Higher oil prices are just what we need

The most favourable outcome would be for the high price to encourage the biggest users to conserve energy
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The Independent Online

The oil warning light is switching from amber to red. The $50 price for a barrel of crude oil reached yesterday is the highest it has ever gone in dollar terms, though not when you adjust for inflation. But it is still expensive and especially so by the standards of recent years.

The oil warning light is switching from amber to red. The $50 price for a barrel of crude oil reached yesterday is the highest it has ever gone in dollar terms, though not when you adjust for inflation. But it is still expensive and especially so by the standards of recent years.

Since oil affects the price of just about everything in the world economy, we will all feel the effects in higher prices - and not just at the pumps. Three of the last four global recessions have been triggered by a sharp rise in the oil price. That is not to say this rise will do so. But we can't go around this problem; we have to go through the middle; and we are not through it yet by any means.

The immediate cause of the present surge is a combination of unexpected blows striking an underlying tight market. The blows include political difficulties in Nigeria, the hurricanes hitting the southern US states and the disappointing progress Iraq is making towards normal production. But there will always be the unexpected blows - there will be more in the future. The underlying situation is ultimately more important, and in one sense disturbing. For oil, and energy in general, seems likely to remain expensive for a generation.

The reason is not just that oil - and gas - production cannot be increased swiftly. It is also that at some stage in the next few years the world will start to reach the practical limits of production, while demand seems set to rise steadily for the foreseeable future.

On the production side of the equation there is both bad and good news. The bad news includes the fact that the world's largest producer, Saudi Arabia, is struggling to increase its output. Yesterday it said it would increase production from 9.5 million barrels a day to 11 mbd.

But many oil experts doubt that this higher level of production can be sustained for long. Saudi Arabia has always been the swing producer, the one country that could adjust its output to keep a balance in the markets. Its reserves are huge but its fields are old. Not much new oil is being discovered. It may not be able to balance the markets for much longer.

The better news is that were the oil price to stay at its present level, it becomes economic to develop oil sources that would otherwise be left in the ground: tar sands in Canada looks a most promising option. It also becomes economic to develop practical alternatives such as bio-diesel - diesel made out of crops. And the higher the price the greater the effort by the oil companies to find more of the stuff, which they will undoubtedly do.

On the demand side, the news is almost universally bad. The US is projected to increase its oil consumption by more than 20 per cent over the next 15 years. And while I have not seen any projections of Chinese demand we know that it has now overtaken Japan and that demand is racing up by more than 10 per cent a year.

Chinese demand really does change things. Either this year or next, it becomes the world's fourth largest economy, passing the UK. Its energy demand is rising so fast that it is commissioning as much new electricity generating capacity this year as the whole of UK output. Most of that is generated by fossil fuels: coal, oil and gas. (Our entire alternative energy programme is equivalent to less than two months' growth in China's output.) This is not going to stop unless there is some economic catastrophe in China, in which case there will be plenty of more serious worries than expensive oil.

Add in similarly growing demand from India, now rolling out the world's largest road-building programme, and the prospect is higher demand for oil for a couple of generations at least. And there is really nothing we in Europe can do about it. Europe has been successful in cutting oil use, but we cannot cut our demand fast enough to make any significant difference in world terms. Asia is increasing demand far faster than we can reduce it.

So what will happen? When and if the present squeeze on supplies eases it may well be that the oil price will ease too. That is what the oil companies expect and it is their job to know about this. Were there to be another global recession the price would certainly come back sharply but that would be a most malign outcome. It would make it four recessions out of five that were triggered by the oil price. Not good.

The most favourable outcome would be for the present high price of energy to encourage the biggest users, the US and China, to adopt energy conservation as a high priority. Were they to do so, they would have the oil market on their side.

Markets do work even if they sometimes do so in capricious and unpredictable ways. In the short-term all that can be done is to apply good-practice existing technology more widely. The higher price should certainly encourage everyone - businesses of course but also public sector agencies and consumers - to do that.

To say that is not to be sanctimonious: Europeans, who led the Industrial Revolution, driven by coal and steel, are not very convincing when they hector the rest of the world about profligate energy use. It is simply to point out that the more efficient the world economy is at using finite energy resources, the faster it can grow and the greater the real prosperity it can deliver. If there is another world recession it will be the poor who suffer most.

What will probably happen will be some intermediate outcome between recession and continued benign growth. Things will slow because energy affects everything.

For example, about $350 worth of energy is used to make a new car. Cement is a big energy user, so the cost of building a house goes up too. And transport accounts for more than 10 per cent of the economy and it is directly affected. So things will slow next year as a result of what is happening now. We are being naïve if we don't acknowledge that.

In the longer-term the future prosperity of the world will depend on the next technology that comes along behind oil. We simply do not know what that will be. What we do know is, that as coal was displaced by oil, so oil will be displaced by something else. We know that it won't be nuclear power, which can help a bit but has failed to live up to the hopes of its early enthusiasts. (In 1954 the head of the US Atomic Energy Commission famously declared that, "It is not too much to expect that our children will enjoy in their homes electrical energy too cheap to meter.") And it won't be the present generation of renewables - wind turbines and the like - because demand is rising too fast for these ever to catch up.

My guess is that there will not be a single new technology but lots of different ones, including those that work on the conservation or demand side of the equation as well as those that work on the supply side. But for people to conserve energy, it has to be expensive.

So in a small way, we should welcome the high price of oil. We should hope that it will stay high-ish but not so high as to cause a world recession. And we should figure out ways of using less of the stuff.

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