Oil prices rise as the economy falls

The price of oil still rising but the economy of the world is slowing down. This at first sight seems like a paradox. If the world’s economy slows down you would expect less energy to be used and therefore the price of oil should fall. Today oil stands at around $120 a barrel – it has never been higher, but businesses face fewer sales, lower profits or greater losses and people’s employment will be threatened as businesses reduce staffing levels.


We are told that this is the result of the sub prime lending foolishness which the world’s banks embraced to the extent of buying worthless securities; having done so they became afraid to lend each other money and are still so afraid. The rate at which UK banks lend to each other is known as LIBOR – the London Interbank Offered Rate, and banks in turn fixed loans they made by reference to LIBOR, giving themselves a small margin over it when lending to commerce.


It is worth noting that none of the recent three Bank of England interest cuts has had the normal knock on effect of reducing the LIBOR. The margin is now historically very high, reflecting the risks that banks feel they take if they lend to each other.


Also it is by no means clear to me that the banks actually have the money to lend. The Royal Bank of Scotland is short £12 billion and will seek to raise this money from a rights issue to their shareholders who must pay up or have the value of their shares diluted. In addition the banks are benefiting from a £50 billion loan being made by all of the taxpaying citizens in the UK.


So the economy is not healthy and at the same time oil price rises inexorably. It has always been thus. In his excellent book, “the Last Oil Shock” David Strahan points out that some analysts have found that movements in oil prices since 1954 have been closely mimicked by US unemployment figures after a time lag of around eighteen months. http://www.amazon.co.uk/Last-Oil-Shock-Extinction-Petroleum/dp/0719564239


Mr Strahan suggests that while oil consumption as a proportion of gross domestic product is falling, because we are increasing our population and driving more, flying more and living more comfortable lives oil consumption per person is increasing. We find more things to “spend” our energy on.


There is a relationship between the availability of energy and economic growth but somehow governments overlook this basic fact. Our present Energy Minister, Mr Malcolm Wicks, is a junior minister and he does not have cabinet rank. He also does not have complete jurisdiction over energy; his boss gets in on the act from time to time as do the people at DEFRA; the Treasury set the policies for energy taxation which further limits Mr Wicks’ brief. No-one it seems to me, is bothering to look at the whole picture and this is worsened by the fact that Energy Ministers in the past ten years have tended to come and go like the newspapers.


This means that we get a muddled energy policy; one day photovoltaics are in vogue, the next day wind turbines. Biomass then becomes fashionable and now nuclear is proffered as a solution. The Government is not joining the various energy dots together and even worse is not linking the energy picture to the economic picture.


The government’s main energy policy is to cause us to invest in insulation – first for lofts and then for cavity walls. This makes energy use more efficient but efficiency is often outweighed, as I explained in another post, by those with good insulation turning the thermostat up to enjoy a more comfortable home wearing lighter clothes. The efficiency gains end up with more economic growth in the sense that we spend the efficiency gains and more on other energy consuming practices.


Now an economic downturn may be caused by a high oil price, as businesses dependent on oil collapse. The oil price would then fall, reviving the economy but in the nature of the beast as the economy grows so the oil price would rise all over again. I am not an economist but it seems to me that a rising and falling and re-rising oil price (and coal prices and gas prices) would lead us through a series of sharp boom and bust cycles, with the bust cycle lasting longer each time until the energy finally runs out.


That, I think, is the fundamental problem that Governments have to solve. The solution must be to use whatever resources we can muster to produce benign energy ourselves. The Government needs to require us to invest in microgeneration and pay attention to the details– not throw money at grandiose schemes dependent upon depleting resources.


That means higher building standards, solar water and space heating for virtually everyone, more offshore turbines, taxation on fossil fuel energy to reduce demand and make people more careful about the energy they use, penal taxation on large-engined inefficient vehicles, as well as what they are doing now.


There will come a time when energy will be at the very top of the political agenda; the fuel duty strikes almost brought down the new labour government in 2000. The future position could be far worse than political inconvenience and far harder to solve.