By Andrew Mckillop

28-05-04 Leading economist Irving Fisher, in 1929 and 1930, repeatedly advised investors that growth of equity values could only bounce back.
Today’s look-alikes forecast that Cheap Oil is just around the corner -- the $ 20 barrel will be back “within 5 years”.

This type of pronouncement is now to be found under the names of high-paid and respected gurus in magazines from “Barrons” through the “Economist”, to weighty communiqués from BP Amoco. Of course the reasons advanced for this so sure and certain crash in oil prices are multiple, variable and above all incoherent: demand is increasing fast, despite (or because of !) record prices, yet oil output outside OPEC is on an erratic track.
The gurus go on to inform their readers that current and record oil prices are not quite yet “hurting economic growth”, but assure us all that demand will soon crumble under the onslaught of oil at nearly $ 40-per-barrel. Supply can only expand, so the world will soon again be “awash with oil”.

While real and physical discoveries are a subject the well-paid columnists are more than economic with. Discoveries are low -- the 10-largest world oil corporations declared a total and record low score for 2003 of about 3.5 bn barrels, while world demand pushed through the 30 bn barrel-per-year ceiling, and is growing at 2.5 %-per-year, from early 2004. The “antidote” for this reality is paper reserves, which are growing dramatically.
Though not as fast as Hubble telescope photos of galaxies some 17 bn light years away from us suggest the Universe is growing, world oil reserves on paper are now, we are assured, still growing and have reached about 4,000 bn barrels. Much of this growth -- at least a doubling from the more likely real figure of below 2,000 bn, of which 1,000 bn has already been burned -- is due to a mysterious category of hypothetical oil called “reserve growth”.

This “antidote” to declining production in a very large, and growing number of producer countries whose discovery/production curves comply with the so-called “Hubbert Curve”, provides reassuring, if lying figures for oil reserves almost anyplace. Apart from Iraq’s 200 or 300 bn barrels, at least one-half of which was hidden below Saddam’s palaces and in the virtual oil province called “Western Desert”, Saudi Arabia would still have around 300 bn and Russia at least as much.
Probing the mysteries of the world’s oceans, “deep offshore” reserves in the Atlantic and Mexican Gulf, together with another virtual oil province called “offshore Africa” can hold almost any figure that is to fit-to-print. In total, all this guarantees the return of Cheap Oil.
Wherever doubt might creep into this rosy picture of Cheap Oil’s return, some tech gurus cobble further delusion in the shape of “heavy oil”, oil shale and tarsand reserves -- always ignoring the technical detail that prices around $ 60 or 70-per-barrel will be needed to trigger any serious and rapid increase in output from these “tertiary oil” reserves, that need at least the equivalent of a half-barrel of energy, and 8 barrels of water to produce one barrel of synthetic crude.

High oil prices do *not* cut world oil demand
Likely the key reason the so-called “business community” so feverishly seeks the return of Cheap Oil is that a whole generation of analysts, along with their mother’s milk, have absorbed the fairy tale which features Big Black OPEC. This producers’ group, according to no less than the Wall St Journal, is a simple front for terrorists, and called “One Purely Evil Cartel” by the August WSJ, together with its evil gremlin the High Price Barrel, gobble up equity value, destroy economic growth, and leave a trail of inflation behind like Al-Qaeda leaves cassette messages behind on its ravaging trail. Only very stern medicine in the shape of sky high interest rates, and (later on) smart weapons and regime change experiments, can vanquish the ogre or overpriced oil, goes the fairy tale.
Well-crafted chapter and verse is added to the tale by high-paid researchers and analysts -- for example the claim that the US economy somehow “lost” about $ 7 tn of output, simply due to oil shocks, in the last 30 years. The price-elastic function, from as far back as Nixon times, is always claimed to exist: a doubling of oil prices, from any number to the double of that number, will cut economic growth by the percentage number the study was paid to prove, and reduce world oil demand by at least twice that figure, to punish OPEC for its greed!

