Energy realities and prospects are improving at breakneck speed and, as a result, so too is global growth potential. Production of oil and gas has increased faster during the last two years in the United States than at any other time since record-keeping began in 1859. Oil finds have also multiplied in the South Atlantic, in Australia and in the Russian arctic.
Yet, the price of crude oil remains stubbornly high and so does the retail price of gasoline, constraining rather than encouraging global growth prospects. It is a kind of torture to have an easier energy future tantalizingly close, and yet the old difficult energy past seems determined to hang on. For the time being, investors need to deal with both.
An Ugly Past
At present, the enduring unpleasantness from that old difficult world is the tension surrounding Iran's nuclear ambitions. Because the United States and others believe Iran is developing a nuclear arsenal and because Iran has shown considerable belligerence toward the West and its neighbors, the Persian Gulf is full of warships. Israel has threatened a unilateral strike on Iran's nuclear facilities. Neither President Obama nor the new secretary of state, John Kerry, has fully discarded the U.S. military option. Iran has threatened retaliation and even pre-emptory attacks.
The threats all around have convinced global oil markets that the Persian Gulf could plausibly become a battleground, cutting flows of oil and gas not only from Iran but also from Kuwait, Qatar, Bahrain, Oman and the oil emirates, which all ship through the Gulf. Right now, more than a quarter of the world's fossil fuel supply passes through this body of water. The loss of those supplies could raise prices to $150 a barrel for West Texas Intermediate.
Actually, the price could rise almost that much even in the absence of open hostilities. Further threats by Iran to close the Strait of Hormuz at the head of the Persian Gulf could push prices up almost as much as actual shooting would. In such an environment, insurers might worry so much about their potential liability that they would raise premiums substantially or even refuse to insure tankers in the Gulf altogether. Either action could stop the flow of oil just as surely as if the Strait was mined.
Faced with this threat but not its reality, prices have risen part way. West Texas crude sits in the low $90s a barrel, a $30 premium above where the price would probably otherwise settle. Immediate price directions depend on the geopolitics of these unstable circumstances in this equally unstable region.
Morever, prospects for relief on this front look slim. If a price increase lasts long enough, Europe, already in recession, would sink deeper. What's more, the United States, although so far still able to sustain a mediocre growth rate, would likely lose ground, as would Japan and emerging economies.
Except in the most extreme of outcomes, the economic and market setbacks of such heightened tension are likely to fall short of the damage experienced during the 2008-2009 financial crisis. But economies would be set back significantly nonetheless, and the prices of risk assets would drop as well, in just about every market and asset class.
A Brighter Future
If investors and economies are still clearly being forced to cope with these kinds of threats, the good news is that the pressure will almost surely fade over time. Although peace in the Middle East is as distant as it ever was, three kinds of technologies have begun to make a difference in the areas of extraction, exploration and efficiency.
All developed directly or indirectly in response to the insecurities and price gyrations associated with the dependence on Middle Eastern oil that still dominate. Interestingly, the Saudis some 20 years ago warned their colleagues in the Organization of Petroleum Exporting Countries of just such technological responses should they gouge on price or make the developed world feel too insecure.
The most exciting aspect of this technological revolution is the success of hydraulic fracturing, or fracking as it is commonly called. This extraction technique has enabled drillers to bring to market oil and gas that was formerly trapped in shale deposits. To date, its largest application has occurred in the United States, allowing the nation's overall oil and gas production, virtually stagnant for decades, to leap almost 18% in the last two years.
What is more significant, the International Energy Agency calculates that the growth is likely to persist for quite some time. By 2020, it estimates, the United States will produce more fossil fuel than Saudi Arabia and will move from a net energy importer to a net exporter. That shift will increase global supplies and also diversify them away from the Middle East. The difference, just from the American switch from importer to exporter, could amount to as much as 7% of world usage.
