Whatever happened to peak oil? As recently as last spring, Dr. Jeremy Leggett, former advisor to the UK government and co-arranger of the high-level Trans-Atlantic Energy Security Dialogue, was warning that dependence on “increasingly expensive fossil fuels” would usher in a second oil shock by the end of 2015, leading to a “tsunami of economic and social problems.”
Leggett’s views were extreme, but the basic assumption was widely held. Hardly anyone expected the remarkable 50% plunge in the oil price which was one of the key economic events of 2014 and will continue to reverberate powerfully in 2015. The balance of advantage between producers and consumers of energy, which has been solidly in favour of the former for the past ten years, has suddenly been turned on its head.
Crucially, oil is just the latest and largest shoe to drop in the commodity complex. The combination of weak demand, especially from China, and additional supply had already triggered bear markets in industrial metals such as copper and nickel. The Thomson Reuters CRB Commodity Index has halved since 2008. For several years oil had appeared immune to these forces, but eventually it too succumbed.
One observer who would probably not have been surprised is the late American economist, Julian Simon. In 1980, another time of sky-high commodity prices and widespread concern that the world was running out of resources, Simon made a famous bet with Stanford University ecologist Paul Ehrlich. The subject was the price of a basket of industrial metals ten years later. Ehrlich believed that prices would be driven higher by increasing demand from a booming world population. Simon took the view that prices would fall and was proven right.
MALTHUS VERSUS MARKETS
Ehrlich was following in the footsteps of the British clergyman and economist, Thomas Malthus. At the turn of the nineteenth century, Malthus’ “Essay on the Principle of Population” had laid out the case for perpetual resource scarcity, alleviated only by population shrinkage caused by war, disease and “gigantic, inevitable famine.”
Malthus’ logic was impeccable, but he failed to foresee the gains in productivity that continue to keep food prices low despite a six-fold increase in world population. The same factors are alive today. Higher prices for commodities stimulate conservation, substitution, exploration and the development of new technologies – all of which drag prices lower. Nobody predicted the shale revolution, but it was inevitable that the trebling of oil prices to over $100 per barrel would have a powerful effect on incentives.
Commodity prices rise and fall in cycles, with no discernible trend over time. By some reckoning, copper has been in a bear market since the era of Ancient Egypt, when a few kilograms could buy a slave girl. At some point, though, prices will fall enough to reverse the incentives, reduce supply and trigger the next boom. Exactly when that will happen is impossible to guess, but historically commodity cycles have been long-drawn out affairs, reflecting the multi-year lags involved in developing new supply and removing it through insolvencies. Despite recent declines, most commodities are still at somewhat elevated levels in inflation-adjusted terms. If the last down-cycle is any guide, the bear market has a lot further to run.
WINNERS AND LOSERS
The safest prediction about the oil price is the one that John Pierpont Morgan is said to have made about the US stock market – it will fluctuate. But the scale of the decline is already enough to make the world a different place. The division between winners and losers is likely to be stark.
The BRICs are splintering into BRs and ICs as commodity-exposed Brazil and energy-dependent Russia endure sudden falls from grace while resource-poor India and China experience welcome boosts to terms of trade. Thailand is another country which will benefit greatly from cheaper energy, whereas resource-rich Indonesia faces new challenges and Australia’s fabled luck may finally have run out.
For countries like Japan, Taiwan and China that are close to deflation, the short-term impact may be to depress already soft consumer price indices, but ultimately the stimulatory effects should prove much stronger. In fact the North East Asian manufacturing powerhouses should be double beneficiaries. The lower oil price will act as a tax cut for ordinary households everywhere, thereby benefitting the companies that supply the world’s consumer markets, with auto producers likely to feel the improvement the soonest.
For the financial markets the effect is less clear. High commodity prices were a mechanism for enriching plutocrats, oligarchs and sovereign wealth funds – effectively turning global labour income into capital which was then recycled into securities, prime real estate in London and New York and art and other collectibles. Here the winner could be the real economy and the loser the asset markets – a turning of the tables that would be welcome in many quarters.
Overall, though, the net impact will be strongly positive for the global economy as the doom-mongers’ scenario goes into reverse gear. And that is surely worth celebrating with a New Year’s toast.