Wednesday, May 14, 2008

Achilles' Peak

The ESRI's latest Medium Term Review 2008-2015 was greeted with near jubilation today. I'm a big fan of the ESRI; on balance they've called it right more often than they've got it wrong since I started reading their reviews back in the 1980s.

But this time I'm not so sure. I'm no fan of the doom and gloom merchants, especially as regards the near term outlook. The ESRI expect a significant slowdown this year and next (but not a recession) - with recovery going into 2010. It's hard to disagree. It's their medium and longer term outlook that I have problems with. Their benchmark forecast beyond 2010 is base on a number of, frankly, heroic assumptions - Herculean even. The key assumption is a recovery in global economic performance which in turn drives an upturn in Irish exports.

Fair enough as assumptions go, but I'm just not sure we will see the type or scale of recovery that they anticipate in the global economy. The source of my doubts lies in their analysis of Energy, Environment and Transport in Chapter 5 of the Review. Take their assumptions for the price of oil over the forecast period. The ESRI simply adopt the International Energy Agency's forecasts which amount to a price of $73.9 a barrel in 2012, and $9o.5 in 2020. As of today, WTI oil costs $125.12 a barrel: I think the IEA/ESRI might just be a tad optimistic about the outlook for the oil price.

So where might the price of oil really go over the next few years? Goldman Sachs are forecasting anything up to $200 a barrel in the next 6-24 months, before falling back. CIBC bank are forecasting $225 a barrel in 2012 AND an actual fall in global output as production peaks in 2011. You can see why some of the Review's assumptions start to look Herculean.

In fairness to the ESRI there isn't a lot of benefit in departing from the IEA's oil forecasts since they amount to the scenario the Government is working from. And clearly the ESRI's intent in their Review is to persuade any objectively-minded observer that the Government's current targets for electricity generation (with a ludicrous dependence on wind) AND the Government's targets for CO2 emissions are simply unachievable. Here's what they have to say about the latter:
Even with a carbon tax that starts at €20/tonne of CO2 emissions in 2010 and grows over time, emissions from transport grow by more than 35 per cent between 2005 and 2020. This is notably higher than the 20 per cent decrease for the economy as a whole suggested by the EU climate change and renewable energy package currently being discussed in Brussels.
You don't say! I do like their line in gentle understatement.

The key issue - from the perspective of Ireland's economic prospects - is whether we are near the peak in global oil production (2011-12 according to CIBC) and the consequences this will have for fuel prices (and much, much else besides). Peak Oil is the Achilles' Heel of any medium term economic outlook for Ireland, or anywhere else for that matter.

The question then becomes how will businesses and nations respond to a far higher oil price than that we're already experiencing? Martin Wolf has a handy summary of 'Do Nots' and 'Dos' in today's Financial Times. There's also an excellent paper published by the Vienna Institute for International Economic Studies (WIIW) just out on the subject of Economic and Trade Policy Impacts of Sustained High Oil Prices. The authors note the potential for Europe to respond to higher oil prices by reducing other costs facing energy users (including the non-fuel element of energy prices such as vat and duties). As well as insisting on our trading partners removing subsidies to fuel prices that then drive consumption higher than would otherwise be the case.

Unfortunately there is little we can do in the medium term to avert much of the adverse impact of Peak Oil and higher oil prices. As the ESRI rightly points out in its Review, our transport and accommodation choices are mostly given at this stage because of the long lead time for providing significant alternatives. But we won't be in recession this year or next: so now is the time to be making what adjustments we can (domestically and through lobbying in Brussels) to prepare for even greater challenges over the next ten years.

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