Oil Crunch and Eurozone Crisis

Photo by Ron

We are three and a half years into the Eurozone crisis that kicked off in October 2009 when Greek minister of finance George Papaconstantinou made it apparent to the outside world that his country’s budget was essentially a gaping hole. The recent bailout (or bail-in where depositors and creditors have to pay their share) of the Cyprus banks is just the latest chapter in this ongoing story of recession, austerity measures, high unemployment, strikes, protests, credit rating cuts, financial reforms and leadership resignations. But what if, on top of all of this, the price of oil was to spike at over US$200 a barrel? Would that mark the end of the Eurozone?

Why do I mention US$200 per barrel when the historic peak price for oil (reached in July 2008) was US$147 and today’s price is just US$94? We will get back to that point later. Also, isn’t the notion that that we could face potential oil price spikes just a thing of the past or of the distant future? Peak oil, as a theory, is dead after all — isn’t it?

At least that is the argument recently from Rob Wile over at Business Insider. It is a view echoed by Colin Sullivan in his article “Has peak oil gone the way of the Flat Earth Society?” and in the February 2013 paper from the Boston Company Asset Management Company.

The main driver behind these statements has been that the United States (US) is unlocking new reserves of oil and gas found in shale rock with techniques like hydraulic fracturing (fracking) and horizontal drilling. This had led to claims that the US will become the world’s top oil producer by 2017 and a net oil exporter by 2039.

Others point to the June 2012 report by former oil executive Leonardo Maugeri entitled “Oil: The Next Revolution” that argues that global oil output capacity is likely to grow from 93 million barrels per day today to 110 million barrels per day by 2020. So, we are ‘saved’ and surely won’t be seeing anytime soon those nasty oil price spikes like we witnessed in 2008. Or will we?

Oil crunch point anytime soon?

One concern here is that claims about the death of peak oil are just red herrings. Peak oil is just a label covering a diversity of viewpoints (e.g., oil depletion and the end of cheap oil) and these are not fixed, but evolve to reflect the changing energy picture as new evidence becomes available. The greater problem may be that these claims are diverting our attention away from the actual prospects of shale oil and gas (how long the boom will last), and from the assumptions underpinning Maugeri’s study.

Quite a few commentators have raised concerns about Maugeri’s overly optimistic projections including Jean Laharrere, Stephen Sorrell and Christophe McGlade, and Sadad al-Huseini. Meanwhile, Paul Stevens, energy researcher at Chatham House, sheds doubt on the hype surrounding the so-called “shale gas revolution” in a 2010 paper contending that environmental concerns and high depletion rates place a big question mark over its validity. In a follow-up 2012 paper he also argues that there are serious obstacles to the development of shale gas outside of the US and particularly in Europe. Shale oil and gas may not be the energy revolution we would hope for since it may not be that widespread or as prolonged as many would have hoped.

So, what would an oil price spike mean for Europe? This brings us to the November 2012 report by the Greens in the European Parliament with the title “Europe Facing Peak Oil”. The report focuses on what they describe not as an oil production problem, but a “demand side shock”, particularly as oil consumption in China and India continues to grow.

When discussing the potential of a shale gas revolution, the report authors, Benoit Thevard and Yves Cochet, make the following comment:

“The prospect of one hundred years of gas power entails major structural changes, including converting vehicles to gas operation, re-equipping service stations, replacing boilers, etc. This situation poses a very serious risk for the United States, given that, if the shale oil and gas boom does turn out to be a bubble, production will decline rapidly, gas prices will rocket, and substantial investments — mainly financed through debt — will have been made to adapt to an energy source that will no longer be available. The dream of energy independence — which will probably not come true — could lead Americans into a dead end that might prove to be an even worse situation than the one they face today.”

So, while recognizing that the US could be in trouble, they also argue that the future energy picture for Europe is even less rosy. The European Union is the second largest consumer of oil in the world, but is only capable of producing 13 percent of its requirements. Thevard and Cochet explore European vulnerability in terms of its energy security through a scenario that would involve oil prices spiking to US$200 per barrel. The reasons for this spike could include a supply cut off due to conflict in the Middle East or elsewhere, speculation due to declining production or increasing demand, or some other unforeseen circumstances.

It is interesting that, back in August 2008, Paul Stevens at Chatham House published a study entitled the “Coming Oil Crunch” where he argued that an oil supply crunch appears likely around 2013 and that this would translate into a spike in the price of a barrel of oil at over US$200. Stevens contended that such a spike could have major macro-economic impacts and, as a result, “break down opposition to a much greater interventionist approach by governments in their energy sectors. Thus it might do to energy policy what 9/11 did for US military and security policy.”

The purpose of Steven’s paper was to describe how an oil crunch could occur and to suggest some policy options to avoid its occurrence, rather than to describe the actual impacts of the prices spike. Subsequent to this paper, we have witnessed the dampening of oil demand in Europe due to the ongoing recession, bringing it to the lowest level in the past 20 years.  However, we have not yet seen a transformation of European energy policy.

