Gwynne Dyer: Upside of rising oil prices

We ran out of US$2 oil in 1973, said Henry Groppe of Groppe Long and Littel, at 79 the oldest active oil consultant (and one of the most respected) in the business.

Then we ran out of US$8 oil, then US$15 oil. Now we're running out of US$40 oil.

It's a different and useful way of looking at what is happening to oil prices.

Last week the price of a barrel of oil reached US$66 ($93). Oil has doubled in price in the past 18 months, and oil industry experts speculate that the price might hit US$80 ($113), even $100 ($141) a barrel before year's end, hugely depressing world economic growth.

But here's an interesting fact. Oil companies still decide whether a new field is worth developing by calculating whether they would turn a profit from it if the price per barrel fell to US$25 ($35). Do they know something the rest of us don't?

Not really. They just know that prices always fluctuate, that swings in commodity prices tend to be much wider than in other goods, and therefore that running out of US$40 oil doesn't mean that the oil price will never fall below US$40 again.

It won't stay down there for good, but as John Maynard Keynes once remarked, markets can remain irrational longer than you can remain solvent.

You have to be able to make a profit from your field when oil drops to US$30 a barrel (even if it is for the last time) and stays there for a couple of years.

The price of oil may hit US$80 or even US$100 this year, but if it does it will be an extreme fluctuation, not a new average price. It will eventually fall back towards the US$40-US$55 band - but eventually is the key word as far as the global economic boom is concerned.

Despite low growth in Japan and most of Europe, the global economy grew at an unprecedented annual rate of 4.5 per cent over the past 18 months.

The rule of thumb says that US$20 on the oil price means a drop of one per cent in global growth six months to a year later, so we aren't in bad trouble yet.

Oil prices have gone up around US$30 in 18 months, 1 1/2 per cent off the growth rate, but some of that lost growth is already accounted for in that remarkable 4.5 per cent figure.

If the oil price stabilised now, the world economy would still be growing at a comfortable 3 per cent after the rest of the damage fed through.

If, on the other hand, oil goes up to US$100 and stays there for a year or two, that's another 2 per cent off the growth rate, and then everybody hurts.

The current growth spurt is bound to end sooner or later - they haven't abolished the economic cycle yet - but the sharp swings in the oil price don't necessarily mean we are headed for an especially severe recession. Neither do we have any reason to think the oil price will stay up in the stratosphere forever.

This is not like the two oil shocks of the 1970s, when a sudden constriction in the oil supply drove the price sky-high.

This price peak is driven mainly by rapidly rising demand in the emerging Asian economies and the US, where people are still spending and the impact on the global economy is much less.

Moreover, the big oil producers now have much more developed economies than in the 70s, so they are also able to spend their extra income and keep the wheels turning, rather than letting it pile up as surplus petrodollars.

And developed economies are much less oil-intensive nowadays. It takes only half as much oil as it did in the 70s to produce the same amount of gross domestic product, so oil price rises no longer lead to runaway inflation.

After the current turmoil is past, the important thing is that the median oil price for the next half-decade, say (until we run out of all the US$40 oil) will be in the mid-US$40s. That is good news in terms of the real crisis, climate change.

Its high enough to encourage energy conservation and drive people towards alternative, preferably non-carbon energy sources, but it doesn't paralyse the economy.

We will need more pressure from a higher price later on if we are to avoid a global climate disaster, but the economy can respond only so fast. And we are practically guaranteed a higher price later on, another doubling of the average price by 2010 or 2012, say, because we are probably at peak oil production right now.

Seventy per cent of the world's oil comes from big fields that were discovered before 1970, and they are almost all in decline. The new discoveries are mostly smaller and more expensive to develop.

Henry Groppe recently predicted that oil production worldwide would decline by a million barrels a day each year from now on.

We can take no credit for it, but maybe we are on the best available glide-path for a soft landing on climate change. Whether that will be good enough is, of course, another question.

* Gwynne Dyer is a London-based independent journalist whose articles are published in 45 countries.