Looking Beyond Oil

If demand continues to grow, in part because India and China will continue to be hungry for more oil, then prices could now be on a long-term ascendant as the psychology of inadequate supply takes hold.

Published: 25-Mar-2005

LE class=TableClas cellSpacing=0 cellPadding=0 border=0> Among the things that can upset India’s economic apple-cart is oil -- with some forecasters (including leaders of India’s own oil industry) talking of prices reaching the stratospheric $75 per barrel.   Domestic consumers have been protected these last few months from any change in retail petroleum product prices, and the oil companies have taken the hit.   But the expectation is that the government will increase retail prices next week.   Prices in general will climb as a consequence, aided in part by manufacturers’ decisions in areas as diverse as consumer durables and steel to pass on cost increases that they have been absorbing so far.   But since there is no generalised inflationary pressure, the inflation curve can be expected to stay within the 6 per cent limit, or return to it quickly if the line is breached—as happened last year.   That story line will change if oil prices climb further, to $75 per barrel. Last October, when oil prices crossed $50-55 a barrel, the general forecast had been that prices would drop once the winter surge in demand was over.   Prices did drop as expected, but have surged again—despite OPEC deciding to raise output and keep a lid on prices. If experts are now warning of further price spikes it is because, unlike previous such episodes, this is not the result of cartelisation or political action; indeed, OPEC is pumping out oil in record quantities.   What we are seeing is a new demand-supply balance for oil, partly because India and China have practically doubled their share of oil consumption over the past decade, to 10 per cent.   Both economies will continue to grow strongly. And with the global economy as a whole showing no signs of slowing down, oil demand can be expected to keep pace and prices will therefore climb.   That is not necessarily a reason to press the panic button, because even $75 per barrel will not be an unprecedented development.   Adjusted to today’s dollars, oil had reached the equivalent of $90 in the late 1970s, and today’s price level in real terms is no higher than at the time of the first Iraq war in 1990.   So long as supply is assured, even if prices spike briefly there should be no reason to fear a petroleum-driven recession. The International Energy Agency (IEA) forecasts now that average oil prices this year will be only marginally short of $50, and next year may not be very different.   This reflects the time it will take to build new production capacity (and to re-build Iraq’s oil industry), but $50 is a price that India has already learnt to live with.   The issue to focus on therefore is not immediate market conditions but the medium-term future. New oil discoveries in the world peaked some 15 years ago.   If you go by what some experts say (and bear in mind that oil forecasting is a hazardous business), production usually peaks 25 to 30 years after peak discovery.   That would seem to suggest that global oil production will peak by 2015 or a little later and then go into slow decline—and this is what the IEA too says.   If demand continues to grow, in part because India and China will continue to be hungry for more oil, then prices could now be on a long-term ascendant as the psychology of inadequate supply takes hold.   An options contract was reported the other day for oil at $100! You could argue, as some experts do, that human ingenuity will find new ways of getting more oil out of the ground, and that high prices will automatically make it worthwhile to tap marginal fields.   True enough, because the global oil giants had reduced their investment in fresh drilling and that trend may now be reversed. For all that, what if supply falls short?   India’s response to this scenario has been to seek energy security by getting international oil companies to drill in India, bidding for exploration contracts wherever available, trying to buy into companies in the large oil surplus countries (like Russia), and by getting the oil surplus states to invest in Indian refineries—the logic being that their stake in India’s petroleum industry will guarantee future supplies.   All this is fine, but the issue is not necessarily supplies to India, it could more likely be supply in general. In short, the time may have come to start thinking of a post-petroleum world.

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