The Effect of a Global Oil Shortage on the US Economy Essay Example for Free

The Effect of a Global Oil Shortage on the US Economy Essay Oil is a very important 21st century product. It is a vital source of energy, an irreplaceable transport fuel, and an essential raw material in many manufacturing processes. Crude oil is a source of great economic power. Since its production cost in many places is far below its selling price in world markets, the ownership and control of oil reserves have been a means by which great wealth has been earned and lost (Deffeyes, 2001). Oil has become the world’s most important internationally traded item in both volume and value terms and changes in this trade have had enormous financial, political and socio-cultural repercussions on the parties involved. Wars, revolutions and mass migrations are perhaps only the most visible manifestation of oil shortages. The purpose of this study is to explore what implications a global oil shortage would have for the US economy. Toward this end we will scrutinize the economic valuables being influenced by oil supply, analyze the ability of the US to meet domestic demand as well as extent of oil–dependence of the country, and make the conclusion. There are three major players in the global oil marketplace – the consuming countries, the producer countries and the international oil industry which mediates between them (Cleaver, 2002). The three biggest consumers in 2000 were: the United States (18. 7 million barrels per day), the European Union (13. 3 million barrels per day) and Japan (5. 5 million barrels per day). As a group the OECD countries exert most pressure on world markets, since they have the highest incomes yet produce insufficient oil to satisfy their own needs. OECD countries consume 62. 4 per cent of the world’s oil, yet produce only 28. 1 per cent (Cleaver, 2002, p. 169). Could the US Produce Oil Supply Sufficient to Satisfy Own Needs? The US has always been a significant producer but its mature oilfields have been in slow, steady decline since the mid-1980s. But perhaps of greater importance is that the country holds some 2. 8 per cent of the world’s reserves volume and, in addition, its oil is not cheap to produce. For instance, in 1985 Saudi oil was estimated to cost less than US$1 a barrel to extract, compared with $7-$8 for Alaska and the North Sea (Cleaver, 2002, p. 181). Thus, the US cannot drill its way to petroleum self-sufficiency in the long run, or to lower gas prices in the short run. Even if Congress opened the Arctic National Wildlife Refuge to drilling tomorrow, the oil would not begin to flow very soon. The US Geological Service estimates 3. 2 billion barrels of economically recoverable oil lie beneath the refuge – enough to meet the nations current demand just for six months. At peak production, the refuge would meet about 2 percent of the nations projected petroleum demand (Stanke, 2002, p. 912). Tapping the Strategic Petroleum Reserve, or bringing a new arctic field on line, would not change the US fundamental energy outlook: continuing growth in demand, declining domestic production and increasing dependence on imported oil (Chapman Khanna, 2000). What Implications the Global Oil Shortage Would Have on the US Economy The implications of oil shortages spread throughout the industrialized world, causing classic microeconomic reallocation of resources. Oil supply and prices affect decisions to invest billions of dollars in different industrial projects: whether to build major highways or rail networks trains or electric cars; offshore drilling platforms or nuclear power stations. Oil shortages also affect macroeconomic variables such as the levels of national incomes, aggregate spending and the balance of payments. The enormous sums involved affect countries’ rates of economic growth, levels of international debt and the overall functioning of the world’s financial system (Hunt, Isard Laxton, 2002). As Deffeyes (2001) ascertains, the coming oil shortage cannot be avoided. He suggests that U. S. political leaders, the news media, and the public are either unaware of or uninterested in the problem, although detailed reports forecasting the peak in world oil production have appeared in many scientific journals. The US oil industry itself maintains its focus on such issues as improving technology, drilling deeper for oil, finding new reserves, and accelerating production. None of these measures can have a significant impact on the coming oil shortage, argues Deffeyes (2001). He forecasts that a permanent drop in oil production will begin within current decade. Deffeyes (2001) argues that the list of fundamental activities is short: agriculture, ranching, forestry, fisheries, mining, and petroleum (p. 159), thus, a permanent drop in oil production will pull one of the blocks out from underneath the pyramid. If Deffeyes is right, the implications are enormous. He anticipates that sharply higher oil prices will bring difficult economic, social, and political passages for those societies most dependent on oil, especially on imported oil (Deffeyes, 2001), as the US is. Exporters will charge top dollar: a gigantic windfall for the Saudi Arabia, Kuwait, and other big oil producers. He implies that the tumult will be greater than that occasioned by the oil price hikes of 1973 and 1979 (Kohl, 2005). Three things could upset Deffeyes prediction: the discovery of huge new oil deposits, development of drilling technology that could squeeze more oil from known reserves, and a steep rise in oil prices, which would make it profitable to recover even the most stubbornly buried oil (Cleaver, 2002). Previous oil shocks have all followed periods of strong economic demand, accelerating inflation from higher levels than prevail currently, a weak dollar at least in terms of the major foreign currencies, actual or threatened cuts or disruptions in oil