While waiting to find out how many million barrels of daily oil production OPEC says it will cut, it’s a good time to review the financial-energy situation as the two are now inextricably linked.
As is well known, the most prominent features of the landscape for the last few months have been plummeting oil prices and a deepening economic crisis. So far oil prices have been falling faster than the economy seems to be coming apart, thereby giving many the impression that cheaper gasoline will soon heal our economic woes and all will be well.
We may never understand how to properly weigh the factors that went into this year’s collapse of oil prices. The collective perception that the world is headed towards a time of very serious economic difficulties obviously heads the list. The rise of the dollar or the falling euro, margin calls on speculators, the collapse of the U.S. housing industry, the start of the Olympics which ended the great Chinese oil buying binge, and more recently the lack of credit to finance oil transactions all have contributed to the plunge.
Currently the world’s attention is focused mostly on the credit squeeze that was precipitated by insolvent banks’ reluctance to admit their condition. Considering that the world’s governments have spent, lent, pledged, guaranteed, promised, or what-have-you, four trillion dollars in an effort to get banks loaning money again, it’s no wonder the markets leap or plunge on every twitch of the London lnterbank Offered Rate. Few commentators as yet seem to really grasp that behind the credit squeeze lies a universe of troubles: unaffordable mortgages, falling housing prices, dropping consumer sales, rising unemployment, defaulting home equity, car and credit card loans. This recession, or whatever it ends up to be, is still in the first inning.
So where does all this leave the world’s oil supply – the life blood of our civilization? Recent reports say world production dropped rapidly in September. As stockpiles seem to be rising, we can presume OPEC will cut production again or be faced with much lower oil prices. Given that nearly all the world’s oil exporters have let their economies become accustomed to six years of steadily climbing oil revenues, they, as well as their customers, are in for some hard times.
The scariest factor at the minute are reports that smaller traders, that have been an essential part of moving oil across the globe, can no longer get financing for oil shipments – though Exxon, Shell, BP and WalMart don’t have to worry about such things. This lack of loans is forcing many traders to the sidelines leaving the market to only the largest participants.
Since no one really can foretell how all the myriad of forces at play are going to work out, it might be useful to look at a scenario or two to gain some insight into what the future could have in store for our oil supplies and prices. First we must remember that world oil production assuredly has peaked due to the financial crisis, so that by the end of this year production is likely to be substantially lower due to lack of demand and cuts. A corollary to this drop is that investment in new oil production projects is already slowing due to “insufficient oil prices” and lack of financing. While well-financed major oil companies are likely to finish work on projects already underway some of these too could be put on hold.
Let’s take a bad, if not the worst, imaginable scenario. Suppose the world economy really goes sour in the next year or two; unemployment soars into double digits; consumer sales, agriculture and industrial production drop markedly across the developed world and international trade melts. What happens to oil production, demand, and prices? For starters, there are numerous countries in the world that are already in an economic death spiral. For those unable to earn foreign exchange, demand for oil will drop precipitously and large parts of their economies will soon be back into the 19th century.
China, however, with a large population and expanding economy maintains that it will be disconnected from the rest of the world so that it can keep right on growing and importing more oil each year. Europe, which has been through hard times in living memory, uses only half the oil per capita as the U.S., and has excellent bus and rail transport and can probably make do with still less oil and natural gas.
U.S. oil consumption in the midst of a great economic slump is probably the major unknown. Currently our consumption is down by about 8.5 percent, (4.3 percent for gasoline) due to the high prices of last summer and the stagnating economy. As gasoline is likely to be down to $2.50 a gallon or so shortly, the $4 prices of last summer will not be inhibiting consumption for a while. For the next few years we likely will be left with high unemployment, lower economic activity and scared or impoverished consumers as the main reasons for less oil consumption. Whether this cuts U.S. demand by 10, 20 or 30 percent, we as yet just can’t tell. Serious conservation efforts – lower speed limits, car pools, buses, more insulation – could have a role in determining how far demand drops.
The final question is what effect does a severe economic recession have on world oil production? Will it drop rapidly, or stay on the current plateau? Will demand for oil drop so fast that, at least for awhile, it keeps ahead of the declining capacity of the world’s oil fields to produce? Can we forget about alternatives to oil for a while as lower worldwide demand means we can get all the oil anybody still wants relatively cheaply? Can we afford to transition to alternative sources of energy?
For now these are only questions, but the next year or so should start to bring answers into focus. One way or another, it will not be an easy time.