ONE TOWN SQUARE: at the intersection of peak oil, climate change, and land use

A recent paper by Bassam Fattouh of the Oxford Institute for Energy Studies titled Oil Market Dynamics through the Lens of the 2002-2009 Price Cycle argues that oil prices over the past year (2009) have been driven by a loss in faith that rising prices will result in increased supplies – in other words, by the looming reality of peak oil. Oil supplies stubbornly are refusing to increase in response to rising prices.

During the 1980s and the 1990s, expectations about short-term oil price behaviour rested on the assumption that changes in oil prices would induce supply, demand or policy feedbacks – or a combination of them – which would prevent prices from rising above a certain ceiling or from falling below a certain floor. These perceptions of strong feedbacks stabilised long-term expectations about oil prices. However, as oil prices rose sharply during the boom years, uncertainty about the existence of and the timing of feedbacks from prices to oil supply and demand markedly increased. The perception of strong feedbacks in the oil market was replaced by the perception of limited feedbacks.* * *

It is possible to dissect the 2008-2009 price cycle into three distinct phases:

• Phase 1: In the first half of 2008, doubts about the existence and timing of feedbacks from prices to oil supply and demand became pervasive. This destabilised short-term expectations and created a wide band within which the oil price could oscillate. . . .
• Phase 2: The sharp reversal in oil prices from July 2008 to February 2009 came in two distinct phases. The first was a cooling off in prices from their peaks, brought on primarily by the combination of a supply side response from the key marginal producers, following the Jeddah meeting in June, and by mounting evidence in the rear-view mirror that OECD demand had weakened far more than initial expectations and provisional data flows had suggested. The second phase was more directly associated with the intensification of the global financial crisis, and the consequent rapid fall in consensus expectations for global economic growth. Until expectations about the global economy began to stabilise, there was, and probably could not have been, any recovery in oil prices.
• Phase 3: In the second quarter of 2009, the powerful shocks that affected global oil demand were counteracted by perceptions of global recovery and the perception of tight future market fundamentals — fuelled by increasing concern that the credit crunch and the low price environment would limit investment flows in the oil sector and in alternative energy.

Fattouh notes that some economists think there is an “inverse relationship between oil price changes and economic growth” – in other words, that increasingly strained supplies could bring an end to economic growth.  But being a two-handed economist, he also notes there’s an opposing school, which believes that oil price shocks are not special and can be offset by appropriate policy responses – although he cautions that this view “undermines a key element in the conventional wisdom on the relationship between GDP growth and oil prices”.

Fattouh’s observation above is a startling one: to believe that economic growth can continue in an environment of increasing constraints on oil supplies and consequent rising prices is inconsistent with economics as we have come to know it.