High oil prices are bad for the world for any number of reasons. They cause inflation, which enriches the wealthy before indirectly causing unemployment once interest rates are increased by central bankers. They directly redistribute wealth to the wealthiest, because the average oil consumer – a blend of countless Third World village women cooking on primus stoves, thousands of tycoons burning kerosene in their private jets, and the millions of the rest of us who variously heat, drive, fly or perhaps boat with fuel oil, diesel and petrol while using any number of petrochemicals – is much poorer than the dynasts, dictators, kleptocrats and oilmen who sell the stuff. For the same reason, increases in the price of oil tend to depress worldwide demand, production and employment, because the aforementioned dynasts, dictators, kleptocrats and oilmen tend to save much more of their extra revenues than the consumers from whom they are extracted, so that the effect is both inflationary in the short term and deflationary later on: a prescription for the dreaded stagflation that afflicted advanced economies during the 1970s, not coincidentally a time of multiplying oil prices.
Today, again, the triplication in oil prices, from less than $10 per barrel to more than $30, could have surprisingly damaging consequences. The longest boom in American history – increasingly miraculous, increasingly precarious – could end in the worst possible way: not in a ‘soft landing’ of gently declining sales, production and employment, accompanied by a gradual reduction in stock values, or even in a ‘hard landing’ of abrupt falls, but rather with a take-off into high inflation and even higher interest rates, which would most likely trigger the long-dreaded Wall Street crash with all the resulting financial disruption. When the Japanese speculative binge of the later 1980s finally ended in successive slides of both the stock exchange and property markets around Japan, huge paper gains, mostly by corporations, were nullified, and a lot of real money was eventually lost by banks and other lenders which had staked the players in the ‘bubble’ economy. But except for a tiny minority, individual Japanese households lost only quite small amounts, mostly of unrealised profits, because the bulk of their savings had remained all along in perfectly safe post-office and deposit accounts, against which they typically had no debts at all. Moreover, Japan was a net creditor when the bubble burst, as it still is. Even so many Japanese now consider themselves impoverished, and stubbornly refuse to spend, thus keeping the economy depressed, not because of their past losses in the defunct bubble economy, but rather because their personal savings – which are still huge – can generate very little post-retirement income at interest rates of 1 per cent or less.
Matters are quite different in the United States, the country of second mortgages to extract whatever equity might have accumulated in family housing, of multiple credit cards ‘maxed out’ to buy the latest hot gear, but also hot stocks. To borrow at 18 per cent or more in order to buy e-shares or, better, e-options, became a commonplace procedure for the remaining non-millionaires of Silicon Valley, many of whom did indeed become rich, at least on paper, just that way. After years of declining savings – lately they have been less than zero as past savings have been liquidated – and ever-rising consumption, the average American household now has debts amounting to 110 per cent of annual income, offset only in part by stock market investments inflated by unrealised gains, with very little in bank deposits, and only trivial holdings of government or solid corporate bonds.
A collapse in stock-exchange values caused by high oil prices, the resulting inflation and the inevitable increase in interest rates would therefore have a double impact, by both diminishing the net worth of American households and their own estimates of how much they can spend, and increasing their interest payments on outstanding debt, causing a substantive reduction in all other spending. With household debt so high, that is no small matter. If one American’s debt were another American’s asset, and the higher interest payments of one the higher interest income of another, and if wealth levels and saving propensities were the same for all Americans, not much need happen. But none of the above is true: with a total foreign debt approaching two trillion dollars, the United States is now much more a country of borrowers than of lenders, and because its distribution of wealth has become notoriously unequal, the average American who receives net interest income is very much less likely to spend the money than the borrowers would have done, had they been able to hang onto it. For all these reasons, a US stock market crash – indeed any reversion to historic ratios in stock valuations – would substantially depress consumer demand, and could force the American economy into a recession.
