Brain power can meet the energy crisis
By Larry Elliott
Back in the 1970s, North Sea oil was seen as the saviour of the British economy. The money would be spent modernising industry so that it could play in the big league with the Germans, the Japanese and the Americans. Instead, we spent the money on unemployment benefit and tax cuts. The industrial renaissance never happened.
By the time the oil started to run out, financial services were the next big thing. The City would be Britain's unique selling point, we would pay our way in the world through banking, insurance, arranging bids and deals and by being better speculators than our rivals. With the banks bust and the financial sector in a state of petrification, we are now going to find out what life is like without artificial stimulants.
It won't be nearly as much fun as the years of living in a dreamland, but stripping away the pretence that there is some easy, painless solution to Britain's long-standing problems represents the first stage to recovery.
Britain has no shortage of talented people. There is plenty of creativity and always has been; the problem is that it has not always been channelled in the right directions. If ever there was a moment to remedy that systemic failure, it is now, because this crisis has only just begun. The first phase involved banks; the second phase will be energy.
Oil prices nudged above $60 a barrel briefly last week before falling back on news that inventories are high and that demand for crude is set for its biggest fall this year since 1981. An oil price at these levels looks suspiciously high amid the first fall in global gross domestic product since the second world war, although there are possible explanations. One is that commodity traders believe there will be a more rapid recovery in the global economy than anybody is expecting. A second is that the money central banks are pumping into financial markets through quantitative easing is spilling over into speculation. Third, and most worrying, the days of cheap oil may be a thing of the past. If this is the true explanation, there will be serious consequences.
In the post-war years, there has been a clear link between oil prices and global growth: the long boom of the 1950s and 1960s was an era when crude was dirt cheap; all four major recessions (1974-75, 1980-82, 1990-92 and 2007 to now) followed a spike in oil prices.
The last trough in oil prices occurred at the end of the 1990s, coinciding with the dotcom bubble and talk in the US of the new paradigm economy. Since then, the trend has been inexorably up, with supply struggling to keep up with strong demand from the mature markets of the developed world and the big emerging economies such as China and India.
Chris Sanders, of Sanders Research Associates, traces the origins of the current crisis back to the turn of the millennium, when the fall in production from the big finds of the late 1970s – Alaska, deepwater Mexico and the North Sea – ended the era of cheap oil.
A serious recession in the wake of the dotcom bubble was only averted because policymakers – Alan Greenspan in particular – manipulated interest rates to create another unsustainable boom. This did not mean the problem had been solved; indeed, putting it off for another day simply meant the problem grew bigger. Seen from this perspective, what we are witnessing is not the early stages of a new bull market, but a temporary lull in a much longer crisis that will see recovery hampered by high and volatile energy prices. Indeed, the volatility of crude over the coming years is likely to be as damaging as the fact that fuel will be becoming steadily more expensive.
To envisage this scenario, you don't have to accept that we are at – or close to – peak oil. There are many oil experts who have deep reservations about the notion that the moment of maximum petroleum extraction is at hand; they argue that rising prices will encourage exploration and make it viable for oil companies to extract crude from parts of the globe that were uneconomic at a price of $20-$30 a barrel. New and better technologies will be deployed to keep oil supply in tandem with demand.
There is no doubting the economic validity of this case. Price signals do matter, and oil companies are far more likely to beef up their spending on exploration and new refineries if the oil price is $100 a barrel than if it is $10 a barrel. That's the good news.
The bad news is that even if the peak oil sceptics are right and there is plenty of untapped crude in the South Atlantic, Canada's tar sands or Central Asia, it is going to be more expensive to extract it. Oil has been critical to the development of industrial societies but energy firms, unsurprisingly, went for the oil that was easiest to get at and of the highest quality, since that meant low extraction costs and high profits.
In other words, the energy required to get fuel out of the ground was small; the energy return on energy investment (EROI) was high. But as companies have moved to tougher environments, the EROI on oil and gas production has fallen – one estimate is from 33:1 in 1999 to 19:1 in 2005. This global trend mirrors what happened in the US, where oil is still produced in large quantities but much less efficiently than it was 75 years ago. From an estimated 100:1 in 1939, the EROI for American oil production dropped to 30:1 by 1970 and 11:1 in 2000.
As Sanders puts it: "Today we are attempting to extract oil and gas in commercially viable quantities from offshore deposits that lie under more than 25,000 feet of water, rock and hot salt. It may well be possible to do so, but what is highly unlikely is that it will be possible to do so in sufficiently large flows to make a material difference to general prosperity. Another way of putting this is that economic growth rates are going to have to slow."
On the basis of what has happened in the recent past, we are likely to see oil prices on an upward trend but with wild gyrations. Frequent oil spikes when the global economy appears to be on the mend will be followed by a crash in prices as the impact of dearer energy raises business costs and bites into consumer spending power.
There is a silver lining to this cloud. Another half century of global growth at 5% a year powered by cheap fossil fuels would almost certainly be the death of the planet as we know it. But we are as ill prepared for the post-fossil fuel age as we were for war in 1939.
But we are at our best when we have our backs to the wall: let's establish a Bletchley Park for renewable energy schemes, where the best scientists work out how Britain will survive when the oil runs out. And let's do it now.