Will High Prices Solve the Problem of Oil Underinvestment?

Steven Kopits, Managing Director of Douglas Westwood Energy Analysts in New York wrote in June 2009 in an article entitled, Oil: What Price Can America Afford, examined the historical connection between oil prices and recession and argued that to avoid recession caused by oil prices, policy makers should ensure that:
 * Crude oil expenditures should not exceed 4% of GDP
 * Oil prices should not increase by more than 50% year-on-year
 * Oil price increases should not be so great that a potential demand adjustment should have to reach 0.8% of GDP on an annual basis, as shedding demand at this rate has generally been associated with recession.(more...)Oil_Price_Volatility_&_Recession.png

He suggests that policy makers shouldn't fear the boggeyman of carbon taxes or cap in trade systems given the extreme volatility of oil and energy prices. In fact he argues for for them as a means of stabilizing those prices, increasing them when oil prices are low and decreasing them when oil prices are high. Kopits suggests the US Administration would do well to heed the forecasts and concerns of wide range of a mainstream analysts. For instance he pointsa to a recent April 2009 report from the Commodities Research group at Macquarie, a leading natural resources investment bank:

“When looking out into 2011-12 and beyond, we see global spare capacity reduced to zero by 2013. Prices will again need to rise to accelerate upstream spending. We do not think, however, that production can be ratcheted higher fast enough. Oil prices could then rally to reflect scarcity, just like they did in 2Q of last year.”

The Oil Depletion Analysis Centre (ODAC) has further simplified Kopits' contention. The arguments that the market for oil and energy supplies can remain health if prices stay high is naive in the light of recent experience. ODAC says critics of peak oil should repeat the following phrase: "oil-price-spikes- cause -recessions-  cause -oil-price-slumps- destroy -business-case-for-marginal-oil-projects- tightens -oil-markets- cause -new oil price spike." High oil prices initiate a negative economic feedback loop that gains strength from the size of the initial spike and the relative difficulty by which new oil, or its substitutes, can be pulled into the market. Given the recent retreat from oil investment in the current recession and the IEA's estimation of declining (6.7%) production rates from existing wells, the stage is set to nip the current recovery as soon as consumer spending and manufacturing begin to show some upward sign of growth again.

"Should oil return to $150/barrel, as Saudi Oil Minister, al-Naimi has warned, the statistics are not ambiguous. Expect a recession, and a severe one at that", says Kopits. (more...)