Both in Europe, just now beginning to recover from years of very slow growth and very high unemployment, and in East Asia, just now emerging from financial crisis, it is very likely that high oil prices are already beginning to have their perverse inflationary/deflationary effects, though statistics aren’t yet available to bear this out. But only Euroland faces the immediate danger of an outright reversal into recession, because there is no East Asian counterpart to the European Central Bank, which indeed has no counterpart anywhere on the planet. No other central bank has the control of inflation as its one and only duty, without regard to the phase of the business cycle, unemployment levels, growth rates, even outright famine for that matter. It is certain that the ECB will react to any further inflationary pressures caused by higher oil prices by further increasing interest rates, certainly impeding and perhaps strangling the recovery. That the euro also happens to be low against the dollar – for entirely different reasons – is not supposed to influence the ECB in any way, but naturally it does, increasing the likelihood of higher interest rates. Euroland exporters have been pleasantly surprised by the fall of the currency, which allows them to sell, produce and employ that much more, and of course there is no City of London in Euroland, steadily using its financial power, political influence and social ascendancy over grubby manufacturers and grubbier unions to keep the currency as high as possible to attract deposits, regardless of the impact on industry’s ability to export competitively. Yet the euro cannot simply continue to decline for years on end as the dollar did – contrary to legend, Wall Street never had the City’s influence – because the entire euro-scheme will blow up if the Germans become sufficiently alarmed by what is happening to their savings. Money is merely a medium of exchange for French, Italians and others like them who keep their savings in real assets, but it is still a store of value for Germans – and they are very much aware of its relative value as compared to other currencies. If the euro declines much more against the dollar, the elite consensus on the irreversibility of monetary union will be overthrown by a populist uprising, with consequences all the more disastrous because, quite deliberately, no procedures for withdrawal were ever established.
With higher oil prices, moreover, European consumers have less money with which to buy all other things, cutting internal demand at a time when Europe’s economic recovery is already weak precisely because Europeans consume so little of their income – the new syndrome of most mature economies except for the American. Long considered a piece of thoroughly obsolete economic archaeology, the ‘liquidity trap’ has become a real phenomenon once again, fully capable of entrapping entire economies in prolonged stagnation, as Japan’s recent experience shows.
It is the weakest economies, however – the non oil-producers outside North America, Europe and East Asia – that will be hardest hit in spite of their scant use of energy. Higher oil-import bills displace imports of capital equipment and economic know-how; rising interest rates increase the burden of public and private debt; and diminished demand from the advanced economies for all commodities other than oil reduces export income. When somebody is getting richer without producing more or better but merely by charging higher prices, as the oil exporters are now doing, somebody else must be getting poorer – and several mechanisms are at work to ensure that the poorest countries will pay a disproportionate share of this redistribution of wealth to the wealthiest. One is the habitual incompetence of their macro-economic management; another is the rigidity of narrow economies with a few commodity sectors on a non-monetary subsistence base; a third is the inefficiency of financial superstructure that results in very high transaction costs (it costs more than $130 to wire money from Lima to New York, only $30 from New York to Lima), and in the case of sub-Saharan Africa, there is the prevalence of kleptocratic rule that routinely diverts hard currency from productive uses to the import of the costliest luxuries. Higher oil import costs do not in themselves create these dysfunctions, but they do intensify their consequences.
So there are all sorts of strong reasons to wish for much lower oil prices: at $15 per barrel or less, there would be no inflationary impulse; interest rates could go down instead of being raised by central banks and there would be no added transfers of income to the oil producers to weaken internal demand in Europe, East Asia and the United States while reducing their imports of commodities other than oil.
Yet there are even better reasons to wish for high oil prices. Almost two decades of cheap oil have had devastating effects on both the demand and the supply side of the world’s energy balance. The vigorous energy conservation efforts launched in the aftermath of the 1973 Arab oil embargo and the ensuing explosion in oil prices have everywhere been abandoned. In 1975, even the Americans, with their passion for large and powerful cars, were buying mostly ‘compacts’ with four-cylinder engines, and the smallest cars on the market were also the ones most in demand, so that General Motors, Ford and Chrysler all started offering typically ‘European’ small cars, though they were mostly made in Japan. In recent years by contrast, with petrol prices falling, sales of small cars virtually came to an end in the United States, while the market for six-cylinder sedans kept getting smaller.
