Hamish McRae: Let's get real: cheap oil is never coming back

Economic Studies
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The Independent Online

Oil is back up above $100 again – a level which, coupled with a none-too-strong pound and yet more tax increases, has pushed the price of fuel at the pumps to record levels. The immediate trigger for this rise has been political: the unrest first in Tunisia, now in Egypt and maybe too in Jordan.

But this reaction is not really about politics; it is about economics. In a tight oil market, any possibility of disruption to supply has a disproportionate impact on the price. Though neither Tunisia nor Egypt are significant oil producers themselves, they have set in motion concerns about wider regional instability – and that in turn should remind us that the world is tremendously dependent on the Middle East and will almost certainly become more so over the next couple of decades. And this is not just about oil; it is about the price of energy and raw materials for the next generation.

The sequence is clear. Oil is the most important single source of primary energy, supplying in round numbers 35 per cent of the total. Gas is another 25 per cent, with coal about 30 per cent. All the rest – hydro, nuclear and the various renewable sources – are only 10 per cent. The significance of oil has fallen from a peak of a little under 50 per cent in the 1970s. But oil is so immensely convenient, and since the oil and the gas prices move pretty much together, it remains the key energy price, the benchmark for everything else.

Its significance goes further. It is a key feedstock for chemicals, plastics, fertilisers and so on. So what happens to the oil price has the most profound impact on food prices, living standards, indeed on our entire civilisation. What happens next? Well, I don't think any of us can predict with any confidence what will happen to the region over the next decade or two but we can say some things about energy demand and supply, and maybe too about the oil price.

A couple of weeks ago, BP produced some long-range forecasts in its BP Energy Outlook 2030. Several messages emerged. One was the extent to which the world is likely to remain driven by fossil fuels for another 20 years at least. While, in BP's best-guess scenario, the proportion of primary energy supplied by non-fossil fuels might rise to 20 per cent, overall demand for energy is such that there will still have to be a huge increase in supplies from coal, oil and particularly gas. Indeed, fossil fuels will account for some two-thirds of the world's additional energy needs over the next 20 years.

A second message is that virtually all the increased demand for energy, some 93 per cent of it, will come from outside the developed world. We in the present rich world will increase energy needs a little over the next 10 years but by 2030 our consumption will be falling. By contrast, energy demand from the emerging countries will rise by more than two-thirds and still be rising fast.

A third point is that for the first time ever the energy consumption of the emerging world is greater than that of the developed world – a tipping point, you might say. So it would follow that what China does is vital, the key to the demand side of the equation (BP accepts the assumption of, among others, Goldman Sachs, that by 2030 China will be the world's largest economy). If you look at global carbon dioxide emissions, the emerging world, which is already producing more than the developed world, accounts for the entire increase over the next 20 years.

So much for demand. Now look at supply. Here the big shift is the increasing importance of Organisation of the Petroleum Exporting Countries (Opec). Opec members have, since the 1970s, been producing a declining proportion of the total, as concerns about energy security have boosted exploration and production in the rest of the world. But, to over-simplify, non-Opec oil is difficult oil: it is under the sea or in the Arctic, or bound up in tar sands from which it has to be separated. By contrast, Opec oil just comes straight out of the ground. In any case, even if the technical difficulties can be overcome, the actual ability of non-Opec producers to carry on ramping up production is in question. As a result Opec, producing less than 40 per cent of the total now, will be producing nearly half the world's oil in 2030, and most of that increase will come from the Middle East.

There are, of course, a number of things that might change this profile of ever-greater dependence on an unstable region. Biofuels will help on the supply side. Maybe demand could be reined back, something that depends crucially on China, which will account for half of the increase in world demand. World GDP might grow more slowly than forecast, but it might actually grow faster. There might be even stronger policies aimed at cutting carbon dioxide emissions, such as more efficient cars and electricity power generation. Were these successful, then oil demand would indeed rise somewhat more slowly.

But it would still rise. That should make us realise that energy is likely to be expensive for the rest of our days. BP does not give any price forecasts, perhaps wisely, but we know enough about the power of the market to know that even at present prices the hunt for finding ways of using less of the stuff is a vital one. Meanwhile, as the past few days have shown, the world remains troublingly dependent on one region for its oil supplies and hence its economic stability. Unfortunately, it will become even more dependent in the years ahead.