Tuesday, March 8, 2011

Oil Prices - Don't Panic!

This is the message from Dominic Lawson, who argues in the Independent that because there is currently no oil supply problem, and no obvious source of one, we should all calm down and get back to normal. Nothing needs to change.

Which completely misses the point. If you work in any well-run commercial company, a lot of your time will be spent minimizing risk. You ensure your suppliers are capable of delivering quality raw materials or sevices on time. You ensure your customers are capable of paying their bills. You make sure your contracts are watertight. You make sure your costs aren't going to rise unexpectedly. You insure your assets. You might hedge against unfavourable price changes.

That's what didn't happen in the banking sector. Systemic risk built up and eventually led to a massive global recession. The economic damage that could be done by an oil price spike could make that look like a picnic.

Doing something about oil dependency is not about "terrifying the public" as Lawson puts it - it's the opposite: it's about acting calmly to minimise the economic impact of various scenarios which may play out. It's about the fact that there are many risks - the geopolitical issues we're seeing today in Libya and elsewhere, a gradually reducing global oil supply, increasing extraction and exploration costs, increasing demand from emerging economies in the future, uncertainty over reserves, climate change, China buying up chunks of capacity, hoarding of reserves, and so on. Just because there isn't an oil supply problem now does not mean there won't be one in the future. The more diversified we are in terms of energy sources, and the more flexible we are when it comes to transport, the better from a risk perspective.What the unrest in North Africa and the Middle East is showing is how cruelly exposed our economy is to changes in the oil market. It's a good thing we got this wake-up call.

Lawson also makes the mistake of assuming that the oil market is a perfect one. We've seen in the past that oil prices can become volatile for no readily apparent reason. The market can behave in an apparently irrational way. There is also considerable uncertainty as to reserves and spare capacity that can cause volatility. Lawson claiming there isn't a supply problem won't change the oil price - and price alone will cause economic damage.

1 comment:

  1. Oil prices really seem to be the in all and be all of everyday conversation now, but your post really helps put things in order, especially when there is so much conflicting information out there. (Although there is one article I read today that's likewise very insightful: http://www.pressdisplay.com/pressdisplay/showlink.aspx?bookmarkid=CLR30V6Y32S&preview=article&linkid=d48bd2ce-b664-48a2-a062-934a80373813&pdaffid=ZVFwBG5jk4Kvl9OaBJc5%2bg%3d%3d)

    anyway, thank you for the post!