Economist Donald A. Norman explains how the price of oil will continue to rise unless world production expands sufficiently in a new MAPI report.

The rise in the price of oil since 2003, and particularly since mid-2007, poses a challenge for the economy and manufacturers, especially if the price continues to rise, according to a new Manufacturers Alliance/MAPI report. Whether the price will continue to rise largely depends on whether world oil production can keep pace with consumption forecasts.
In The Future of Oil: Are We There Yet? (ER-656e), Donald A. Norman, Ph.D., economist and report author, looks at the drivers of oil consumption – supply and demand conditions, and geopolitical risks, as well as factors such as the fall in the value of the dollar, speculation, and the lack of refining capacity that some believe have contributed to the dramatic and prolonged rise in the price of oil. The oil price spikes have created headwinds for the manufacturing sector and the overall economy. The extent to which economic growth could be reduced depends on the extent to which a combination of the following occurs:

  • the costs of alternative sources of energy such as wind and solar power, other renewable forms of energy, or unconventional sources of oil, like oil shale, fall significantly while their supplies increase;
  • cost-effective improvements in energy efficiency beyond those built into current projections become available; and
  • capital investment increases, thereby substituting for oil’s reduced contributions to economic growth.

Remarkably, “the impact of higher oil prices on the economy has been muted to date because the percentage of income devoted to energy purposes remains below its peak of 1981,” Norman writes in the report. The reason is that the intensity of energy and oil use, relative to GDP, has declined since the 1970s. In addition, the percentage of income allocated to energy remains below its peak level reached in 1981. The report points out, however, that the percentage of income necessary for energy purchases is rising again, and that if prices continue to rise the economy could be more vulnerable to an oil price shock.

Manufacturers are severely affected by the rising price of oil. “In 2002, the manufacturing sector spent $1.7 billion for residual and distillate fossil fuel,” Norman explains. “Assuming the price of oil holds steady at its May 2008 level for the remainder of 2008, manufacturers will spend approximately $7.4 billion for residual and distillate fuel oil for all of 2008. Some of the increase reflects larger output, but by far most of the increase in spending (96 percent) is attributable to the four-fold increase in the average refiner acquisition cost of oil since 2002.”

The paper concludes with a review of optimistic and pessimistic long-term production forecasts, emphasizing the large gap between these alternative outlooks. “The strong growth of oil consumption in recent years comes at a time when it is becoming more difficult and costly to increase production,” Norman told U.S. Industry Today. “This difficulty is partly geologic and partly one of government policies affecting access to areas where oil is thought to be located. While a case can be made that further significant additions to production can be expected, there is growing doubt that increased supplies will be sufficient to accommodate long-term projections of consumption. To the extent production falls short of these projections, the price of oil will continue rising in order to constrain projected consumption growth.”

Over the next 18 months, economists will have a better idea as to future potential production. In the paper, Norman discusses energy’s contribution to economic growth and argues that energy policy should aim at expanding production of all types of energy – oil, natural gas, nuclear power, and renewable energy – as well as increased energy efficiency.

The Manufacturers Alliance/MAPI, established 1933, is a nonprofit organization engaged in economic and policy research, continuing professional education, and allied activities. The Alliance’s corporate membership includes U.S.-based and international companies in manufacturing and related business services. Visit: www.mapi.net


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