Hamish McRae: We will never have cheap oil again

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When this wave of higher oil prices subsides, is it going to be business as usual? After the oil shocks of the 1970s and early 1980s, the oil price came back down and we went pretty much back to our bad old ways.

But this time it feels different. It is true that all the attitudes that characterised previous surges in the oil price are evident now. There is the resentment against the oil companies at their profits. There is the cockiness of Opec, with its president warning on Monday that the price might go to $200 a barrel. And there are the exhortations to conservation, but without much follow-up.

Taxes on energy are smaller relative to the total tax take now than they were when Labour took over. And there are the mad-cap government initiatives that do more harm than good. In the US in the 1980s the legal requirement on car manufacturers to improve the fuel consumption of their fleets merely pushed Americans into four-wheel-drives that were exempt. This time it is legislation and subsidies in favour of bio-fuels in the US and Europe that have helped force up the price of food globally.

However, though on the surface there is a sense of déjà vu, there are several reasons to suspect that it really will be different this time: that though the oil price will eventually fall back somewhat, we will never have cheap oil again – cheap in the sense of the $20-30 a barrel range of most of the 1990s and the first part of the 2000s.

Never? Well never is a long time but if it is so it is good news for conservation and indeed the planet. In the short-term there may well be some shading back in the price, but our economic structure is determined by long-term prices, not short, and the present surge seems likely to hasten us along the path to a less oil-dependent world.

Here's why. It is that the balance of power between those two old warriors, supply and demand, has irrevocably shifted.

Supply, as Opec keeps reminding us, is tight. Any disruption in supplies has therefore a disproportionate impact on the price. You can see that in the way disruption in the North Sea and Nigeria pushed up the global price over the weekend. Some 60 per cent of the world's supply comes from the non-Opec producers and they are pumping at or close to their limits.

You could say, over-simplifying grossly, that this "Nopec" oil is difficult-to-produce oil in politically easy places, whereas Opec oil is easy-to-produce oil in politically difficult places. As far as Nopec is concerned, many of the easier (ie, cheaper to produce) fields, such as on-shore US supplies, are in decline. The first generation of off-shore fields, including the North Sea, are in decline too.

Oil is still being found but the really big opportunities are in non-conventional sources, such as shale oil and tar sands, and these are expensive to exploit and may carry high environmental costs. So, over the next generation, the total Nopec supplies may creep up a bit – though even that is not clear – but it is not going to be cheap oil.

Opec oil, by contrast, is in geologically easier places. We know where it is; and we know how to get it out. Actually, it is mostly in the Middle East, with a fair amount in Africa. Saudi Arabia remains the world's largest producer. Opec members, for perfectly understandable reasons, wish to retain control over their output, which they do either by operating through national corporations or, when they do get Western companies in on the act, keeping them tightly controlled. In theory it would be easier for Opec to increase its production than for Nopec, but political realities curb the extent to which that is likely to happen.

So supply will remain tight for the foreseeable future. It may become very tight indeed if the "peak oil" advocates are right. These are geologists who believe that the world is close to the technical limits on what can be produced and that oil production is set to reach a peak and then to decline in the next few years. Most people in the big oil companies disagree but even "big oil" would acknowledge that the age of easy oil is past. That is materially different from the situation in the 1970s and 1980s.

Tight supplies clash with strong demand. The burgeoning demand from China for all sources of energy has been widely recognised, with China last year becoming a net importer of coal for the first time. (It has been a net importer of oil since the early 1990s.)

The point about oil, of course, is that it is not just a source of energy but also a feedstock for many chemicals, so while China is scooping up world coal and gas supplies too, it cannot carry on growing without relentlessly, year after year, importing more oil.

Add in demand from India and the consumption situation is utterly different from every previous global downturn. Every time up to now, and particularly in the 1970s and 1980s, a slowdown in the developed world economy fed through into a decline in demand, or at least a slowing in rate of growth. That does not seem to be happening now.

US oil demand is slackening, as you would expect, and European demand may well follow suit. But Asian demand is not. So Chinese growth comes down from 11 per cent a year to, say, 8 or 9 per cent? That does not help release much pressure on the oil fields. Oil becomes more expensive? Sure, but China has huge foreign exchange reserves and has to have it. So it will pay.

As a result, both supply and demand are less responsive to price changes than they were in previous cycles. Eventually, at some price, people are forced to conserve more oil. We either use less of it or we substitute where possible with alternatives. Eventually, if the price is high enough, the oil companies will figure out ways of extracting more of the stuff. But this process will not happen as swiftly or as dramatically as it did in previous cycles.

That is good news. The plunge in the oil price, particularly after the peak in the early 1980s, and the low price through the 1990s until about three years ago, undermined a lot of the conservation efforts those spikes in the price provoked. The price hit $80 a barrel in the early 1980s, in real terms roughly where we are now. Had that price been maintained through the following quarter century we would be in much better shape than we are now.

So we should reasonably hope that the world will not have much more expensive oil. At the present level it is expensive enough to start forcing conservation, and as a result of the impact it is having on food prices – oil at $100-plus takes money from the poor and gives it to the rich – it is not something that supports social stability or human decency.

But let's equally hope that it does not come down too much either. The market mechanism can be a brutal one, but it can also be a powerful one, forcing a necessary change in the way we live on our planet home.

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