Rising prices at the pumps….

An increase at the pumps is a sure way to get the attention of the public, we all love our cars, and we resent any reduction of our right to drive where we want, when we want. The recent international developments have driven up the price of oil to record levels and the threat of protest is causing the government to sweat.

Today Gordon Brown addresses the TUC conference in the hope of placating industry, and will call for OPEC members to increase production. One wonders how much more capacity the oil producing countries are capable of; China’s daily consumption has risen from 2 million to 6 million barrels a day (representing nearly a third of the increase in energy consumption in the past 5 years).

The obvious Conservative response will be that the treasury should reduce fuel taxation but this response would queer the price mechanism, and the natural equilibrium that could solve the energy crisis and leave the UK more competitive.

It is widely anticipated that demand will outstrip supply over the next year or two leading to an increasing oil price and a likely global economic slowdown. In the September Outlook Report from the EIA (Energy Information Administration - the US governments official energy bureau) it predicts that global demand will reach 86m barrels-per-day, equal to predicted global capacity. With growth and usage climbing it’s hard to see any easing on energy prices for the foreseeable future.

The new globalised world is indeed leading to rising consumption in emerging economies (i.e. China and India), and we should not preclude others from enjoying the standard of living we in the west have enjoyed for decades, but infinite demand cannot be satisfied by finite supply and rising tensions between nations may lead to conflict. There is an argument that economic interdependence will prevent any squabbles becoming violent, but with rising military spending in China and the emergence of a Central Asian alliance (including Russia, China, and the former Soviet Republics) the threat of confrontation is increasing.

Free-Market thinkers will argue that increased demand will lead to improved efficiency and new resource exploration, but we know that oil is finite and exploration has been unable to maintain pace with the rapidly growing economies of Asia. Stability in Iraq may well lead to some progress on the supply-side but all these solutions represent short-run measures against the long-term problem of increasing consumption.

The argument that increasing fuel consumption will lead to greater efficiency is key to Britain’s future in a world of reducing energy supplies. One of the major problems with oil exploration is that the remaining supply is increasingly difficult to get out of the ground. The law of thermodynamics dictates that when the energy expended in sourcing oil becomes greater than the energy received, the process becomes redundant. As using oil reduces the natural pressure within the subterranean reserves (which causes the oil to naturally gush to the surface) the oil becomes increasingly costly to acquire.

We can assume therefore that the economies that are the most energy efficient will thrive in the coming decades. The economies most vulnerable will be the US – as the world’s largest user of oil – and China whose economy is geared for resource hungry manufacturing. In the US, industry is becoming more efficient (natural in a developed economy), but any gains are wiped out by rising domestic consumption (increased proclivity for air-conditioning and the rise of the SUV automobile).

In the US the record trade deficit will only widen as oil prices rise sending more capital to some of the most despotic regimes in the world, and leaving the US increasingly insolvent. Trans-global terrorism is also directly linked to the oil industry via the need for a complaint Middle East, oil revenue props up undemocratic governments in the Arab world leading to a disenfranchised and angry population who turn to Islamic Fundamentalism and violence in their frustration.

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Necessity is the mother of invention, why therefore should we reduce fuel taxation? We need to ensure the price mechanism does its job and drives innovation and reduced consumption. To reduce taxes we would corrupt the natural market forces that would lead to alternative solutions.

Last year the UK became a net-importer of oil following its peak production in 1999, this economic adjustment represents a reversal of capital flow, which hurts our own trade-balance. This outflow of capital needs to be addressed, as the money moving out of the economy will only increase as the North Sea reserves diminish further. We need to ensure there is ample necessity to drive our economy to innovate, by reducing fuel taxation we would hinder the long-run efficiency of our economy for a short-run gain.

Globalisation has up until this point been very beneficial for the UK. We have become increasingly prosperous over the past decade and employment has been healthy. While many British manufacturers have gone out of business we have been effective in attracting foreign companies such as the hyper-efficient Japanese carmakers. To maintain this position we need to ensure we involve and react to emerging pressures that will shape the new world order; the major pressure will indeed be energy supply.

If anyone is any doubt as to the critical nature of the oil supply they should note that BP estimates that Iran – OPEC’s second largest producer of oil – will be a net-importer of fuel by 2024. These frightening statistics should be enough to persuade politicians of the need to diversify our energy supply or face rapid economic decline.

So when the self-serving fuel protestors begin their blockade of Britain’s refineries, remember the difficult choices we face and the real cost of our dependence on oil.