At the time of Nixon’s “Project Independence”, whose aim was to cut US oil imports to zero by about 1984, US imports were increasing as oil prices increased (as today: imports increased 15 % in the 12 months Jan 2003-Jan 2004, at the same time as average oil prices increased). The intellectual base of Project Independence, an econometric model costing around $ 20 mm in 1974 dollars, or close to $ 60 mm in dollars of 2004, proved to the satisfaction of its high-paid authors and inventors that no legislative or even technology changes would be needed to achieve the desired compression to zero of US oil imports in the 10 years 1974-84.
Already rising prices, from $ 4 to $ 9-per-barrel in 1974 dollars, would be more than sufficient, the report’s respected economists concluded. Exactly like today, reality turned out very different. Through 1975-78, despite a 295 % rise in nominal prices, US oil demand increased, and so did oil imports! Even better than that, since good fairy tales should be amusing, was that US economic growth, after a short and sharp dip, bounced back to year-on-year averages around 3.75 % to 4.5 %, along with rising oil prices. The same pattern occurred with all other OECD oil importers, for example Japan, Germany, France, and Italy.

The second oil shock of 1979-81, while “only” causing a 110 % rise in nominal prices, took the barrel price to over $ 105-per-barrel in dollars of 2004, for a few months in late 1979 and early 1980. At the time, world oil demand was growing at a yearly rate of about 4.5 %. It took very determined, that is “courageous” interest hikes to far-out double-digit rates, and wall-to-wall economic recession through 1980-83 to break the oil demand growth trend.
In those 3 years (1980-83) world oil demand fell about 9.6 %, the one-only period since 1950 in which world oil demand fell for 3 straight years. Since 1983 world oil demand has increased about 17 mm bpd, or more than two times the real and current maximum production of Saudi Arabia, and far above two times net exports of Russia, the world’s second-biggest exporter.

Perhaps the “business community” suffers from aristocratic delusions of the Bourbon dynasty sort -- being unwilling or incapable of learning anything, or forgetting anything, its high-paid stars are condemned to mouthing 25-year-old slogans, to amuse the crowd and influence politicians in their regime change zeal?
In the case of the “Iraq war experiment” this has already blown back rather comprehensively: not only did “liberating” Iraq not produce gushers of hot, cheap oil, but it also reinforced worldwide terror war, which itself is not exactly good for business. Iraq may or not one day re-attain its 1980-81 peak output of about 3.5 mm bpd net export capacity, but no “breakthrough” to twice or three times that number will ever occur. Since late 2003, business journals and columns have pedalled back on the big and lying numbers for Iraq’s future export capacities -- for the simple reason they are impossible. And the terror war goes on.

Real world data -- a suicide pill for Cheap Oil!
World oil demand remains strong, and world import demand is growing at its highest rate since the early 1980s. In percentage numbers, consumption is growing at around 2.25 %-2.5 % annual, and imports are growing at close to 1.5 times faster than that. Supply growth is erratic and hesitant, discoveries have plunged to low-low annual averages: the age of peak discoveries -- the very last peak -- is now more than 35 years back in time. Peak output must occur within a very short time, perhaps in 2008, or for pessimists has already happened but is “hidden” by increasing tertiary oil output, gas-to-oil conversion, inventory movements, false accounting (of the Shell Oil type), and other artifices.
Even worse news for Cheap Oil aficionados and preachers of New Economy wisdom, comes in the shape of the really new and giant New Industrial Countries called China and India (with Pakistan, Brazil, Iran, Turkey and others not too far behind). The “new NICs” are all to a certain extent modelled on the success story of the Asian Tigers, such as South Korea and Taiwan. The only difference for the “new NICs” is their massive size.

