Economics Marc ColemanThe issue of oil prices was the uninvited guest at the Gleneagles summit. Although not as urgent as the plight of Africa or global warming, it is almost as serious.
The world's oil supplies will not run out, nor even begin declining, for several decades at least. But the imminence of the oil issue was brought home by the issuance of a statement by Saudi energy officials last Wednesday.
According to the statement, OPEC will fail to meet the oil needs of western countries in 10 to 15 years. Note the word "western". The statement did not address the impact on future demand for oil from China nor India. Both of these waking industrial giants have populations in excess of the western countries referred to in the Saudi statement.
China is relying on coal, but its demand for oil is likely to grow significantly in the long term as the pollutant effects of its coal-driven power stations become apparent.
The Saudi statement followed a rise in the price of Brent crude oil (a representative benchmark grade) to almost record nominal levels. In real terms - ie compared to the price of other goods in the economy - oil prices have not yet surpassed earlier records and in themselves don't yet threaten the economy.
Oil price hikes have happened before. In 1974 and 1979 oil prices were caused by OPEC constraining supply. In 1991 the Gulf War created similar supply related price increases. In each case a serious recession ensued. But in each case there was no shortage of oil relative to demand, merely a decision to restrict supply. Oil prices fell significantly once these bottlenecks were removed and economies gradually recovered.
This time, oil prices are rising for reasons that we can't walk away from. The impact is longer term, but more inevitable. Futures markets - markets used by those needing to secure oil in the future at prices that are fixed - suggest that the present crude oil price of $60 a barrel is here to stay.
In his book The End of Oil, Paul Roberts suggests that oil production might peak in 2030. His may be a pessimistic view. But given the importance of oil to the world economy, we could do worse than to build on a worst-case scenario.
What can be done? Raising the priority of the oil issue internationally is necessary, but not enough. Germany has raised the issue of the oil price at the G8 summit, but this has resulted in little more than the issuance of a platitude. In the short to medium term, we cannot presume on the emergence of an international consensus. We need a national strategy to tackle the economic impact of rising oil prices.
In broad terms, oil prices affect the Irish economy through at least two main channels. The impact on transport costs is the most obvious. The Republic is spatially dispersed with a poor public transport system. Car usage is relatively intensive and although petrol price levels are not as high here as in other EU countries, price changes are likely to impact on consumers more here than elsewhere.
In this regard our future spatial and transport policies are crucial. Do we aim to be characterised by sprawling suburbs and car dependency? Or do we wish to aim for a more condensed and efficient system of urban planning and reliable public transport. The completion of the M50 last week is supposed to herald a shift in emphasis from road building to infrastructure projects that favour an efficient and reliable public transport system. The question is less Boston versus Berlin than Los Angeles versus Paris. The long-term position we take will determine the energy efficiency of our way of life.
The second impact relates to the indirect impact of oil prices on energy costs for consumers and business. Our electricity is generated mostly by coal and gas, but the price of these substitutes is influenced by the price of oil. As the cost of such inputs rise, we need to become more efficient at using them. This goes beyond lagging jackets and energy-efficient bulbs. We need to address the efficiency of our overall electricity regime.
Last week members of the Oireachtas Committee on Communications heavily criticized representatives of the Commission for Energy Regulation. The energy regulator sets the price increases, but also the level of profits that the ESB can earn. TDs were angry over news of higher profits in the ESB's network division in the wake of speculation that electricity prices were to rise by 36 per cent in September. The regulators doubt that such rises will be needed, but say that some increases are inevitable due to oil price increases. But higher electricity prices will make consumers less tolerant of perceived inefficiencies in our electricity regime.
Is more competition the answer? The high fixed costs of setting up any electricity distribution network make it what is known as a "natural monopoly": it is widely accepted that this is an area where regulation, rather than competition, is warranted. In such cases a strong regulator is needed in order to synthesize the effect of competition by capping prices and profits in the consumers' interest. But some suspect higher prices are being tolerated to attract entrants if the market for electricity generation is liberalised further.
This market for generation is different. Different power stations vary in their efficiency and competition could be a positive stimulus to improving performance. But even here care is needed. Competition in generation is less tricky in large countries where those investing in generators can be sure of a large and sustainable customer base. In smaller states like Ireland, generators are subject to what economic jargon refers to as "market risk", namely the risk of not having enough consumers to cover costs.
In this regard the Irish regulator is hampered by an off-the-peg solution devised by Brussels that will force operators in a liberalised market to bear this risk. While suited to larger countries, for Ireland it could be the policy equivalent of an oversized suit. Altering the regime to permit the ESB to retain its status as a single buyer of electricity could remove an impediment to greater investment and competition in generation.
This approach could also help our response to global warming: alternative energy sources like air and sea power take longer to be profitable. Banks can handle the time horizons involved, but baulk at the problem of market risk. An improved energy regime could contribute to more efficient and cleaner energy in coming decades.
