Are we starting to ‘get’ the oil question?

This article first appeared in the South African business newspaper Business Day on 7th April 2011

History doesn’t repeat itself, but it does rhyme.  A little less than three years ago, within the space of a few weeks, oil prices hit a record $147/bbl, Lehman Brothers collapsed into the largest bankruptcy in history, and the global economy fell into a ravine from which it has scarcely emerged.  A recent article by Jacob Weisberg in Slate magazine discussed the cause of the economic crisis by examining “the 15 best explanations for the Great Recession”.  Surprisingly, the price of oil did not feature in that long list of persuasive explanations.  It’s surprising because in the prevailing economic system oil is the economy.  

As unrest in North Africa and the Middle East enters a fifth month since the first sparks of the Tunisian Revolution last December, oil prices are starting to dominate the political discourse.  In the UK, Energy Secretary Chris Huhne warned of a 1970s-style oil shock that could cost the UK economy £45 billion over two years.  Closer to home, last week’s Financial Mail cover story on oil – the three letters that threaten economic growth – argued that a sustained high oil price threatens to completely stall the global recovery.  

Until quite recently, many economists and the mainstream financial media didn’t seem to ‘get’ the profound significance of oil.  True, it was widely acknowledged that economic slowdowns – particularly in the United States, the largest oil consumer on earth – tended to be preceded by spikes in the oil price.  But the clear correlation between high oil prices and recessions did not, in itself, prove any causal relationship.  As far as 2008 was concerned, surely Wall Street’s wizardry and former US Federal Reserve chairman Alan Greenspan’s laissez-faire approach to regulation were the real culprits.  Surely the rising oil price was just another ‘derivative’ of the bewildering world of credit default swaps and collateralised debt obligations.  Better still, by pinning it on these suspects we could even appear to be clever by pretending to comprehend the unintended consequences of ‘innovative financial products’.  

Though we live in an increasingly fast-moving, interconnected and complex world, it remains a truism that the simplest explanations are often the best ones.  First, consider that the economy is ultimately about the movement of people and stuff.  Expressed as GDP – the market value of goods and services produced – it is difficult to envisage economic activity taking place to any great extent without people and things moving around.  Whether it’s raw materials being hauled from the point of extraction to a processing plant, or from there being distributed onwards to retailers, whether it’s customers accessing goods, or employees getting to and from their places of work, very little of our globalised economic system functions without motorised transport.  

Second – and here’s the rub – worldwide, 95% of the primary energy that moves people and stuff from place to place – in cars, vans, trucks, buses, trains, boats, and aeroplanes – comes from a single source.  Transport is uniquely dependent on oil, meaning the economy is uniquely dependent on oil, or rather on the liquid transport fuels – such as diesel, petrol (or gasoline), kerosene – that we obtain from oil refineries.  So when the oil price goes up, the price of transport fuels increases and virtually everything that counts towards economic activity is impacted, either directly or indirectly.  Of course, in the case of oil companies, rising oil prices have a beneficial effect, at least in the short term… more of which later.  

Intuitively it’s easier to understand this effect on the cost of physical goods that actually get shipped around.  But why should high oil prices impact the service economy, and aren’t advanced economies more service-oriented than ever?  Again, the simple answer may be sufficient for our needs.  As household transportation costs increase – and, crucially, they are inelastic because most of us cannot or will not change our abode or place of work according to the forecourt price of petrol – all discretionary expenses experience downward pressure.  Food bills climb as oil-dependent agricultural commodities track the price of crude, an effect exacerbated by the gasoline substitution potential of corn-based ethanol in the US.  Debt repayments are more or less fixed, give or take fluctuating interest rates.  What remains is a shrinking domestic budget: quieter shopping malls, fewer evenings at the restaurant, one less trip to the hair salon.  Economic activity experiences a general slowdown – this is the very definition of recession, and not an ‘innovative financial product’ in sight.  

Anyone doubting the importance of liquid transport fuel to the health of the prevailing economic system – and therefore to maintaining social cohesion and political stability – need only recall what happened in the UK in September 2000.  Truckers and farmers protesting the relatively high pump price of diesel staged blockades of refineries and fuel terminals.  Diesel and petrol supplies slowed to a trickle as the public queued at forecourts to top up their tanks “just in case”.  Within a few days, 90% of filling stations were bone dry, just-in-time supply chains unravelled and people were fighting over loaves of bread among bare supermarket shelves.  The UK had staged a compelling if entirely accidental social experiment.  

Conclusion: five days of petroleum separate an advanced civilisation from savagery.  Note that we didn’t even run out of oil, we merely panicked!  

Returning to the companies that maintain our oil flows: perhaps uniquely in the global economic village, they do rather well when oil prices are on the up.  For instance, in 2008 – the year in which oil spiked to $147/bbl – ExxonMobil posted an annual profit of $45 billion, the largest in corporate history.  That same year, oil companies accounted for six of the seven largest global corporations, as measured by revenues.  (The outlier was Wal-Mart, an enterprise utterly symbolic of the economy’s dependency on relatively cheap and free-flowing transport fuel.)  

In this context, it should not surprise anyone that oil companies are somewhat reluctant to allow the Oil Age to draw to a graceful conclusion, as the transport system inevitably electrifies to become several times more energy efficient and compatible with the full range of sustainable renewable energy sources.  Not vested in the electricity generation game, oil companies continue to lead us astray.  BP recently argued that biofuels are “the only game in town”, the only major way to decarbonise road fuel, possibly contributing around 12% of the road transport fuel mix by 2030.  Or to put it another way, within twenty years if BP have their way the transport sector will be only 88% dependent on oil.  

BP is missing the point, of course.  The question is not only how we can decarbonise the transport sector, rather it is how we can achieve this while meeting the primary objective: gaining independence from oil.  How can we divest ourselves of turmoil in the politically fragile oil exporting regions of the world, and insulate our economic and social stability from events over which we exercise no control?  Ultimately, independence from oil means getting off liquid transport fuels, which won’t be achieved by shifting to 12% biofuels over the next two decades.  

To paraphrase BP, electricity is the only game in town.

Leave a Reply

Your email address will not be published. Required fields are marked *