Fracking-susceptible deposits also exist elsewhere, in Western Europe, Canada and Australia. There is every reason to expect, as refinements in the technology remove environmental concerns, that similar overseas sources of oil and gas will join those flowing from the United States, further enhancing world energy supplies and more thoroughly diversifying them.
Other technologies developed over the past three decades have at last allowed producers to bring the vast reserves embedded in western Canada's tar sands to market profitably. At the same time, other extraction technologies have enhanced the ability to recover oil and gas from conventional wells. The Saudis have applied many and are, according to admittedly spotty figures, pumping more oil than at any other time in the last 30 years. There are indicators that the Russians are trying to apply such technologies, and petroleum engineers estimate that they could double their output without any new finds whatsoever.
Exploration techniques have improved as well, so that entirely new fields have been discovered. One, still far from developed, is the huge South Atlantic find of the Brazilian petroleum company Petrobras. Preliminary estimates put the field's capacity at the equivalent of 50 billion barrels; once in production, this field alone promises to add more than 3% to world oil production. A huge shale structure recently discovered in Australia promises the equivalent of 233 billion barrels of oil, almost 40% more than Canada's entire Athabasca tar sands and carrying the potential to increase global supplies 14%. In addition, new techniques have reduced the risk of exploration enough to encourage Exxon to begin large-scale efforts in the Russian Arctic, where, engineers say, there are very promising signs.
While all these changes have significantly enhanced oil and gas supplies in the United States and globally, efficiency has increased on the demand side of the economic equation. For years, governments in the United States and elsewhere have demanded greater fuel efficiency from car and truck manufacturers. Competition from more efficient Japanese and other Asian producers has spurred such efforts, some would say, even more than mandated mileage requirements. Competitive efforts and compliance have made the U.S. auto fleet a third more fuel efficient than 30 years ago. These, however, are not the only efficiencies at work. Power plants, whether coal, oil or gas-fired, have become increasingly efficient, as have home heating and airplanes and other forms of transportation.
The entire effort has allowed the United States to increase efficiencies drastically during the last 30 years. The country has reduced almost by half the amount of energy needed to produce a dollar of output. Although some of this improvement has emerged from the changed mix of the U.S. economy away from energy-intense manufacturing toward services, efficiency gains have done the heavy lifting. Europe and Japan, which were always more energy efficient than the United States, have made less dramatic strides, but they, too, have become significantly more energy efficient.
This trend will gain momentum globally as the emerging economies, only about half as efficient as Japan and the developed West, apply fuel-conserving technologies. The still relatively high price of oil should spur that effort onward. These economies should also make strides faster than the United States and others have. They, after all, have no need to develop new technologies, but only to purchase and transfer them.
Weaving the Two Threads
With energy use growing more slowly than fuel supplies are surging globally, the Middle East will generally lose relative importance in the overall energy equation. According to the IEA, the traditional OPEC producers' share of global energy supply will fall from more than 70% in 2011 to about 60% in 2020 and probably below 50% by 2040. And since the Saudis are ramping up production, Persian Gulf sources will lose prominence even more precipitously.
So even if the Iranian tension persists, it will over time have a smaller impact on global petroleum pricing. If the threats implicit in that situation add some $30 to the price of a barrel of oil today, that premium could easily shrink to as little as $15 or less over the next few years.
For the moment, the Persian Gulf pressure is evident and will keep prices up. Since peace seems unlikely, prices will probably stay up, with a serious threat of further increases in the coming year or two. Over a more distant forecasting and planning horizon, however, the opposite picture emerges, one with downward pressure on global fuel prices, even if nothing improves in the Persian Gulf.
Milton Ezrati is senior economist and market strategist for Lord Abbett & Co.
and an affiliate of the Center for the Study of Human Capital at the State University
of New York at Buffalo. His most recent book, Thirty Tomorrows, linking demographics
and globalization, will come out this year from Thomas Dunne Books of St. Martin's Press.
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