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Thesis & Antithesis

A critical perspective on energy, international politics & current affairs

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Location: Washington, D.C.

greekdefaultwatch@gmail.com Natural gas consultant by day, blogger on the Greek economy by night. Trained as an economist and political scientist. I believe in common sense and in data, and my aim is to offer insight written in language that is clear and convincing.

27 June 2006

How vulnerable to oil prices?

The most surprising feature of the current oil crisis is that it does not really feel like a crisis. Oil prices may be high and many people are struggling to cope with rising energy bills, but at a macro level, the world’s largest economies have registered solid growth in the past two years. That the global economy continues to grow despite high energy prices contradicts our assumption that higher energy prices ought to slow down growth, if not force a recession. Yet this reality has not provoked a corresponding change to our attitude towards energy prices. Hardly do we revisit the most basic, and pervasive, of our images about energy, and hardly do we question whether the commonly presumed link between oil prices and economic growth is true. A serious study of our ability to cope with high oil prices requires a prior examination of whether oil prices affect economic growth.

ROBUST GROWTH

Figure 1 shows real GDP growth in 2004 and 2005 for the world’s twenty largest economies (corresponding to 80% of world GDP and 77% of energy use; methodology at end of article). Without an exception, all grew in both years. This is remarkable: Brent spot oil prices in 2003 were $30.62, in 2004 $39.57, and in 2005 $54.52. Despite this rapid increase in oil prices, many economies have shown significant gains; and the most sluggish among them (chiefly Germany, France, and Italy) face problems that go much beyond high oil prices.

What explains this counterintuitive fact—that countries grow despite high oil prices? One hypothesis is that energy intensity, the amount of energy required to produce a unit of GDP, has decreased gradually thus allowing countries to grow with less energy. Although this is indeed the case, a survey of the years 2004 and 2005 shows how difficult it is to establish a positive link between energy intensity and economic growth (figure 2). Theory would suggest that this relationship should be reflected in a downward slope—the more energy intensive an economy, the less it grew. This is not the case; in fact, there is little correlation, at least for these twenty economies in these two years.

At the same time, growth slowed somewhat in 2005. Figure 3 plots economic growth in pairs for the years 2003, 2004 and 2005: the x-axis gives the first year, and the y-axis gives the second (e.g. the green triangles show economic growth for 2003 in the x-axis and for 2004 in the y-axis). The 45-degree line shows parity—any data point on that line had similar economic growth for two successive years; data over the line experienced higher growth in the second year of the pair, and data under the line registered a slowdown in growth. In 2002-2003, growth varied considerably; in 2003-2004, however, most of the countries showed increased growth, even though oil prices were much higher. In 2004-2005, about half of the countries were experiencing equal growth as in 2004, and the rest registered a slowdown, albeit a small one.

THE DEMAND-DRIVEN CRISIS

What to make of these numbers? One hypothesis about the resilience of economies to high oil prices traces the reason to energy intensity. In a way, energy matters less today since countries need less energy to produce wealth; therefore, they can grow, even as energy prices soar. Even though there is no correlation between energy intensity and economic growth, a shift has taken place and the level of energy intensity is so low that countries can grow almost independent of it.

Taking this idea one step further is the notion that the link between high oil prices and economic growth was never strong to begin with. This idea has several proponents who have sought and failed to find definitive empirical linkages between oil price movements and changes in growth in the United States. (See Robert Barksy and Lutz Kilian, “Oil and the Macroeconomy Since the 1970s,” Journal of Economic Perspectives, Fall 2004.)

Perhaps what distinguishes today’s energy environment is that the rise in oil prices, while dramatic, has been orderly, much smoother than either the 1973 or 1979 oil shocks. This time, the rise has been demand-driven, primarily as marginal demand has outpaced marginal supply, owing largely to lagging investment, although abetted by fears about disruptions, geopolitical or natural. Today’s prices have they have risen to high levels because consumers have been willing to pay for expensive oil. Not so in the past, when prices rose because of shortages or explicit changes in posted prices.

Figure 4 illustrates this point, even though it does so crudely. On the x-axis is plotted real GDP growth in 2005 and the y-axis plots the difference in 2005 and 2004 growth rates (1% means that the GDP growth rate in 2005 was 1% higher than in 2004). This figure looks anew at figure 3, essentially asking the question: which countries can afford to pay high prices and are less likely to be affected by them? The answer is the countries that are growing faster, even though the proof is intuitively derived from the graph rather than proven mathematically.