Each year’s new model was bigger than its predecessor, making compacts steadily less compact. More than 60 per cent of American car buyers were not satisfied any longer even with full-sized eight-cylinder cars, choosing instead so-called Sports Utility Vehicles – 4x4s hardly ever used off paved roads, with or without frontal bars against charging rhinoceros, but with increasingly powerful engines to move increasingly heavy bodies with ever-increasing acceleration. The latest monsters offered by GM and Ford have huge 6-litre engines, so that the typical user goes to work or to shop, usually alone, in a vehicle big enough and powerful enough to carry two cows and ten cowboys. Even in Western Europe, where high excise taxes meant that the US record-breaking low of 20 cents per litre could never be reached, petrol prices have been low enough to encourage a very strong shift in demand to much bigger vehicles with much more horsepower. It was symptomatic of an entire atmosphere of unlimited energy abundance that Volkswagen was not satisfied with the purchase of Rolls-Royce, maker of famously heavy and thirsty cars: it also decided to revive the Horch super-car brand once favoured by Hitler – his personal model had two rear axles, handy on campaign – while Daimler-Benz chose to revive the Maybach brand to out-Mercedes its own Mercedes. For such cars, today’s maximum-power 12-cylinder, 5-litre engines would be only the minimum option, with yet more powerful engines on offer from the manufacturers.
Improvements in automotive technology have certainly increased propulsion efficiencies since 1973, offering more horsepower and torque per litre of fuel, while bodies of any given size became substantially lighter with the use of plastics instead of iron. But these advances have all been undone by low petrol prices, which have allowed buyers in the United States, Western Europe and even Japan to opt for higher power levels instead of lower fuel consumption. The market share of the smallest cars has continued to decline, sales of bigger cars have continued to increase, while the average family cars in the middle have offered ever-increasing horsepower levels, which are now twice as high as in the 1970s.
Cheap fuel also explains why the highways of all advanced countries are now filled with trucks moving shipping containers, greatly increasing traffic congestion and spewing diesel fumes. Some are making final deliveries from railheads or ports that can be made in no other way, but many more are long-haul carriers successfully competing with far more fuel-efficient railways because fuel efficiency is not that important when fuel is cheap. In fact trucks are now carrying much that ships could move instead, as in the case of the traffic between Spain and Italy that fills the Riviera autoroute and the Autostrada dei Fiori; both were of course blocked during the recent truckers’ tantrum, but only the subsidies gained by previous tantrums explain why the traffic goes by road at all.
Automotive fuels account for a large share of total oil consumption but much less than 50 per cent, except in the United States. And oil only accounts for part of total energy consumption, alongside natural gas (far more widely produced than liquid hydrocarbons), coal, hydroelectric power and what is left of nuclear generation. The retreat from energy conservation on the roads would not have been so damaging if serious efforts had persisted in other sectors, from home heating to electricity generation, to industrial power in general, and also sea, air and mass transport. But they have not. Within a few years of the 1973 oil embargo, new materials and ways of designing buildings were multiplying insulation values in both Western Europe and the United States as well as in Japan. That saved much energy in itself, and in the best cases even offered the possibility of replacing furnaces fuelled by coal, oil or natural gas with solar heating, in spite of the low efficiency of photovoltaic conversion. It was the same with air-conditioning – its power needs could be reduced quite drastically by very simple ways of keeping out direct sunlight. In the few parts of the world which are both sunny and rich, as in the south-west United States, expensive houses abundantly equipped with solar panels to offer energy self-sufficiency, or near enough, were much in demand in the 1970s – there was even something of a boom in cave-houses, luxurious villas semi-submerged in the ground for better insulation in both winter and summer.
It was the same in industry. After 1973, much was done to replace older machines and process plants everywhere with new energy-saving equipment already at hand, while broad research and development efforts were launched to increase energy efficiency in industries of all kinds. Conservation became the slogan of the day, along with recycling.
