Why we’ll all be better off when the commodities curse is dispelled

The existence of substantial fossil fuel resources in a country has often proved a curse for its population, says Max King. The end of the oil era will be a blessing for many – and for the global economy as a whole.

Protesters in Venezuela
Large oil deposits have not proved much of a blessing for Venezuela's people
(Image credit: © Oscar Sabetta/Getty Images)

The Arab oil embargo on exports to the West which followed the 1973 Yom Kippur War, made oil exporters realise the enormous economic power that they wielded.

The Organisation of Petroleum Exporting Countries (Opec), dominated by the Middle Eastern producers, became a cartel which quadrupled the price of oil, exacerbating inflationary pressures in the West and leading to an economic downturn.

More worrying still was the longer-term prognosis.

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We’re no longer worried about running out of oil

During the oil crises of the 1970s, proven oil reserves were enough to last only 25 years, while demand was rising inexorably. With Opec in control of supply, the price could only spiral higher, pulling up the price of coal, on which the UK depended for 70% of its electricity generation, in its wake.

The good news was that higher oil prices encouraged greater efficiency of usage and the discovery of new non-Opec reserves of oil and gas, notably in the North Sea. However, economic growth pushed up demand and hence Opec’s influence continued to grow. This and the Iran-Iraq war caused prices to quadruple again in 1980, reaching $35 a barrel, though the glut which ensued resulted in prices dropping back in 1986.

The stranglehold that Opec had over the global economy seemed to have gone, allowing almost uninterrupted economic growth till the millennium.

Thereafter, the problem re-emerged. Though proven reserves had risen to around 50 years’ worth of consumption, fears grew of an imminent peak in oil production. With demand growing at 1.5% a year, higher prices seemed inevitable. In 2008 they approached $150 a barrel.

The financial crisis caused them to crash but just three years later, the price had recovered to $100 and was trending higher. Then, in 2014, came another crash, since when, barring last year’s temporary drop, the price has oscillated around $60 a barrel.

Why does the long-term trend appear to have been broken? Supply has continued to increase as improved technology and fracking have opened up new oilfields and increased extraction rates, but there have been no major new discoveries for decades. Demand growth has steadily decelerated to below 1% a year, helped by more efficient usage.

More importantly, the relentless growth of renewable energy is encouraging expectations of “peak demand,” a full reversal of the post-millennium “peak oil” thesis. The quip made by Sheikh Yamani, the Saudi oil minister in the 1970s, looks prophetic: “the stone age didn’t end for lack of stone and the oil age will end long before the world runs out of oil”.

This growth in renewable energy generation is being encouraged by falling costs, which, in turn, is expected to push down energy prices. Bloomberg New Energy Finance forecasts that power prices in the UK will fall from £43 per MWh in 2022 to £16 in real terms (ie, taking inflation into account) in 2030 as renewable energy output continues to grow.

This should result in a significant shift from fossil fuels to electricity in transport, the home and industrial processes. For those who were brought up to assume an endless upward spiral in energy prices, it is a remarkable change.

Why the end of the oil era is excellent news for the global economy

This is good news, surely, for energy-consuming countries, but bad news for producers – and hence will have little overall impact on the global economy.

Far from it. Possession of substantial fossil fuel resources has proven to be not a blessing but a curse around the world. Nigeria, Iran, Iraq, Venezuela, Libya and Algeria have derived no lasting benefit. Saudi Arabia’s oil has enriched an elite who have spent their wealth on conspicuous consumption, repression and wars.

The Russian, Brazilian and Mexican economies have lapsed into stagnation and the economic benefit to countries who have managed their luck better is doubtful – arguably, the growth of fracking has made the US economically complacent.

The reason is simple: the fruits of resource wealth flow to governments and their cronies, where it is dissipated in corruption, the military, white elephant infrastructure projects and untold riches for the few, none of which stays at home.

Even the better-governed countries suffer from what came to be known as “Dutch disease” after the discovery of natural gas in the North Sea. The resulting inflow of capital and revenue drives up the value of the domestic currency, encourages imports, and results in other exports becoming more expensive.

It is not a coincidence that most of the world’s most successful economies, including Japan, South Korea, Switzerland, Singapore and Germany have virtually no natural resources. A lack of natural resources does not guarantee prosperity – but it does force their governments, if committed to prosperity, to rely on human ingenuity.

The result of this is that a succession of oil crises have drained wealth from prosperous, efficient economies and given it to corrupt and incompetent governments. Power attracts the corruptible, and oil wealth makes government a magnet for greedy megalomaniacs.

This transfer of wealth from productivity-enhancing to productivity-sapping countries has been a drag on human prosperity for 50 years. If renewable energy and associated technological advances brings the oil age to an end and reverses the treadmill of prosperity-sapping rises in energy costs, it will bring a massive economic benefit to the world.

Strangely, the usual justification for renewable energy is based solely on the environmental benefit, deemed to constitute a “climate emergency” which it is worth paying any price to avoid. This does not have to be true to make the energy revolution the most important technological advance in the last 50 years.

Max King
Investment Writer

Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.

After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.