No Relief

Yesterday the International Energy Agency (IEA) set off alarm bells in the energy markets with a report suggesting that oil supplies would be tight for the next five years. The market reacted predictably, with Brent Crude--a better benchmark for now than West Texas Intermediate--briefly breaking through $76/barrel. Even more worrying is the notion that OPEC's spare capacity will be reduced to a bare minimum by 2012. But what the market--and any consumers who noticed it--saw as more bad energy news must certainly be regarded as welcome in some quarters. Another five years of high oil prices should furnish ample incentives to redouble our efforts on renewable energy and conservation.

I haven't seen the full report yet, because the IEA's website hasn't been updated in several days. From the media coverage it seems clear that the main driver continues to be demand, on the back of strong economic growth. Some will point to the IEA's forecast as the harbinger of Peak Oil, validating concerns that we are approaching the point at which global oil output must stall. But even the rough numbers in the press belie that conclusion. The IEA expects global oil production to rise by a healthy 10 million barrels per day (MBD) over the period in question. If demand weren't expected to grow at 2% per year, that would be adequate to provide significant price relief--which it still could, if the global economy slows. But even with unconventional oil included, the growth in non-OPEC production is slowing, and that means that OPEC will be in an even stronger position in the future than they are today. If this forecast is right, they could abandon their quotas and semi-annual meetings with little fear that prices would cool.

The biggest beneficiaries of yesterday's report are probably alternative energy developers. For anyone looking for a guaranteed oil price floor, this is as good as you're likely to get. The chances of oil prices receding below $40/barrel just dropped appreciably. If anything, alternative energy could become one of the key determinants of oil prices, as indicated by the IEA's apparent concern that biofuels growth will slow after 2009. For all of its faults from an energy and food-competition perspective, ethanol is still a good oil substitute, and an extra 20 billion gallons per year (equivalent to 1 MBD of oil) over the next five years could make a difference in global energy prices.

The other wild card in this outlook is conservation and efficiency. The IEA translates a global economic growth forecast of 4.5% per year into oil demand growth at a little less than half that rate. Could the combination of demand elasticity--consumers changing their lifestyles in response to sustained high prices--and stronger measures to combat climate change alter the BTU/$GDP relationship by enough to trim a million barrels per day from that five-year demand forecast? It would have to depend on factors that don't require turning over our immense capital stock--car fleets, buildings and energy infrastructure. The IEA's report should help erase any doubts standing in the way of such actions.