INSIGHT

Philip Cole

Remember the 1975 hit song “You ain’t seen nothing yet” by Bachman Turner Overdrive? Well last month the price of oil ran over 130 a barrel for the first time ever, doubling the price over the last year. Remembering the explosive increase in commodity prices of the 1970s, that pop tune catchline from more than 30 years ago seems increasingly appropriate.

Crude oil is the engine of the modern, energy-intensive world economy, and its price is keenly followed.

The price has in fact been increasing for most of this decade, by more than five times, although it is only over the last year that the price has really taken off.

For energy-importing South Africa, the consequences are severe. The high price of crude oil has pushed the inland petrol price over R10 per litre at the pumps, and has been a major factor behind the increase in inflation of the last year.

But what can we expect in the future? Analysts are now openly speaking of a further doubling of the oil price at least. Last month, analysts at Goldman Sachs, the world’s largest investment bank, issued a report predicting that oil prices are likely to rise to between 150 to 200 a barrel over the next six to 24 months.

Deutsche Bank has warned that there is a “huge risk” that oil supply constraints and a lack of alternatives will cause crude prices to continue rising up to 250 a barrel until demand collapses, as it did in the mid-1970s.

Only people now in their fifties or older will have lived their early working lives in the 1970s, the last period of sustained high commodity prices. During that decade, crude oil prices rose more than ten times, from 3.20 a barrel in 1970 to peak at more than 35 a barrel by 1981.

Most of this increase came in two periods, driven both times by the fractious geo-politics of the Middle East. Firstly, US support for Israel during the 1973 Yom Kippur war led to the Arab oil embargo and the emergence of the Organisation of the Petroleum Exporting Countries (Opec) as the main player in global oil. Between 1973 and 1974 the oil price quadrupled in a year to 12.21 a barrel.

Second, regional instability after the 1978 Islamic Revolution in Iran kicked off another rapid increase in the oil price. The subsequent invasion of Iran by Iraq boosted the oil price to 37 a barrel by 1981.

Those who lived through that period must be thinking that the rocketing oil price is taking us back to the ’70s.

The similarities with that decade are indeed remarkable. Just like in the 1970s, the first decade of the twentieth century has seen rapid, major increases in commodity prices. Not just oil, but also gold and other precious metals, copper and other base metals, wheat, maize and other food crops have increased rapidly in price during the noughties. Partly as a result, inflation is again becoming a worldwide concern.

There are, however, important differences between then and now, notably the impact of “peak oil”.

Oil is a finite natural resource, and believers in “peak oil” argue that it is progressively reaching the end of its life. While in the 1970s there was plenty of production available to pick up the slack after the Arab oil blockade and the Iraq invasion of Iran, notably from Opec countries, those days are now well and truly gone.

More optimistic oil industry analysts argue that as oil prices rise, it is becoming increasingly feasible to use more unconventional oil reserves to increase production. These include heavy and extra-heavy crude oil, oil sands and bitumen. The rich Canadian oil sands alone are estimated to contain reserves of one trillion barrels of oil.

In November 2007, an article in the Wall Street Journal concluded, however, that a “growing number of oil- industry chieftains are endorsing an idea long deemed fringe: The world is approaching a practical limit to the number of barrels of crude oil that can be pumped every day”.

Analysts disagree about whether oil production has already peaked or whether this will happen over the next 20 years, but are increasingly united in the opinion that low-cost oil is a thing of the past. It is likely that the world will have to live with higher oil prices.

What is the likely impact?

The 1970s increases in oil prices triggered both rising inflation and recession as industry had to absorb sudden cost increases. With world financial markets unstable over the past year, some are beginning to see the risk of a world recession from a sudden spike in the oil price.

High oil prices do, however, make alternative energy sources increasingly cost effective. These include wind, wave, water and solar power for electricity, oil-from-coal technology and, in the longer term, hydrogen based power, once storage and fuel cell technologies are more feasible. South Africa especially has advantages in some of these areas, notably in solar power and also its extensive experience in the Sasol coal-based conversion technologies. But, while some of these technologies are already available, others will require many years of development.

Oil importing countries like South Africa are especially vulnerable to high oil prices. A recent study by the World Bank has found that in South Africa, a 125 percent increase in the price of crude oil and refined petroleum reduces employment and GDP by approximately two percent, and reduces household consumption by approximately seven percent, affecting mainly the poor.

In the meantime, targeted subsidies will be vital to mitigate the impact of high oil prices on the poor. Oil price increases especially affect the poor as they have to spend a high proportion of their income on food, fuel for cooking and heating and transport – items that are directly affected by increases in the oil price.

Philip Cole is an East London-based development economist.