UK think tank warns of $200 oil in five years

New report warns that world's oil supply chain will be stretched too far and prices could rise to above US$200 per barrel.

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The world's oil supply chain will be stretched to breaking point and oil prices could easily rise above US$200 per barrel in the next five years, warns a new report from the respected UK think tank, Chatham House. Arguing that investment in oil production capacity in all exporting nations has failed to keep pace with demand, Paul Stevens, the report's author and a senior research fellow at the institution, writes that there is precious little that governments can do to avert a crisis of supply in the short to medium term. Mr Stevens added that a major worldwide recession would be the only phenomenon capable of stemming rising demand.

"The message is clear," Mr Stevens wrote. "As the oil market approaches the end of this decade, spare crude producing capacity moves closer to zero. Any supply outage would therefore create a supply crunch." Although many analysts believe this year's record run-up in prices was due at least in part to an inflow of speculative investment from Wall Street and a fall in the value of the US dollar, it is also accepted that surging demand for energy in Asia combined with falling production numbers have raised fears that the "era of easy oil" is over.

Mr Stevens is one of a number of experts who believe the current respite from price increases is only temporary, as fundamental supply problems in the market take hold. Mr Stevens said spare capacity had declined along with a steep fall in investment, which he chalked up to a web of reasons rooted in the last oil crisis, in the 1970s. The international oil companies, driven by a change in philosophy among more expectant shareholders and facing few low-cost oil prospects, have reduced their level of investment and turned more value over to shareholders in the form of higher dividends and stock buybacks.

Meanwhile, in major producing countries, Mr Stevens said that growing "resource nationalism", incompetence at national oil companies and fear of economic harm from exploding export revenues - which could drive up inflation rates and create domestic inefficiencies - had convinced many national oil companies to simply leave more oil in the ground for future recovery. The evidence is the failure of many Opec nations to reach increased capacity targets, whether because of technical delays, a shortage of skilled manpower, or lingering fears of the onset of a "resource curse", Mr Stevens suggested.

Saudi Arabia, for example, has failed to reach a long-declared intention to raise capacity to 12.5 million barrels a day. Non-Opec nations have witnessed production slip steadily. Without the onset of a major worldwide recession, Mr Stevens wrote that governments in major consuming nations would face difficulties in meeting surging demand. "Only extreme policy measures could achieve a speedy response, and these are usually politically unpopular," he said. "It would therefore require some form of crisis to allow such policy measures to be introduced."

Easing a supply crunch through conservation is also much more difficult for consuming nations today than during the last oil crisis, he said. In the 1970s, as oil prices soared, consuming nations slashed demand by switching power plants from liquid fuel to coal or natural gas, and made rapid gains in improving the energy efficiency of industries that had never been challenged. Making similarly sized gains today will not be as easy.

The ready response to higher prices has been further dulled by a prevailing belief, developed in the 1980s and 1990s, that governments should not intervene in the energy industry, Mr Stevens said. "As the oil price began its inexorable rise after 2002, there was an innate opposition within many governments to intervene," he wrote. "This was crucial, since conservation, fuel switching and increasing energy supplies are all areas riddled with market failure, which requires government to intervene."

Today's solutions are much more complex and less certain to pay off, Mr Stevens said. Governments in consuming nations could promote strict conservation measures, open up exploration acreage and improve the economic terms for international oil companies, he said. More importantly, they had to reach out to leaders in major producing countries and create incentives for them to produce more oil today.

Consuming nations, he said, had to help producing nations address the problem of high revenues by accepting investment from sovereign wealth funds and helping them restrain fiscal spending at home. In any case, he said, the influence of governments on energy was certain to grow. "A supply crunch leading to an oil price spike would be sufficient to break down some of the last vestiges of opposition to a much greater interventionist approach by governments in their energy sectors."