production, and hostilities in the Middle East. Yet each episode also exhibited some unique features that aggravated the oil price increases (Little, 2001). For instance, an examination of the US postwar quarterly GNP data shows a slowdown in GNP growth after the oil crisis in 1973. Scholars consider the slowdown in growth after the 1973 oil crisis as an event external to the domestic economy (Zivot Andrews, 2002, p. 25). But, it seems reasonable to regard the formation of the OPEC as an exogenous event, there were other big events such as the 1964 tax cut, the Vietnam War, and the financial deregulation in the 1980s that could also be viewed as possible exogenous structural breakpoints (Zivot Andrews, 2002). Nevertheless, the financial world has reorganized since 1980. Effects of oil shortages and subsequent price rises, during the late 1970s, took months to years to spread from industry to industry; from price increases to wage demands. In the new economy, the shock of an oil price rise will spread in milliseconds (Deffeyes, 2001). Moreover, recent rising gas prices are a signal that the consequences of relying on imported oil will become harder to bear (Tonn, 2004). Petroleum is priced in dollars, and the value of the dollar has declined steeply against major currencies If oil were priced in euros or yen, the price per barrel would appear more stable. The American appetite for imported oil may end the dollars privileged status as the leading currency of trade (Kohl, 2005). The great oil dependence of the US economy could be shortened by means of more extensive use of nuclear energy, but unfortunately the US failed to take full advantage of this kind energy for political reasons. While nuclear-power plants are large capital investments, once those costs are sunk the marginal cost of nuclear fuel is very low-currently corresponding to about $4 per barrel of oil (Miniter, 1991, p. 37). Volatility of oil prices during the oil shortage will be aggravated by the unusually large imbalances between the US supply and demand associated partly with the recent unexpectedly rapid global growth. Over the medium term, moreover, the long lag times between decisions to drill new wells or build new refineries and increased supplies of petroleum products can amplify these instabilities (Cleaver, 2002). For instance, recent estimates by the OECD suggest that even a $10 increase in the price of oil maintained for a year is likely to add 0. to 1 percentage point to overall consumer price inflation and to cut 0. 2 to 0. 5 percentage point from output growth in the major industrial countries within two years after the oil shock (Little, 2001, p. 6). Economists have proposed a variety of mechanisms linking oil price increases with economic downturns. These include terms-of-trade shocks, negative productivity shocks, shifts in relative prices that may induce a costly reallocation of resources across sectors, and the monetary policy response to the increased price pressures. In the case of a terms-of-trade shock, an oil price increase acts like an excise tax – with a major part of the income gains going to foreign oil producers (Cleaver, 2002). The global oil shortage also would have an impact on the wages in all the US industries. Economists propose an efficiency-wage model in which an increase in the real price of oil resulting from oil shortage, as an important input price, leads to a decline in real wages as firms seek to avoid losses. They find that real oil prices and real interest rates explain the overall path of U. S. nemployment from 1979 to 1995 reasonably well (Hunt, Isard Laxton, 2002). Rotemberg and Woodford in 1996 presented related evidence that introducing a modest degree of imperfect competition in product markets considerably magnifies the impact of oil price changes on real wages and output beyond what might have been expected given oils relatively small role in the US economy (as cited in Little, 2001, p. 9). This would have an enormous negative impact especially on the small and medium–sized enterprises which contribute largely to the US GNP and are major contributors of new jobs using more labour-intensive production. They will have to shut manufacturing units and discharge workers because of the surging costs of electricity. But some factors testify that the picture is not despairing. Thus, increased energy efficiency, robust economic conditions, enhanced central bank credibility, and stable inflation expectations in the US suggest that the impact of possible global oil shortage in the nearest future will be more muted and manageable than in previous oil shocks (Tonn, 2004). Conclusion The discussed above demonstrates that the implications of the global oil shortage for the US would be very negative in many sectors of its economy due to substantial dependence of the country on the oil import, impossibility to satisfy domestic demand by own oil resources, recent weakening of the US dollar and poor progress in developing alternative sources of energy. The United States can restrain oil demand as a matter of public policy, or wait for rising prices to force consumers to cut back. Now the country has chosen the latter course by default. The efforts of the US public to swing energy policy in the direction of renewable kinds of energy are blocked by the Bush Administration and its fossils fuel industry supporters. Thus, the USA remains vulnerable to oil supply and price shocks. One implication is that current US policy, in promoting still heavier investment in fossil fuels, is misguided. If we dont shift away from oil, we may as well gift-wrap the entire budget surplus and send it to the oil producing countries – Saudi Arabia, Kuwait and other. As Deffeyes (2001) reasonably ascertains, rather than have the crisis sneak up on us, we can see it coming and initiate some of the long lead-time projects in advance. Forewarned is forearmed (p. 187).