Rhein on Energy and Climate

A barrel of oil todaycosts more than twice the price a year ago and 10 times as much as 10 years ago. Since the 1970s we have not seen such a steep price increase in such a short time.

Understandably, this worries many people.

Central bankers worry about the impact on inflation. The price of oil is the single most important price in the global economy; it has multiplier effects on every single product and service being traded globally.

If social partners were to incorporate these price increases in future wage contracts it will provoke a dangerous inflationist spiral. That should be avoided by all means. We have to accept that the higher oil price reduces our purchasing power. There is nothing governments or trade unions can do about that. We have to understand that rising oil prices express a basic imbalance between the rising global demand for oil, especially in the emerging countries, and an inflexible and costly supply. Today, the cost of additional oil produced off-shore is around $ 80/barrel, compared to $ 5-10 for oil pumped in the Arabian Gulf. Economic theory teaches us that it is the marginal, not the average cost that determines the market price.

Politicians worry about their voters. They want to please them and therefore come up with proposals, ranging from calls to OPEC to raise their production, to reduce excise taxes on gasoline and fuel or to grant heating subsidies. Fortunately, such measures have little chance of being implemented. Politicians better abstain from tinkering with fundamental trends of market forces.

There are only two effective ways to address them: by influencing supply and demand.
Supply will rise only when existing wells are more fully exploited or new capacities come on stream. New capacities will take years to mature. Nobody, not even the US President, can force producers to increase their output if they prefer not to and rather benefit from further price raise.

Finally, we are no longer in the 1970s when non-OPEC countries could relatively easily jump in with new wells, e.g. in the North Sea.

Demand also takes time to react. But it will react if prices stay high and even more so if they are expected to rise even further, which is the case. Consumers will use oil more economically, and companies will try to enhance energy efficiency. Equally important, utilities will replace gas-fired plants and invest in wind energy, nuclear plants or coal.

These are sound reactions. We have to phase out the use of oil and gas. Oil will become too precious for heating buildings or driving automobiles. We have to think of conserving enough reserves for much more precious uses, e.g. as chemical inputs. We are at the beginning of this process which may take up to four decades to complete.

Above all, we should never forget that humanity must cut its fossil energy consumption by more than half within the next 40 years if it wants to leave the planet in reasonably good health to future generations.

Let us therefore consider rising oil prices as a blessing in disguise! They help humanity accommodate to the inevitable: a global energy supply completely based on renewable energy by 2100!

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