Cheap oil changed all that. Efforts to increase the energy efficiency of buildings of all kinds from villas to office blocks were virtually abandoned, even though new polymers could further improve insulation. At the same time, it became steadily easier and cheaper to use computer control to limit the waste of light, heat and air-conditioning in any space left unused more or less temporarily. Instead of energy austerity, we now have a Post-Modern architecture characterised by its emphasis on non-functional adjuncts, whose only purpose is to be visibly useless. In industry, on the other hand, labour-saving rather than energy-saving became the central goal in developing or buying new equipment, with much less emphasis on conservation, except in a handful of process industries. It is a most revealing feature of the ‘new economy’ companies that they keep their offices brightly lit all night long. In part this serves to advertise their ‘24/7/365’ culture of non-stop work to achieve the next software breakthrough, but in part it reflects an entire mentality in which profligacy has replaced austerity. In many different ways, from the new demand for extra-powerful offshore boats once required only by smugglers, to the prevalence of motorcycles with more horsepower than the family cars of the 1960s, to Post-Modern buildings, it has become positively fashionable to waste energy.
The impact of cheap oil on the supply side of the energy equation has been even more destructive. The worldwide search for new sources of energy, which started immediately after the 1973 embargo, mobilised much scientific enthusiasm as well as an abundance of technical resources. While many other imaginative schemes were seriously investigated, from the trapping of North Sea tides to the thousand-metre-high heat-circulation towers still favoured by Shimon Peres, the more immediately practical possibilities of solar and wind power were given their chance in a multitude of pilot projects. The first plants were built to extract petroleum from the immense surface deposits of shale rock in the United States, and of oil-bearing sands in Canada. And there was in general much effort to find non-Opec sources, to install production wells – often in costly offshore platforms – to lay down collection pipes, and to deliver the output to market, sometimes by constructing lengthy pipelines. Where dams could still be built in spite of environmentalist objections, hydroelectricity was exploited, and so were the odd geysers. It soon became clear, however, that only natural gas, coal and nuclear power could seriously diminish dependence on Opec oil.
Each had its problems of course, from the high incidence of transport costs in moving natural gas across long distances, whether overland by large-diameter pipe or in liquefied form by costly specialised vessels, to the elaborate scrubbing needed to burn coal without poisoning the air, to the imperfect safety of nuclear reactors. But two decades ago, with oil prices already high and increasing yet again because of the crisis in Iran and then the outbreak of the Iran-Iraq War, nobody would have imagined that the search for new non-Opec oil and gas fields would slow down, that reserves already found would remain undeveloped and export pipelines unbuilt (even to bring abundant North Caspian oil to market). Or that coal-burning electricity generation would hardly expand in spite of far better scrubbers, and the construction of nuclear plants would largely come to an end except in France. It was the failure of Opec to keep its prices high that removed the incentive to increase the capacity of all other energy sources. In the absence of longer-term policies, there were only immediate commercial calculations, in which such things as an accumulating dependence on potentially precarious Arabian oil, or any sort of environmental consideration, simply do not compute. Yet the reason we have governments is that they are supposed to complement the instantaneous wisdom of markets with remedies against future market outcomes that we dislike.
Cheap oil also meant that there was little opposition to post-Chernobyl obscurantism. Had oil prices stayed as high in real terms as they were in 1980 (more than $50 a barrel in today’s money), Chernobyl might well have been interpreted in quite another way – as evidence that even the worst-designed, worst-built, worst-maintained of nuclear reactors can be quite secure, unless all safety devices are wilfully shut down or deliberately by-passed and all warnings of imminent disaster are ignored by insanely reckless, utterly undisciplined and unimaginably incompetent operators. That is why many other Chernobyl-type reactors continue to function to this day without incident. Still, with any disaster likely to produce everlasting consequences, there would be good reason to avoid even tiny risks of further meltdowns were it not for the fact that nuclear power alone can reduce the burning of fossil fuels in the atmosphere, which might yet ruin the planet. What is needed is boldly counter-obscurantist and long-sighted political leadership to shape new energy policies – a commodity unavailable when oil sells at $9 a barrel, but which might perhaps be forthcoming at $50 or more.
In the meantime, the world’s most advanced economies, the world’s poorest peoples and the Chinese and other East Asians who are lifting themselves from ancient poverty by hard work all remain critically dependent on the price-setting marginal oil supplies controlled by a handful of dynasts and dictators. It is an absurd predicament that only many years of high oil prices can resolve. If Opec will not oblige us by restricting output to keep the barrel well above $35, extra taxes should be imposed on oil imports to end the addiction. The only lasting solution for today’s high oil prices is even higher oil prices.