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The High Cost of Energy is Leading the Economy into Recession

Energy is everything. Without energy literally nothing happens. It's easy to overlook the role of energy in the economy because we often just look at it as how much we spend on energy as a fraction of total GDP. But that really is misleading. Because if you take away energy, the GDP doesn't just contract by that percentage, the GDP disappears.

If suddenly there was no petrol at the pump; if suddenly the lights went out and did not come back on, the economy would go away. Energy is central to all economic activity. Up until the last couple of hundred years, the energy that we used was from renewable sources - it was almost entirely from the sun. But something changed with the Industrial Revolution. We developed the tools, the gears, the metallurgy, the simple heat engine, so that we could access and use the fuels that had been created by nature over tens of millions of years.

Think of it this way. You have run out of petrol and have to push your car a couple of metres off to the side of the road. It's a lot of work, especially if it's a heavy car. Think about having to push the car for kilometre after kilometre - that would really be a lot of work. If you do the math, a single litre of fuel is doing the work that's the equivalent to, maybe, six weeks of hard labour. You can't get labour anywhere as cheap as the petrol we buy.

Australia is paying $1.50 a litre for petrol now. Can you get even a month's worth of hard labour anywhere on the planet for $1.50? Obviously no. That is really what has given us so much economic benefit over the last couple of hundred years. We have mechanised every process of production and transport that we possibly could.

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Most important of the fossil fuels is oil because it represents virtually all transport energy. But oil is finite in quantity. We discovered that in my country, the United States, over the course of the 20th century. We started out as the world's petroleum powerhouse.

Around 1930 the rate of discovery of new oil fields started to taper off in the United States, and 40 years later in 1970, the rate of extraction of oil also started to taper off and has generally been doing so ever since. (Right now, the US is having a spate of good luck in extracting unconventional oil, but that's another story.) The same basic process is going on in country after country. Countries that used to be oil exporters are now importing countries - Indonesia and Britain.

Now, everybody can't be an oil importer. We have to have some countries that produce more than they use domestically. Some exporting countries like Saudi Arabia are seeing a rapid increase in domestic demand for oil. This could cause problems along the way; ignoring even the fact that worldwide discovery of oil peaked in the early 1960s. Actual production of regular conventional crude oil has hit a plateau, as of about 2005. This is not for want of effort.

Oil prices have been increasing rapidly and dramatically. Back in 1998 a barrel of oil sold for about $12. Today it sells for 10 times that, and even if you factor in inflation, that's a pretty rapid rate of increase in world oil prices. So, the incentive is there for oil producers to bring as much to market as they can and there's every evidence that they have been doing so. All oil producers are producing flat out, with the possible exception of the Saudis. Even in that case I would argue they're producing as much as they can, and yet, we're flat-lined.

What's going on? The oil industry has changed. In the 1930s, it was just a matter of sticking a hole in the ground. These days, it takes more technology because we have to go to ultra-deep water oil, or to tar sands, or to tight oil that has to be fracked and drilled horizontally. It costs more to explore for and produce oil. A single exploratory deep-water well can cost half a billion dollars to drill and still come up empty. So the oil industry needs high prices to produce that new incremental barrel. There's still oil that could be produced at a profit if the price of oil was $20 a barrel, but there's not enough of that around to meet global demand. So it's that new incremental barrel that sets the price for oil, and that new incremental barrel is expensive.

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There were a couple of years when Australia was an oil exporter, but only a couple. You're importing more oil, every year. Well, get in line. China is importing much more oil every year and it's soaking up just about all exports that it can. And, it's willing to pay. My country is actually seeing its oil imports drop, not just because of slightly increased production from unconventional sources, but also because American drivers can't afford $4 per gallon.

If you look at the recent economic history of the United States, every time there is an oil price spike there is a recession that follows. Now we have had recessions in the post-war period that were not linked to high oil prices, but we haven't had a single oil price hike that wasn't correlated with a recession. We have found from experience that high oil prices have an economic cost.

This is the situation we're in right now. The price that's needed - about $100 - to develop new oil sources is the price that brings on recession. This doesn't mean that the price of oil can never go down again. Indeed, I think it will go down substantially by several tens of dollars but what will cause that to happen is weakness in the global economy and declining demand for oil. When it happens, oil producers will stop going after that incremental barrel and oil production will go down. The scenario that is extremely unlikely is to have low oil prices and demand being satisfied and economic growth continuing to happen. That's not going to happen. Oil, by itself, right now, is capable of undermining world economic growth.

By. Richard Heinberg

Richard Heinberg is an American journalist and educator who has written extensively on energy, economic, and ecological issues. This is an edited extract of a speech he delivered in Canberra last Friday night.




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