Given that today’s markets are also much more responsive to supply and demand dynamics than they were in the 1970s, variations in demand lead producers to adjust prices much more rapidly than in the past. This indicates that high prices will remain as long as there is demand and that if a recession were to follow, demand for oil would come down along with its price. This may appear intuitive, but it is quite the opposite from the assumption that oil prices cause recessions rather than respond to underlying macroeconomic conditions. Alarming as the rise in prices has been over the past few years, we are still far away from understanding precisely how higher oil prices affect economic growth.

Methodology

Annual GDP growth estimated from figures in the country database of the Economist Intelligence Unit (EIU). Energy intensity calculated as: energy consumption in million tons of oil equivalent (using numbers from the BP Statistical Review of World Energy 2006) divided by the GDP (PPP) of that year.

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23 June 2006

Think through before attacking

Following news that North Korea is planning to test-fire a Taepodong ICBM, there appears to be some momentum building in favor of striking North Korea’s missile while still in the launching pad. This reminds me of the furor created a few months ago about using military strikes against Iran’s nuclear program. Surprisingly lacking in those advocating such actions is a willingness to examine seriously what comes next—after destroying North Korea’s missile or Iran’s nuclear installations, then what?

For the most part, advocates either take the best-case response and accept it as the most likely; or they conceive of the military action as an act in itself, which will recast the political environment in which negotiations will take place, presumably such change being for the better. For a country that has invaded two others after being attacked on September 11, Americans have surprising faith in the torpor and inertia which with countries will react if attacked by America.

The most sensible commentary I have read in a long time comes in a column by David Ignatius: he turns to Henry Kissinger for advice: “I asked Kissinger this week what lessons he would draw for the new U.S. engagement with Iran from his own diplomatic experience. Kissinger said he didn't want to give public advice to Rice, but he said that as a general proposition, the United States should seek to find common security interests with Iran -- stressing that a strong and prosperous Iran doesn't threaten the United States so long as the Iranians refrain from reckless and destabilizing actions.”

And this, in a nutshell, is the prime drawback of a foreign policy that makes democracy promotion its ultimate target and chief benchmark: such a policy often refuses to examine countries based on what they do—and the compatibility with American interests; treating a country by what it is, rather than what it does, is a poor basis for any relationship.

References:
Charles L. "Jack" Pritchard, “No, Don’t Blow It Up,” Washington Post, 23 Jun 06 (link); Ashton B. Carter and William J. Perry, “If Necessary, Strike and Destroy,” Washington Post, 23 Jun 06 (link); David Ignatius, “Talk Boldly With Iran,” Washington Post, 23 Jun 06 (link)

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11 June 2006

World Powers survey

Recently released is a survey by the Bertelsmann Stiftung on popular attitudes on world powers (link). The survey polled samples in the United States, the United Kingdom, France, Russia, China, Japan, Brazil, India, and Germany; the purpose was “to investigate public perceptions of the qualities, resources and objectives of world powers.” The report makes for interesting read—hidden between the lines are valuable insights into world politics and popular attitudes. Here are a few of my observations:

- In the question, “what qualities must a country possess to be considered a world power?” only 21% responded military power, in itself an interesting find. Striking is that the highest percentages came in China (36%) and America (33%), followed by Russia (29%), France (28%) and the UK (24%)—all five members of the Security Council. From the aspiring members of the Council, military power was not highly regarded: Germany (7%), Brazil (11%), and Japan (16%), with no number given in India.

- In the question, “Which of the following countries or organizations are world powers today?” America had a commanding lead with 81%, which means that 19% did not regard America as a world power, a curious read of the current distribution of power in the world (oddly, America’s country-response was also 81%). Next was China with 45%, though its neighbors were unwilling to accord it world power status—only 26% of Russians, 31% of Japanese and 34% of Indians responded that China is a world power. The European Union got a feeble 32% driven by high rates in Germany (75%), France (49%), and the UK (53%).

- In the question, “Which of the following countries or organizations will be world powers in the year 2020?” America and China were nearly equals—57% for the United States, 55% for China. What is very interesting is that the percentage for the European Union dropped—from 32% who regard it as a world power now to 30% who think it will remain so in the future. Although the European numbers were pretty equal, there was a drop in the collective responses—signaling both a general pessimism about Europe’s futures and also a gap between how Europe sees itself and its future and how the rest of the world does.