Through their period of fastest and most-classic “takeoff to sustained growth”, South Korea and Taiwan expanded their national oil consumption at a whacking, unrelenting 10 % to 15 % per year, every year. In the period 1965-83, and with a splendid disregard for “exploding oil prices”, their national oil demand increased 1690 % and 715 %, respectively. The Asian Tigers did not crawl to the World Bank and IMF for emergency loans because their economies were devastated by debt and their underpriced raw material exports commanded ever more derisory prices. Instead, they took the most classic, most oil intensive track to industrial and urban growth, exactly the one trodden by the OECD countries through 1948-75, in their Trente Glorieuse period of halcyon growth.
There is no logical reason at all -- except the sheer impossibility of supplying enough oil -- for China and India not to mirror that classic, textbook growth. If we took a “modest” 8-fold growth of their current oil demand (around 10 mm bpd, combined), we arrive at around 80 mm bpd for their combined demand well before 2025. Nearly all of this would be imported oil, and the amount -- 80 mm bpd -- is almost exactly today’s total world output (about 80.5 mm bpd 2004).

On the subject of whether China and India can support and pay for inevitably more expensive oil, the answer again places more nails in the coffin of Cheap Oil. Currently, these “behemoth economies” of the near-term future utilise about one-fifteenth to one-eighteenth as much oil per head of population as the USA. In overall, economy-wide terms, China and India are vastly more energy efficient than any OECD country. Their ability to pay for higher priced will, for some while grow with higher prices.
The “bidding war” in fact has already begun, in the period since 1999 to now, and will almost certainly intensify on a continuing, and unrelenting basis, until and unless the OECD’s finance ministers call a major recession, through an orgy of interest rate hikes. The one other alternative -- quite impossible for No Alternative politicians and their “business community” leaders -- is fast and determined energy transition to a lower energy, resource conserving, more socialist and socially-oriented society.

The reasons why China and India will so easily outbid the aging OECD countries for ever more expensive oil include what technical gurus call “terms of trade effects”, and the geographical structure of merchandise trade. In other words, China and India have growing potentials for South-South trade with fast growing economies outside the aging OECD block. The low income, mostly agricultural and mineral primary product exporter countries, after their near-death experience in the Neoliberal 1980s, are gaining purchasing power with the necessary rebound in non-oil raw material and primary product prices, that higher oil prices entrain.
This can be explained by a simple figure: producing 1 Troy ounce (31 grams) of the real resource called gold, in the most favourable mining areas, needs the extraction and processing of at least 1-ton of rock, dust, mud and dirt. The ton is crushed, transported, leached and sifted to get the ounce by using oil. If that oil costs more to buy, the gold produced will get more expensive and represent more value. Over a relatively short period of time, real resources gain purchasing power relative to manufactured goods and services. This triggers another cycle of economic growth in the world economy.

Yet more real world data -- as if that mattered
World oil stocks in early 2004, using periodic data from the IEA, EIA and the oil majors remain well below average figures for the 2000-2003 period. Combined with recent -- extreme -- figures from the IEA for world oil production (a claimed January average figure of around 82 mm bpd) this clearly suggests there is no change to an underlying, tightly balanced context.
The base for this is world demand. This has been consistently underestimated, now, for over 2 years, with the major oil importer country agencies (IEA and EIA) continuing to forecast slower demand growth being likely “going forward”, but not in the figures they publish for the present and real world! As with the folksy fairy tales of Oil Shock ogres, and in fact, oil demand at the world level is growing faster than in the 1990s due to unstoppable growth of energy demandby key, large population, very fast growing economies including China, India, Brazil, Pakistan, Iran and Turkey. In addition, the USA (taking about 27 % of world oil output) has shown consistent and large demand growth coming out of the 2001-02 recession in what is effectively a “jobless recovery”. It is however in no way “energy lean”, reflecting technology, infrastructure, social and demographic changes.

Weather trends have become strong, even key factors in deciding oil price movement -- the mineral and non-renewable resource of petroleum, through market mythology, being treated like springtime crops subject to weather vagaries, like demand for “Iceberg” lettuce, itself subject to demand varying factors such as the incidence of reported and declared “Mad Cow” and Asian Chicken Flu disease outbreaks, with their impact on hamburger and fast fry sales!
In a certain way, this is another victory for New Economy myth, when we are in fact treating a non-renewable resources whose absolute peak of productionis coming, very soon, to the same planet the “business community” gurus think they are talking about! The real, and real world context is one of serious shortfalls in regional and national oil import supplies, becoming “structural” pricing factors well before 2009.

