Much of the world’s economic history over the past 70 years can be told in relation to movements of the oil price. After 1945, there was a long boom characterised by rapid economic growth, relatively low inflation, stability, exchange rate fixity and full employment. This came to an end in 1974 when the oil price rose from $2.5 per barrel, where it had been pretty much throughout the post-war period, to $15. This brought the world into an altogether new state: inflation rose sharply, exchange rates gyrated, growth faltered and unemployment soared. The era of stagflation was born. Another sharp hike in oil prices in 1979-80 brought another inflation spike and another economic downturn.
Economic recovery in the 1980s owed much to the subsequent sharp fall in oil prices. Since then, they have been up and down, again with significant impacts on the economy. Most importantly, they rose to $143 per barrel just as the world was entering the financial crisis of 2008-9. The reason why the world economy was so weak in the following years is that it had been hit by a double whammy – the worst financial crisis since the 1930s and a huge rise in commodity prices, led by oil. So the news that last week oil prices fell to $78 per barrel, the lowest since 2010, was highly significant. Moreover, there is a good chance that they will fall much further.
Mind you, it is important to recognise that movements in oil prices can be both cause and effect. Other things equal, weaker economic growth reduces the demand for oil and hence tends to lower its price. Lower prices originating in this way aren’t so much good news as a mitigating factor to what would otherwise be bad news.
Yet sometimes oil prices can fall because more oil becomes available, or available more cheaply. This is a supply shock. Both demand and supply elements are at work now but the current low prices seem to be mainly the result of a favourable supply shock, partly associated with the US fracking boom.
There is some important market history in the three paragraphs above, although I believe the headline is misleading.
For decades I have referred to a spike in crude oil prices as an economic ‘game changer’, having a greater impact on GDP growth than almost any other factor. Now, as we approach the mid-point of the current decade, I believe the risk of an upside oil price ‘game changer’ is significantly lower than at any other period for over a century.
What has changed? The short answer can be provided by one word – technology. Today, technology enables us to find more oil discoveries, and more importantly, to produce much more from known reserves than was previously thought possible. Moreover, technology has shown us how to transfer natural gas from a waste product to a cleaner source of energy which may become even more important than crude oil.
Additionally, oil and natural gas fracking is a huge technological breakthrough, barely tapped to date outside of the USA. Technology has also enabled us to develop renewable energy sources which are becoming more competitive every year. ‘New nuclear’ power is now cheaper and safer to produce. Before mid-century, technology should also enable us to produce nuclear fusion at commercial rates relative to most other fuels. By that time, crude oil should be well on the way to becoming a redundant fuel.
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