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Daily Telegraph: Oil ‘addicts’ face painful withdrawal symptoms

By Tom Stevenson

(Filed: 01/08/2006)

What is the most important number in the world? Fans of the Hitchhiker’s Guide to the Galaxy will know that the answer to life, the universe and everything is 42, but that is not what I mean.

The most important number in the world was 73.39 yesterday lunchtime. Last month it reached 79.86, while in the run-up to Christmas 1998 it was just 10.75. Lord Browne thinks it will be 40 again while Goldman Sachs believes it will hit 100. It is, of course, the price in dollars of a barrel of oil.

The value of the world’s most significant commodity is important because, as George Bush noted recently, we are “addicted to oil” and there are no areas of our economic life that are not affected by its cost.

Michael Meacher, the former environment secretary, wrote in these pages a few weeks ago that “oil is the fundamental underpinning of our civilisation”. If ever there were a case of putting all our eggs in one basket, our dependence on the black stuff is it.

From the petrol in your car to the fuel that heats our homes to the plastic all around us, the tarmac on the roads and the fertilisers on the fields, oil is the lifeblood of our world.

It hardly needs pointing out, therefore, that the seven-fold rise in the price of oil in eight years is a problem. Not least because the last time the oil price traded at this level in inflation-adjusted terms the world economy tanked.

After the second oil shock of 1979, the price rose to something like $80 in today’s money and the developed world keeled over.

With the growth of the US economy slowing sharply in the second quarter, it seems self-evident that we are navigating dangerous waters.

Even if you leave to one side the uber-bulls predicting an oil price of $200 or $300 a barrel, it is of supreme importance whether dovish Lord Browne or the hawks at Goldman Sachs are right about the future cost of crude.

The reason the oil price has soared is simple. Demand is growing at 2pc-3pc a year while production is slowly but surely declining as the world’s giant oil-fields dry up.

Since oil was first produced commercially in the US in the 1850s, supply has increased to meet growing demand. For the first time in 150 years that is no longer the case for a couple of reasons.

First, a combination of natural and manmade disasters and conflicts from the Gulf of Mexico to Iraq and Nigeria has forced the rest of the world to jam open the spigots to satisfy demand.

After years of underinvestment when the oil price was in the doldrums, we simply cannot pump any faster and rectifying that situation could take years.

Second, if you believe the gloom-mongers, we are fast running out of commercially exploitable oil reserves. Last week Shell told us about its plans to tap vast pools of tar sands in Canada but it was notably coy about discoveries of conventional oil.

Like the world’s other producers it is not finding enough new oil to replace what it’s pulling out of the ground each year.

There is considerable debate about how close we are to a peak in the global production of oil but there is a wealth of expert opinion that suggests we are close to that tipping point today. Even if demand were flat that would be a problem, but it is rising fast.

Oil consumption has more than doubled in China from 3 million barrels a day in the early 1990s to about 7 million today. In India consumption has also doubled to around 2.5 million barrels a day.

If you consider that the US, with a population of something like an eighth of those two combined, gets through 20 million barrels a day, you get a sense of the potential for the supply/demand equation to deteriorate.

A number of conclusions can be drawn from this grim picture, all of which have implications for anyone managing money. Here are six, but there are many more:

First, persistently high energy prices are most probably here to stay. Although oil producers like Lord Browne are obviously beneficiaries of a high price, they have a vested interest in not scaring the horses. The most profitable scenario for them is a price that keeps the world economy humming so they are bound to claim everything is rosy.

Second, a high oil price should finally fuel the development of alternative energy sources. Merrill Lynch estimates that with oil priced between $50 and $70 a barrel, coal, natural gas, nuclear, hydro, wind and geothermal energy sources are all relatively competitive. Only hydrogen fuel cells and solar energy still look too expensive to be viable substitutes. Big corporations around the world are snapping up small wind and biofuel businesses and that process has barely begun.

Third, the stellar growth in the global economy in recent years looks likely to slow. We are already seeing the first signs of this in America.

Fourth, we should expect the world to remain unstable as long as the US believes it can fend off the day of reckoning by grabbing what remains of the world’s hydrocarbon reserves by force.

Fifth, there will be changes in how we order our societies in terms of transport infrastructure and urban planning to reflect the end of cheap oil. Trains can move the same weight of cargo approximately 100 times as far as a plane for the same amount of fuel.

Finally, the best investment gains of the past 25 years have been from companies benefiting from a world of cheap oil. I expect the next few years to see the baton handed on from the consumers to the providers of increasingly expensive energy and commodities.

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