This is what the EU Greens would like to see and this is why they presented their report at the European Parliament (see video below).

What would US$200 per barrel do to Europe?

Europe is already suffering from a prolonged recession with high unemployment (especially in the southern countries) and even the most powerful economy, Germany, has slowed to near stagnation. No one would like to see these circumstances worsened by an oil price spike, but at the same time the new reality that we may have to face could be one of recession, economic growth, increased energy consumption, spike in energy prices, and then recession again. In this context, the EU Greens are keen to understand what would happen to the overall economy — and to particularly vulnerable sectors like food, health, housing, travel and communications — should oil prices rise over US$200 per barrel.

According to their report, an oil price spike of this order of magnitude would cause production costs to rise and companies to invest less. This would ultimately affect profits and private sector wages while at the same time adding to inflation and sharply increasing energy costs. As a result, they project that domestic energy demand may fall by between 30 and 40 percent.

An associated surge in consumer prices would mean that wages have to be renegotiated, reducing profit margins and causing an overall decline in the demand for labour. The report argues that investment and consumption would shrink, triggering “reflation” where prices rise but there is no growth. This would affect all sectors, even those that are vital to ensuring that society runs smoothly (i.e., police, fire, health, sanitation services, etc.). The poorest would be hit the hardest and unemployment would rise further, while shortages, bankruptcies and debt default would become even more common occurrences.

The report states that “in 2008, a 17 percent surge in the price of agricultural produce triggered a 10 percent increase in food prices. During the same period, the price of a barrel of oil rose by approximately 85 percent. Consequently, if the price of a barrel were to double, the price of agricultural produce may rise by 20 percent compared with 2012 prices and consumer prices may increase by between 12 and 15 percent.”

In the fisheries sector, they argue many fleets would cease to operate and there will be shortages in the markets and in the agro-food industry. This will directly affect 250,000 people employed in these sectors, particularly in Spain, Italy and Greece, which account for 60 percent of the workforce in the fisheries sector, as well as Portugal, France and the UK, which represent 25 percent of the workforce. They project that a food crisis could arise owing to the combination of price rises and the physical shortage of food, causing public outcry and even riots.

If the costs of a reliable energy supply rise, the risk of energy poverty will grow and the health of the poorest people will deteriorate, while persistent stress may wear down people’s mental health. Deteriorating living conditions and lack of access to the most basic of resources may trigger public unrest. The number of households living in energy poverty could rise from about 15 percent today to between 30 and 40 percent. On top of this, power cuts during peak consumption times may become more common and backup oil-fired thermal power stations would no longer be an option.

Fuel accounts for up to 70 percent of operating costs for airlines, so fuel cost increases would inevitably impact ticket prices. Less affluent travellers may no longer be able to take flights and this would spell the end of cheap holidays in the sun. Fixed aviation costs (e.g., for airports, air traffic control and other services) would as a result be passed on to a lower number of travellers, which again increases the price of their tickets. In Europe, a total of 5.1 million jobs related to the aviation sector may be affected by any potential decline in passenger numbers.

The service life of planes would need to be extended and construction orders for planes may be cancelled. The aircraft manufacturing sector, which employs almost 500,000 people (a third of whom are based in France), would consequently face considerable difficulties.

Road freight costs would rise by at least 10 percent, while the distances travelled and trade between EU Member States would fall. The just-in-time production model, where materials for the production of goods are ordered/produced so as to arrive shortly before they are needed, would be called into question. Concerns would be raised about the distribution of food, which is very dependent on transportation and it may be difficult to keep the supermarkets stocked.

That’s pretty grim reading.

So what can we do?

First of all, one important point to note is that the report’s authors do not suggest that an oil spike will happen tomorrow. Rather they suggest that there is a likelihood of a reduction in oil supply sometime between now and 2020, and that this needs to be taken into account in public policies.

Secondly, they are concerned that the current energy strategies being pursued by the EU (20-20-20 Strategy) are inadequate since they do not call into question the EU’s dependence on oil, nor take into account the potential for a decline in oil production by 2020.

The authors therefore call for the adoption of a transitional approach designed to mobilize citizens around the issue of energy security that would involve the promotion of relocalization, diversification, innovation and conversion to improve the EU’s adaptability and resilience.

What the report fails to address, however, is the question of whether or not the Eurozone could survive this kind of oil price spike or whether it would lead to a breakdown of sorts. Already we are seeing a split between the north and south of the Eurozone with very high levels of unemployment in Greece (26.2 percent), Spain (26.3 percent) and Portugal (17.5 percent), particularly among youth. The question is really: how much worse do things need to get before the Eurozone splits or folds altogether? And would a new spike in the price of oil push Europe to a crucial tipping point?

Oil Crunch and Eurozone Crisis is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 Unported License. The article was originally published in the Our World web magazine.