The Oil Crisis

The Oil Crisis

In the past 2 years, oil prices have continued to soar, hence causing record-breaking fuel and heating costs throughout the world. So, what is behind the rise in oil prices? According to OPEC President Purnomo Yusgiantoro, scarcity is not the issue. “OPEC already oversupplies, but oil prices are too high.... This is not a supply and demand balance problem. This is not because of fundamental factors.” (1) Is he right? Let’s explore further.

The issue appears to be that the markets are worried by a series of risks, in Iraq, Venezuela, Russia, Nigeria, and elsewhere, rather than focusing on whether or not there is truly an oil shortage. Are the markets right to be spooked? And if the real risks don't measure up to market expectations, why are they so concerned?

First it is worth noting that, despite the headlines, oil is not at historically high prices. The headlines are only justified by ignoring inflation; they are not justified. Record oil prices followed in the wake of the Iranian revolution - in 1981 the average price of oil was $31.77 a barrel, the equivalent of roughly $60 today. The peak price, in February 1981, was $39.00, or about $73.50 in today's money. This is substantially more than the $48 (or so) that oil actually costs us now.

Even so, set against reasonable expectations, today's prices are high and these high prices reflect broader worries in society about energy. The most immediate concern is instability in the Middle East, and Iraq in particular. There is a common view that reliance on Middle East oil imports is a big problem. President George W Bush, as well as his Democratic rival John

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Kerry, is offering a plan for American energy independence.

The Middle East is part of the wider concern about energy insecurity in a world in which we are dependent on imports for energy. In the UK, news that Newcastle is to begin importing coal captured a mood of uncertainty about a future in which we will be more reliant on imports, especially natural gas.

But a more interdependent world is not necessarily a more risky one. In fact the opposite is true. With respect to oil, the markets have got it wrong. The developed world is actually less dependent on energy for economic growth, less dependent on oil for energy, and less dependent on the Middle East for oil.

We are less dependent on energy for economic growth in the sense that, after an early phase of industrialization, developed economies consistently require less energy for each additional unit of economic growth. Energy intensity (energy per unit GDP) peaked in the USA in 1920, and by 2000 had fallen by about 60 per cent of this peak (2). Improved efficiency resulted in the proportion of US GDP spent on energy falling from a peak of 13.7 per cent in 1981 to 7.2 percent in 2001 (3).

We now derive a greater proportion of our energy from other sources. The main increase has been in natural gas (whose sources overlap, but are not identical with, oil) and nuclear power:

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Source: Key World Energy Statistics, International Energy Agency, p6

The change has been even more marked in the Organization for Economic Cooperation and Development (OECD) countries:

Source: Key World Energy Statistics, International Energy Agency, p7

Furthermore, reliance on the Middle East for oil has decreased from 36.9 per cent of supply in 1973 to 28.5 per cent in 2002. The USA has become more reliant on imports, but this does not mean imports from unstable regimes. There have been small increases in the share of oil coming from Africa, Latin America and Asia, but the bulk of the increase has come from OECD countries, mainly