The coming oil crunch will have a serious effect on the economy, exports and tourism “New Zealand is very vulnerable to oil shocks,” Parliamentary Library economics and industry research analyst Clint Smith argued in a recent report. He argued
The coming oil crunch will have a serious effect on the economy, exports and tourism
“New Zealand is very vulnerable to oil shocks,” Parliamentary Library economics and industry research analyst Clint Smith argued in a recent report. He argued there is risk of a series of oil-supply crunches, leading to huge price hikes and recessions. This would also have a severe effect on export markets and tourism.
I think his report is a valuable contribution to any debate on energy security. It has limitations in ignoring the domestic effects of price rises and inflation but it could a starting point for further study on what should be done to mitigate the effects of future global oil-shocks on the New Zealand economy.
My question is somewhat different from the usual discourse about how energy consumption can be reduced. That is important but New Zealand will be locked into oil for a generation and have to start assessing the risk to present systems of distribution arising from oil-shocks.
A question that might be asked comes via Lloyd’s of London reports on sustainable energy: “The sooner that businesses reassess global supply chains and just-in-time models, and increase the resilience of their logistics against energy supply disruptions, the better.”
Do we need to change our logistics, which may be predicated on constant supply inputs or should we think the unthinkable and imagine we are cut off by price, politics or whatever for a month or more?
I have hinted at this when I called for a food policy in 2009 and praised farmers’ markets, partly because they were increasing regional supply. A broad-based working party could make a contribution to survival and sustainability. Arrangements for emergency supply were made in 2007: that should not preclude an update.
Mr Smith’s argument: supply
Oil supplies 40% of New Zealand’s energy demands. Oil powers most transport, without which trade and production would grind to a halt. Energy is a major part of economic growth (NBR, June 18). There could be supply constraints in the future for many reasons. If there are shortfalls, price spikes will wreak havoc.
Estimates of reserves vary but there appears to be enough oil for another 25-32 years – provided it can be produced. Although new discoveries are made, drilling has been driven to more extreme locations, and returns are sharply diminishing. Between 1963 and 1980, 15,000 drills found 1.5 trillion barrels of oil but between 1980 and 2002, 60,000 new wells found half as much oil. Discoveries come at rapidly rising cost. Prices must increase as low-cost oil volume decreases and is replaced by high-cost new sources.
Production
Production will come to a peak and then slowly decrease as it cannot expand indefinitely. An International Energy Agency study of the world’s 800 largest fields found most fields had already peaked and that the rate of decline in oil production is now running at nearly twice the pace as calculated just two years ago.
Meeting present production targets requites a massive increase in drills, engineers and refining. This capacity is not being added quickly enough and it is held back by cost: the cost to drill one foot tripled in real terms between 2002 and 2007.
There are other constraints. Oil pipelines are often attacked and 65% of global production comes from 30 countries that are not democratic and frequently corrupt. Natural disasters like hurricanes and human error can cause massive infrastructural damage but these blips do not prevent reasonable predictions of production as capacity and depletion rates are known.
New capacity is not being added fast enough to combat overall depreciation. From 2011, almost no net capacity will be added, and there will be a significant decline from 2011-2015. This means the maximum amount of oil that can be produced will begin to fall – despite a huge drilling programme. Oil production is essentially capped.
Supply crunches, price spikes
As supply is capped, much depends on demand. Demand is declining in Europe but global demand has reached a new high on demand from the emerging countries.
Oil supply for importers is being squeezed by consumption in oil producers. The buffer between supply and demand is crucial for prices. The smaller the buffer, the greater the risk of short-falls. Supply crunches lead to price-spikes.
Mr Smith cites several studies forecasting imminent production shortfalls. He states: “The supply buffer is diminishing and another supply-crunch appears inevitable.”
The US joint forces command (US military) says that by 2012, surplus oil capacity could easily disappear, and as early as 2015, the shortfall could reach nearly 10 million barrels per day (about one-twelfth of present day production). A UK taskforce predicts “as early as 2012-13 and as late as 2015, “oil prices are likely to spike, imperiling economic growth and causing economic dislocation.” Lloyd’s opts for an oil crunch around 2013. A German military report says peak oil occurs this year.
Much depends on demand. If the global economy rebounds, oil demand will quickly hit maximum production capacity. Relatively small events have a more pronounced effect on prices and futures markets when peak oil occurs. Oil spiked at $US147 in 2008, over twice the price of the previous record of $US70 during Hurricane Katrina in 2005. This, in turn, was a 30% increase on the previous record of $US55 in late 2004. Price spikes hampered growth, and if prolonged lead to recession.
Mr Smith then claims these spikes “may have been the first in a cycle of supply crunches and recessions following the same pattern: as demand rises faster than production capacity, the world’s supply buffer is whittled away.”
New Zealand
New Zealand has potentially large reserves in deep offshore basins that appear too challenging to tempt explorers at present prices. In the meantime, it is highly dependent on imports and would be affected by supply crunches.
Higher prices would immediately affect the balance of payments and transport costs. Transport is a large element in the cost of bulky goods like timber, coal, meat and dairy. Overseas demand could also diminish and the tourist industry is vulnerable.
Mr Smith argues “the future of the oil market appears bleak.” It is not feasible to increase total production. A crunch could come as early as 2012: “The world may be entering an era defined by relatively short periods of economic growth terminating in oil price spikes and recession.”
Can we be pro-active?
neville@bennetteconomics.com
www.bennetteconomics.com
On the web: www.parliament.nz/NR/rdonlyres/7BEC9297-DEBE-47B5-9A04-77617E2653B2/163251/Thenextoilshock3.pdf
