The Future of Oil, Forecasts and the Threat of Higher Oil Prices to Economic Growth

As oil prices look set to continue rising, policymakers must focus on expanding all types of energy, Manufacturers Alliance/MAPI report argues

Arlington, VA — June 26, 2008 — The rise in the price of oil since 2003, and particularly since mid-2007, poses a challenge for the economy and manufacturers despite increased efficiency in energy consumption, and policymakers must focus on expanding all types of energy, argues a new report from the Manufacturers Alliance/MAPI.

In "The Future of Oil: Are We There Yet?", Donald A. Norman, an economist and author of the report, 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. Norman writes that 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, "[t]he 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.

"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. Over the next 18 months, economists will have a better idea as to future potential production. 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.