‘Oil shrink’ drives a new economic era
The control of airborne particulate emissions will become our real challenge
In 1985, I was fortunate enough to be an intern for Royal Dutch Shell, then the largest company in the world. They had pioneered scenario planning; a groundbreaking and world famous method of forecasting the future. We confidently planned a scenario of oil prices within the US$20 and $40 per barrel envelope – after all we were the experts. As the youngest team member, I operated the Lotus 123 (remember that?) spreadsheet.
None of us expected that within a year, a surge of production would see the oil price just above US$10, having peaked at US$35 in 1980. Today, Brent Crude is firmly below the US$30 level, down from US$115 a mere 18 months ago – and now just US$15 in 1986 inflation-adjusted terms. In 2014, oil fell 55 per cent from its highs; in 2015 45 per cent; and in 2016 it is already down 30 per cent. This is the most historic price collapse in a generation, again going unheralded by scenario planning teams.
We are likely to see a dead cat bounce from these extraordinary lows but there is little prospect of a real recovery when shale oil producers lurk like cockroaches – ready to scurry out the moment oil bubbles over US$50.
This price collapse means that our oil-based economy will survive for another 200 years. What reason is there to advance expensive and inefficient alternative energy now? Investments in alternatives like hydro, geothermal, nuclear, solar and tide energy look dated and fads such as biofuels and wind energy seem just bad economics.
If we are to continue to use fossil fuels, the control of the emission of airborne particulates, which directly relate to the incidence of lung cancer, will become our real challenge. The desire to be green will not go away, but the mood will now turn to cleaning the air. After all, global warming will continue whatever fuel we use, while we produce heat in the winter and cool in the summer, and live on a globe with a wobbling axis.
Clean Hong Kong’s air, which is regularly polluted to double the World Health Organisation’s “safe limit”, and you solve both warming and pollution. A walk in an Australian or European city proves immediately that dirty fuel emissions can be cleaned by existing technology. The best investments to make will be those in technologies that capture carbon emissions, such as scrubbers, filters, and absorbers like catalytic converters.
Yet we must still move away from cheap oil because the black stuff is generally found in strategically vulnerable regions. That instability will only be exacerbated by the sharp collapse in their economies. Russia’s oil revenues account for half of its income and it is slashing its public budgets by 10 per cent, and they were based on unrealistic US$50 oil. And how wise do those with oil-based sovereign wealth funds – the United Arab Emirates, Norway, Saudi Arabia and Kuwait – look now? They fixed the roof when the sun was shining.
The “oil shrink”, so named because the world’s oil economy is shrinking fast, is effectively an enormous cut to global costs of production. The oil economy pervades every part of our activities – much more than minuscule falls and rises in interest rates. This fall of historical proportions will act in reverse to the oil shock of the 1970s and 1980s. It will be highly beneficial to the core engines of global economic growth, namely the United States, Europe and Japan, as well as China and India.
The short term will be difficult as markets work out the winners and losers. The oil sector has become a disproportionately high proportion of many stock markets and these areas will naturally shrink. We will have to identify disinflation due to the oil price collapse (good) and that due to declining economic activity (bad). Geopolitical issues will multiply. Could Russia become more expansive, flexing its muscles to divert attention from its problems? Will more small oil nations slip into anarchy? How will Saudi Arabia react as it crushes more expensive producers?
The oil shrink will change the status quo and realign wealth around the world. It represents a huge shift of power and wealth from oil producers to oil users; from big business to households and small businesses; from fat cats to the guy in the street. In a week where Oxfam reported that the richest 1 per cent hold as much wealth as the rest of the world combined, who would have thought that Big Oil would ironically benefit the little guy?
Richard Harris is chief executive of Port Shelter Investment Management