of Lawrence Berkeley's China Energy Group, which collaborates with China on end-user energy efficiency, government energy management programs, and energy policy research. Mr. Fridley has nearly 30 years of experience working and living in China in the energy sector, and is a fluent Mandarin speaker. He spent 12 years working in the petroleum industry both as a consultant on downstream oil markets in the Asia-Pacific region and as business development manager for Caltex China. He has written and spoken extensively on the energy and ecological limits of biofuels.
3. LIBYA & MIDDLE EAST UNREST WIDEN A VICIOUS CIRCLE
Oil and gas were formed in the geological past, meaning that for every gallon used, one less remains. Although the details are masked by unreliable data and ambiguous definitions, it becomes evident that Oil Age is about half over. Growing oil production during the First Half facilitated the rapid expansion of industry, transport, trade and agriculture, allowing the population to grow six-fold. Declining production during the Second Half will likely give a corresponding contraction.
Shortages appeared following the peak of Regular Conventional oil production in 2005, and led to a surge in oil price in 2008, which gave an economic recession and financial crisis, killing oil demand. Prices then fell back to 2005 levels before Governments intervened to stimulate consumerism under outdated economic principles. Oil demand recovered to again threaten the supply barrier, such that prices had risen to almost $100 by the end of 2010.
The transition to the Second Half threatens to be a time of great social, political, financial and economic tension, as recent events, ranging from student demonstrations in London to revolutions in North Africa, confirm. Some of the affected countries, including Libya, are important oil producers, run by authoritarian regimes controlling underlying tribal conflicts. Oil revenues allowed the elite to amass colossal wealth but also bred a corresponding resentment, which exploded when the people at large faced soaring food costs and rising unemployment.
Oil production will fall in Libya whatever the political outcome, and it will not be easy to replace it elsewhere. Oil prices are accordingly likely to rise again prompting a certain vicious circle: the higher the price, the greater the social tension and the risk of further cuts in supply.A critical element is of course Saudi Arabia, responsible for more than ten percent of the world's supply of conventional oil, and it is significant that tensions have been rising in Bahrain, an island off its coast, and in the neighboring countries of Yemen and Oman.
If this vicious circle widens, it will represent a turning point for mankind of historic proportions.
4. HEY TEACHER: LEAVE THOSE AUTOCRATIC REGIMES ALONE!
Many in the US cheered as decrepit dictators in Egypt and Tunisia fell. But now that more democracy for North African and Middle Eastern nations seems to translate to higher gasoline prices for American motorists, the real motives for, and costs of Western nations' decades-long support for autocratic regimes in oil-rich nations are becoming apparent. This was a strategy to control the world's most important resource, but it was wrong-headed from the start because it could not be sustained on the backs of millions of people with rising expectations but declining ability to afford food and fuel.
If somehow the uprisings can be confined to Libya, Yemen, and Bahrain, oil-importing nations may be able to weather 2011 with minimal GDP declines resulting from $100 oil prices. But that is a big "if." It is really only a matter of time until Saudi Arabia is engulfed in sectarian and political turmoil, and when that happens we will see biggest oil price spike ever, and central banks will be unable to stop the ensuing economic carnage.
It's both comic and sad to see certain economists insisting that a 10 percent rise in oil prices will translate only to a certain smaller percentage of decline in GDP growth. There are thresholds-such as $5 a gallon gasoline for US motorists-that will make hash of such forecasts. Energy is not a segment of the economy; it IS the economy.
We think we're probably in for a very nasty ride these next few months.
5. CHINA & THE INTERNATIONAL ENERGY AGENCY: BOOKS BALANCED?
Prior to the unrest breaking out in the Middle East, all eyes were on China for an answer to the question of "How high will oil prices go in the next year or two?" In 2010 the demand for oil surged ahead by 2.8 million b/d, much more rapidly than had been expected. Much of this increase in demand came from China where a number of factors converged to push demand to new highs.
To avoid predicting a growth-killing price spike this year, the International Energy Agency (IEA) decided that the increase in demand for oil in 2011 would be only 1.5 million b/d. This forecast assumed that the seriously overheated Chinese economy would have to cut back markedly on the annual growth of its oil consumption this year in order to control price inflation.
In order to balance the books IEA envisioned OPEC slowly increasing production in 2011 out of its spare productive capacity. The IEA now recognizes that production from newly opened oil fields is very close to balancing declines in production from older fields, so not much increase in total world oil production is expected in the future.
We have a whole new game. After working through Tunisia and Egypt, the Middle Eastern unrest came to a significant oil producer, Libya, which had been exporting circa 1.3 million b/d of the world's best crude. Now it is exporting little if any oil and world prices are $15+ a barrel higher.
As it became apparent that the loss of Libyan crude exports was going to be a major economic problem for the European economy, the Saudis stepped in to say they would increase production from what they claim to be 3 or 4 million b/d of spare productive capacity. As the Saudi's are reluctant to announce production above their OPEC ceiling, they have relied on leaks to get out the message that they are now producing somewhere over 9 million b/d - various reports have their output at 9.2, 9.3, or even 9.4 million b/d, up from 8.4 million in January. A few other OPEC states with spare capacity are said to be increasing production by another 300,000 b/d. All this makes it look, on paper, that should Libyan oil production remain shut-in for weeks or months, the missing oil output will be replaced and oil prices should move lower.
This happy scenario, however, does not take into account China and its voracious appetite for imported energy. Should the IEA be overestimating OPEC's real spare capacity, or underestimating the size of China's demand for imported oil, or should unrest force another Middle East producer to slow or halt its output, the global oil world will be a different place by the end of the year.
6. ADDICTS EVENTUALLY PAY THE PRICE
We need to prepare for the inevitable crises that will upset the apple cart on oil supply. Macondo was just an appetizer. So far, the Libyan revolt is only an unforeseen precursor that has caused indigestion in the oil importing countries. The Saudi's are numero uno when it comes to a major case of the oil deprivation flu. If they go at it, all bets are off. And if Iran goes, watch out world.
The worst case scenario I usually toss out in my talks is the obvious: If Israel takes aggressive action against Iran, Iran will in turn shut down the Strait of Hormuz, shutting off 20% of the world's oil supply.
If the Libyan revolt is contained and either someone sane or maybe even Gaddafi retains power, then oil prices will stabilize-for awhile.
American's are broke and hopelessly oil addicted-this could be the wakeup call needed in terms of high oil prices and potentially even supply restrictions that will make Americans believers in the vulnerabilities of their current lifestyle.
The implications of the current unrest for the global economy and the industrialized world, which imports over half of its oil consumption, should be obvious.