Bill Totten's Weblog

Sunday, June 08, 2008

The Peak Oil Crisis: Speculation, Subsidies & Megacities

by Tom Whipple

Falls Church News-Press (May 29 2008)

The energy issue of the week is whether high gasoline prices are being caused by supply no longer being able to keep with demand or by speculators garnering untoward riches at the expense of hardworking motorists.

The facts, economic theory, and the most knowledgeable observers such as the US Secretary of Energy are telling us that the problem is one of supply and demand. Speculators, however, make an irresistible scapegoat that few politicians can ignore. They are nameless, faceless (probably foreign) individuals that can be bashed with impunity without the slightest hint of political incorrectness.

Blaming speculators is now worldwide. OPEC officials routinely mention the role played by speculators as the chief cause of high oil prices. German leaders have proposed a worldwide ban on oil trading by speculators. The transport chief for Germany's Social Democrats said his party will call on the G8 powers to prohibit leveraged trading on energy contracts, claiming that 25 percent of the current crude price is caused by speculators.

The Germans, however, can't compare to the US oil executive who told Congress last week that the real price of oil might be as low as $30 a barrel without the speculators. If he is right, gasoline could fall back to eighty cents a gallon, SUV sales would flourish, and all would be well. Placing limits on speculators, probably by mandating that leverage on futures contracts be reduced or eliminated, seems like a good idea to many in Congress. Since Congress cannot realistically expect to summon up more oil production in the short run, nor order the Chinese to stop growing their economy, cracking down on speculators seems like a sure vote-getter in this fall's elections. Sensible or not, restrictions on speculating combined with drilling in Alaska looks like a good bet.

Of more importance, however, are the reductions in government mandated price caps that have happened or are under consideration around the world. To appreciate how serious this issue may become, it is necessary to remember that since the beginning of the oil age a hundred years or so ago, the world's population has increased from about 1.5 billion to 6.7 billion. The CIA estimates that about forty percent of the earth's population is busy growing food which leaves about four billion of us who aren't. Now a lot of the four billion, who depend on somebody else growing food for them, live in reasonably advanced countries that can probably figure out how to keep its people fed without lots of cheap oil. Unfortunately a lot don't and that is where the problem begins.

As the world's population grew, more and more people found themselves gravitating to cities which grew to megacities (population of more than ten million) and many will soon reach hypercity (population over twenty million) status. Unfortunately, most of our mega- and hypercities are not in the more well-off countries. Jakarta, Dhaka, Karachi, Bombay and Lagos are all in contention to become hypercities shortly.

Once you move or are born into one of these places, you are no longer in a position to raise much of your own food or gather your own cooking fuel. Whether you realize it or not, you have become dependent on cheap oil to raise and bring to you much of the food you eat, and petroleum-derived fuel, usually kerosene or propane, to cook it. Many in the underdeveloped world's megacities live right on the edge. For them, food and fuel prices are a life and death issue.

Governments have long been aware of the affordability problem and have mandated various forms of subsidies or price caps for fuel. This practice is especially prevalent in Asia and oil in exporting countries which consider low fuel prices as a birthright. Venezuela is still the champion with gasoline retailing at around twelve cents a gallon.

In many cases, national oil companies were simply given a set retail price and were told to swallow any losses. Given that many of the most populous countries such as China, India, Indonesia, Pakistan and Bangladesh all had subsidies, many of he world's consumers have been shielded from the six fold increases in petroleum prices in the last five years. Cheap retail fuel prices did nothing to dampen demand and only contributed to the run-up in world prices. In the last few months, however, prices have increased so rapidly that national oil companies and even several large national governments could no longer afford to maintain the subsidies.

Last week the subsidizers began to fold. Indonesia increased fuel prices by 29 percent, Sri Lanka did the same and India and Bangladesh are expected to do the same shortly. Only the Chinese, who have world class inflation underway and $1.2 trillion in liquid reserves, are saying they will continue to subsidize fuel costs.

While there seems no choice but to raise prices, the consequences are not predictable nor likely to be pleasant. Already enduring rapidly increasing food costs, it is feared that increasing the cost of transportation and cooking will result in government-toppling social unrest.

The fuel subsidy situation obviously is not going to get any better. Oil prices will continue to rise. In the advanced countries the solution to increasing oil prices will be to park the cars and planes and start riding on buses and trains, while continuing to outbid the poor countries for the remaining supplies of oil. Those living in the world's new mega- and hypercities are going to have a far tougher time. Oil has built these monstrosities where hundreds of millions will be trapped without direct access to food supplies and cooking fuel. Someday, the historians will note that the collapse of many megacities was among the first real tragedies of peak oil.

Copyright (c) 2008 Falls Church News-Press

Bill Totten


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