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Daily Telegraph: Dear oil is here to stay, so let’s explore what that means

By Tom Stevenson
Last Updated: 1:25am BST 10/07/2007

The latest report from the International Energy Agency makes scary reading. You don’t have to be a “peak oil” doom-monger to believe the world faces an energy crunch. Investors, and everyone else for that matter, need to think through the implications of a significantly higher oil price.

Oil has risen by around 50pc this year to within a whisker of the peak hit last August after Israel’s invasion of Lebanon. At $76 a barrel, the price of crude is seven times its recent low. Crucially, it is close to the inflation-adjusted levels at which the global economy has, in the past, started to squeal.

The International Energy Agency said yesterday it believes demand will rise by 2.2pc a year between 2007 and 2012. It now believes demand for the black stuff will be 95.8 million barrels a day within five years, up from 86.1 million barrels today.

While meeting that demand is manageable, assuming a degree of co-operation from the oil-producing countries that are members of Opec, satisfying the International Energy Agency’s estimate of demand for 2030 of 113 million barrels a day looks more of a stretch. Jeroen Van der Veer, the chief executive of Shell, thinks the world will probably be using twice as much energy by 2050.

You can argue about when the gap between our thirst for oil and our ability to find more of it becomes a major problem, but few now claim that it isn’t an issue.

There are two sides to the energy squeeze, neither of which looks good. On demand, we all know that energy use is rising but it is questionable whether we have really taken on board the scale of the increase.

Population growth is part of the problem, with a rise from six billion people to perhaps nine billion, made worse by rising levels of prosperity. More people are using more energy per head. As Van der Veer says: “China and India are entering the energy-intensive phase of their development. This is the point when people buy their first television or car, or board a plane for the first time. Most people in China and India have never boarded a plane yet.”

The modern industrial world does not just use a lot of oil, it is fair to say that current western civilisation would not be possible without it. Oil gets us from A to B, it heats us, it fertilises our food, it keeps us clean, it is a constituent of pretty much every man-made thing we touch. Given the developed world’s addiction to oil, what is surprising is not that China’s oil demand is doubling every 10 years but that it is not growing even faster.

The other side of the energy conundrum is supply. Here the harsh truth is that the easy oil has already been tapped. We have already used up the oil and gas that is easy to extract. So while the International Energy Agency thinks there might be as much as 20,000 billion barrels of oil and gas hidden under the earth – as much as 400 years’ supply – most of it will never see the light of day.

There are also serious doubts about how much oil is really left. Saudi Arabia, for example, has reported reserves of 260 billion barrels every year for the past 15 years, despite having produced about 100 billion barrels over that period. It is no coincidence that Opec production quotas are determined by claimed reserves.

In such a fundamentally tight environment, it does not take much to push the oil price higher. The latest nudge has been increasing violence and disruption in Nigeria. The release yesterday of the three-year-old daughter of a British ex-pat oil worker brought that episode to a happy ending, but she was only one of 200 such kidnappings this year in the Niger delta. Shell, which pumps half of Nigeria’s oil, has seen its production there fall by two thirds.

What is worrying is that the oil price is at record levels when we have not yet had the first hurricane of the year (expect a big one in 2007, the experts say) or any serious upheavals in the Middle East.

John Noyce, a technical analyst at Citi, who forecast last year’s slide in the oil price to $50 with uncanny accuracy, told me recently that he believed the up-trend was very much intact. Hedge funds, which exaggerated the slide last autumn, are adding to the upward momentum this year.

I believe that the oil price is very likely to move higher and to stay there for longer than many expect. That has both short- and long-term consequences. In the short term, it means the valuation of oil companies is probably too low. BP and Shell are both valued at around 11 or 12 times expected earnings, a valuation which assumes that the current oil price is unsustainable.

What is good news for energy stocks is, however, bad news for consumer-facing companies such as retailers, for whom higher utility bills and pump prices are even more disruptive than rising interest rates. When the Bank of England moves to increase the cost of borrowing, at least savers benefit. Rising energy prices, however, hit everyone.

Longer-term, the higher cost of conventional energy is good news for alternative energy producers. Wind power, solar energy and biofuels all become more viable as the oil price heads into uncharted territory.

Looking a generation and more ahead, I think the unspoken truth about the looming oil crisis is that the so-far inexorable march of globalisation should not be taken for granted. In the great sweep of history, the 200-year oil age may be seen as a blip before a return to a more sustainable, more local economic system.

I’m just not betting my pension on that brave new world arriving any time soon.

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