Klaus Rehaag, head of the oil markets group at the International Energy Agency, in a presentation last month asked, "Is the world facing a third oil shock?"The first such shock occurred in 1973 and 1974, when the Organization for Petroleum Exporting Countries quadrupled the world price of oil, contributing to nearly a decade of stagflation in the global economy. The second oil shock occurred in 1979 and 1980, when Islamic militants overthrew the brutal dictatorship of the Shah of Iran, resulting in a doubling of the world oil price, which contributed to a serious recession in much of the world and to the subsequent Third World debt crisis.With oil prices edging over $45 (U.S.) a barrel this week (though still lower in inflation-adjusted terms than the peak in the early 1980s), and growing concerns over threats to supplies from the Middle East and Russia in a world where there's little spare capacity, there is talk of a third oil shock. Moreover, and more disconcerting, futures markets point to an oil price of $39 (U.S.) next year and prices for oil deliveries 10 years from now exceeding $35 (U.S.) a barrel.
An oil shock means reduced economic growth, increased inflation and higher unemployment as more dollars are needed to pay for energy, leaving fewer dollars to be spent or invested elsewhere. The effect can be seen in everything from higher personal driving costs and bigger airline fares to higher trucking costs for manufacturers and bigger boards of education bills for school busing. The higher oil price is equivalent to a tax increase. In a paper earlier this year, the IEA estimated that a $10 (U.S.) increase in the price of a barrel of oil would cost the global economy $255 billion in lost output in the first year alone. Oil prices are more than $10 higher than they were two or three years ago.Yet the real issue is not that the world is suddenly running out of oil — it isn't — but that demand is growing faster than supply because of a decade-long underinvestment in bringing on new supplies, tanker fleet and pipeline capacity, and refining capacity. The IEA estimates world oil consumption at 82.2 million barrels a day, with this forecast to raise to 100 million barrels a day by 2020 and 120 million barrels a day by 2030. Much of this growth will come from China, India and other major emerging market economies.So the real issue is how the world squares demand and supply. The focus, especially in the United States, is on boosting demand. This explains U.S. pressures on Russia to boost supply; its diplomacy in West Africa to boost supplies there; its diplomatic pressure and set up of military bases in Central Asia; its pressures on Mexico to allow Big Oil to move into that country; and even the war in Iraq to help bring massive Iraqi supplies onto world markets. Clearly, as Rehaag argues, one challenge is to mobilize the investment dollars and gain access to potential oil-producing regions in order to increase supply. We will continue to need oil even with a low-carbon and high energy-efficiency strategy. As older oil fields are depleted, new reserves have to be found, both to replace depleted reserves and to meet new demand. This, in itself, requires major new investment in exploration and development.What is being underplayed in this effort to match supply and demand, though, is the potential to reduce demand, such as through stringent fuel-efficiency standards for automobiles. In Canada, for example, the sharpest increase in energy demand has been for transportation as consumers insist on driving gas-guzzling sports utility vehicles rather than more energy efficient cars. Yet the coincident need to reduce greenhouse gas emissions that are accelerating climate change should — with the desirability of also reducing the need for high-carbon fuels such as oil — lead to a demand strategy that focuses on fuel efficiency; new technologies to reduce the need for oil such as the move to hybrid vehicles and to hydrogen-based fuel cells; and to investment in smarter urban planning and public transportation.The failure to curb the demand for oil in the richest countries such as Canada and, in fact, to reduce demand could be the real source of a future oil shock, with all the economic pain and political instability this would imply. This is why we need an energy strategy in Canada. We don't have one today.
David Crane's column appears on Wednesday and Saturday. He can be reached by fax at 416-926-8048 or at email@example.com.