When it comes to oil, the global economy is still addicted

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The world may be less dependent on oil now than it was during the energy shocks of the 1970s, but the conflict in Ukraine is clear evidence of a persistent desire that can still disrupt economies, confuse policymakers and spark political strife.

When the Yom Kippur War of 1973 triggered an Arab state oil embargo that shook world markets and sent inflation to double digits, oil made up nearly half of the global energy mix — a figure that has since fallen to about a third.

The shift came as rich countries focused more on services, factories became more efficient, and electricity generation moved from using oil to coal and natural gas.

A Columbia University study last year found that the same economic growth that required one barrel of oil half a century ago can now be achieved with less than half a barrel.

Some analysts had even speculated in recent years that the global economy could absorb future oil shocks. Others pointed to the COVID-19 lockdowns of the past two years as evidence that the economy – in one form or another – could function with dramatically lower oil consumption.

But the resurgence in oil demand in 2021 and the spike in oil prices caused by the conflict in Ukraine has once again highlighted the magnitude of the effort it will take to wean the global economy from an oil habit that has been entrenched for decades.

Shifting demand for oil is difficult in the short term because it takes trillions of dollars to replace aging infrastructure such as vehicles and equipment, said Alan Gelder, VP of refining, chemicals and oil markets at consulting firm Wood Mackenzie.

“Investments are needed to reduce the link between economic activity and oil demand,” he said.

The latest rally in oil prices – up 50% since the start of the year LCOc1 – has buried hopes harbored by the world’s central banks last year that inflation fueled by pandemic-era stimulus packages would be “transient.”

Instead, it has made it all too clear how deep oil permeates the internal mechanics of the global economy.

gas pump rage

Americans drive less and airlines charge higher fares. From the petrochemicals used in plastics or fertilizers to the fuel burned to transport goods around the world, crude oil derivatives make up a large part of the higher prices consumers are now paying for all sorts of essential goods.

In the United States, the Fed estimates that every $10 a barrel rise in oil prices reduces GDP growth by 0.1 percentage point and raises inflation by 0.2 percentage point. In the eurozone, as a rule of thumb, every 10% increase in the oil price in euros increases inflation in the eurozone by 0.1 to 0.2 points, according to research by the European Central Bank.

The most visible impact is inevitable at the gas pump.

Europe’s oil-importing countries are rushing to offer motorists fuel discounts and other concessions, aware how their anger could spill over into wider protest — as it did with the “yellow vest” movement in France in 2018.

Asia, as the region with not only the world’s highest demand for oil, but also the fastest growing demand, is also being hit hard. Japan and South Korea are the ones raising fuel subsidies to offset the higher prices.

The world’s largest oil producer, the United States, needs to be better shielded than others. Fed Chair Jerome Powell noted on Monday that the country is clearly more resilient to an oil shock now than it was in the 1970s.

But that didn’t stop him from delivering his strongest message yet on his battle with over-inflation, suggesting the central bank could act “more aggressively” to prevent an upward price spiral from becoming entrenched.

Expensive habit of kicking

If it took five decades for oil’s share of the global energy mix to fall from 45% to 31%, it remains an open question how quickly the world – now with its stated goal of a carbon neutral economy – can further reduce that share.

The switch of motorists to electric vehicles is expected to cause a tipping point in global oil demand, causing it to decline. Passenger cars are the sector with the highest demand for oil, consuming about a quarter of the oil used worldwide.

“Oil intensity will decline much faster from now on as global oil demand will peak in the coming years and then decline, while GDP will continue to grow,” said Sverre Alvik, energy transition program director at energy consultant DNV, who sees electric vehicles reach 50% of new passenger car sales in 10 years.

Yet that is only one side of the story.

The rising demand for oil in Asia, plus the fact that key sectors such as shipping, aviation, freight and petrochemicals are much further behind the auto sector in switching to alternative fuels, means that large areas of oil demand remain firmly anchored.

“Our forecasts suggest that dependence on oil, especially imported oil, is unlikely to disappear anytime soon,” IEA analysts concluded in a 2019 note titled “The world cannot afford to relax about oil security.”

Such prospects suggest that, even in the best-case scenario, the global transition from oil and other fossil fuel sources will present new challenges for consumers and policymakers alike.

Isabel Schnabel, a board member of the European Central Bank, used the term “fossil inflation” this month to refer to the price to be paid for what she called “the old cost of dependence on fossil fuels”.

For Schnabel, those costs stem partly from how policies like carbon pricing make fossil fuels more expensive, but more so from how power producers can artificially create tight markets to drive prices up at the expense of importers.

Add to this the embargoes imposed by the United States and Britain on Russian oil, and Europe’s goal to reduce its Russian gas imports, and she concluded: “A marked decline in fossil energy prices, as indicated by current futures prices , seems quite unlikely from this perspective.”

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