The bottom line -- oil at $ 60-per-barrel in 2004
Over the last 30 years, the oil price impact on world oil demand trends can be appreciated through comparing and contrasting year-peak oil prices in constant 2003 dollars, and year average demand, together with demand trends on a 3-year base.
Basically, each time that oil prices have jumped in a “fiscal neutral” context (that is: no knee-jerk rise in interest rates), oil demand growth has continued, and even reinforced.

Conclusions
Growth rates for world oil consumption (e.g. 3-year averages) bottomed in the 1986-99 Cheap Oil interval, and started recovering from 1994-96. New impetus has been added through higher oil and gas prices, and the very fast economic growth of China, India and other large population, fast industrialising countries. Current world consumption growth is likely about 2.25 %-per-year, and world oil import demand is on a growth track well above 3 %-per-year. Oil price rises since 1998-1999, it should be stressed, have not reduced these trends, but have bolstered and reinforced them.
Through a mix of factors, oil demand by the US economy -- consuming about 26.5 % of world oil production for 4.5 % of world population -- is showing sustained growth. Excluding a self-imposed recession through a panic rise in interest rates, year-on-year trends for the US will likely remain well above 1.75 %. In Europe, traditionally high gas prices will set a floor to any short-term falls in oil prices due to “ratchet effects” in interfuel pricing, and increasingly erratic oil supply increments, themselves due to the world moving rapidly towards Peak Oil (the maximum production rate the world can ever achieve).
China, India and certain other fast industrializing, large population economies may triple or quadruple per capita oil demand within 10 to 15 years, on a “trends continued” base. They will necessarily bid up oil prices. All “psychological ceilings”, such as $ 40 and 50-per-barrel, will be pulverized in the next 3 years, 2004-07.

Price transition before energy transition
Very large investments are needed if both OPEC and non-OPEC suppliers are to blunt the arrival of structural undersupply on world oil markets, which is likely imminent without much higher prices. These (higher prices) will both limit demand growth in the energy-saturated OECD countries, and enable financing of increasingly risky, higher cost exploration-development.
Based on statements by Lee Raymond, and by John Thompson (notably in articles published by ExxonMobil in its journal “The Lamp”) spending in the oil sector, on a worldwide basis, may need to exceed $ 2500 bn, at early 2003 purchasing power levels (or about $ 3000 bn at early 2004 parities), in the next 12 years. Enabling this quantum leap in exploration and development is likely impossible without much higher, and sustained prices, well above $ 45 or EUR 36 per barrel, and about $ 7.50 or EUR 6/mm Btu for natural gas.

These pricing levels, it can be noted, were surpassed in constant dollar and purchasing power terms through 1975-78, in which OECD country economic growth rates, and oil demand growth rates averaged about 3.75 %-4 % annual. At the time oil prices expressed in 2003 dollars were about $ 38-$ 55 a barrel. Suggesting a price level similar to that of more than 25 years ago is difficult to call “radical”. Unfortunately, the subject of oil prices is given benign neglect when they fall, and energetic propaganda treatment, now with assorted military adventures, when they rise. Most politicians and economic policy makers believe in a simple slogan: the lowest price is always the best.
Moving up to new price bands can be the focus of serious and committed international attention to the risks facing all players at this time. Runaway price rises in a free-for-all bidding process following supply loss of no more than 5 % is the worst possible scenario. Underlying all this is the basic need for higher and less volatile oil and energy prices, accompanying serious and committed energy conservation, transition to renewable energy and restructuring for a low energy economy, habitat and society. These are the real long-term solutions to emerging supply difficulties which will surely raise prices. However, and at present energy transition is discarded as utopian and unworkable by the current crop of political decision makers.