- In the question, “What are the main objectives that a world power should pursue?” the issue that topped the list was poverty reduction (44%) followed closely by combating international terrorism (35%), environmental conservation (33%) and democracy and human rights (32%). Curious that of the top four only one is essentially an international act—combating terrorism; the other three are essentially policies entrusted (and best done) by states, yet there seems to be some consensus that leadership in these issues is important.

- In the question, “In the future, what country or organization should play a more important international role in maintaining peace and stability in the world?” America tops the list with 51%, followed by the United Nations (38%), China (36%), and the European Union (33%). Large remains the gap between European and world perceptions of the EU’s contribution; curious too is the French ambivalence—48% for America, 45% for the United Nations, and 51% for the European Union. Interesting too is that China is warmly regarded only in China (71%), followed by Germany and the UK with 50%.

- In the last question, “What is the best framework for ensuring peace and stability?” striking is the overall ambivalence in answers. Large percentages (60-80%) think the world is better off lead by the United Nations or a system of balance of regional powers; unipolarity is highly regarded in Russia and India, while 35% of Japanese have no view on the issue, an excessively high percentage.

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10 June 2006

Very big oil

The Financial Times just published its list of the world’s 500 largest corporations by market capitalization. Thirty-seven oil and gas companies made it onto the list with a total market capitalization of $2.5 trillion, which amounts to 11.2% of the total for the world’s largest 500 (Banking was the top sector with 80 companies, and 3.9 trillion market capitalization). In the top fifty were eight oil and gas companies:

1- ExxonMobil ($371 bn)
5- British Petroleum ($233 bn)
7- Royal Dutch Shell ($211 bn)
10- Gazprom ($196 bn)
17- Total ($162 bn)
27- Chevron ($129 bn)
34- ENI ($113 bn)
48- Petrobras ($91 bn)

Notable is that only two companies are American--Exxon Mobil and Chevron (the next American oil and gas company is ConocoPhillips, which ranked 53rd). Notable too is the presence of Gazprom, which last year ranked 58th and jumped up to 10th place this year; a great increase in ranking was in store for Petrobras too, which increased from 113th last year to 48th now.

Needless to say that this list includes only publicly traded companies; in the oil and gas sector, these are miniscule compared to the giant National Oil Companies of the Middle East, whose reserves alone would boost them beyond any company in this list.

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04 June 2006

OPEC enlargement

News has come out that OPEC is considering inviting Angola and Sudan to join its ranks. Expectedly, this has worried markets and politicians who fear anything OPEC and who believe that the cartel will be made more powerful if the two African countries join along.

But the fears are a bit exaggerated: the two producers do not add much to the cartel: in 2005, OPEC produced around 34 mbd, Angola around 1.25 mbd, and Sudan 0.36 mbd (world production was around 84 mbd). A second reason to feel less worried is that OPEC is hardly a successful cartel, especially in tight markets. To defend prices, OPEC members must bind together, but cohesion is low when prices are high. For a year now, OPEC has disbanded its quotas. In tight markets, whether Sudan and Angola are members of OPEC will not make a big difference.

It is even not clear that Angola and Sudan will want to join. Free-riding on the cartel’s actions is preferable to making production cuts oneself; this is what Mexico, Norway and Russia have done in the past. Wanting foreign investment to develop natural resources, Angola and Sudan would scare off the oil majors, fearing that their return on investment would be subject to OPEC quotas. This is no guarantee that they will not join; governments make energy policy by taking into account much more than the dollar return of their actions.

What if Angola and Sudan joined OPEC? The cartel has always split between price hawks and price moderates. Countries with low reserves take a near-term view of markets and tend to want high prices; countries with high reserves usually try to defend oil’s competitiveness and tend to advocate moderation. Sudan has medium reserves with a Reserve to Production (R/E) ratio of 57 (meaning it will run out of oil in 57 years if it maintains current production); Angola’s R/P ratio is 24 (by way of comparison: Saudi Arabia has 67, Iran 88, Iraq, Kuwait and the UAE over 100).

Reserves alone will not govern price policy; Sudan is fighting a war in Darfur, it has signed a fragile peace treaty with the South, and has major internal problems, leading it to be likely a price hawk. Angola has similar problems, trying to rebuild its infrastructure which was destroyed during years of civil war, and to alleviate its high level of poverty.

Although this may mean that both countries may favor high prices, their interest in developing resources (and their dependence on foreigners to do so) may moderate their willingness to join OPEC. But in the current markets, OPEC is not really a force to fear.

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