The Impact of Surging Petroleum Prices

(This article was originally written in 1999)

Last year’s big economic story was the Internet. This year’s mega story is the return to high petroleum prices.

At the gas pumps, Canadians are already learning about the altered economic terrain. Canadian gasoline prices soared to a record average of 67. 5 cents a litre this week.

For the past two decades, the industrialized world has been living off a glut of cheap oil, which has massively underwritten the great economic boom of recent years. The consequence is that everyone has forgotten that petroleum is a finite, depleting resource and that there is a perpetual battle between producing and consuming interests when it comes to petroleum.

Since the early 1980s, when the Organization for Petroleum Exporting Countries (OPEC) lost its hold over the price of oil, consuming interests have been in the driver’s seat. But now OPEC has regained a significant degree of control over the supply of petroleum. Despite pleas to moderate prices from U.S. President Bill Clinton, OPEC will not lightly relinquish its new leverage. Crude oil prices have surged to over $30 (U.S.) a barrel from $10.35 in December 1998. While many analysts think $30 a barrel is unsustainable, crude prices could remain as high as $25 a barrel for the rest of this year.

It’s been such a long time since we’ve faced the impact of skyrocketing oil prices, that we’re going to have to relearn them, virtually from scratch. Over the next six months, we may revisit some of the features of the bad old days of the 1970s, the last time that oil-producing interests held the whip hand.

Between 1973 and 1979, when the price of crude oil quadrupled and then doubled again, the world was hit with "stagflation", a very unpleasant condition which combined high unemployment with high inflation. For a while inflation became so extreme that bond holders actually experienced a negative return on their investments.

Here are a few of the possible consequences of a sustained return to higher oil prices:
The market for gas guzzling sports utility vehicles, a signature product of the current boom, will dry up like rain from a summer storm.

• Economic growth in both Canada and the United States could slow as consumers have to stretch to pay much higher prices at the gas pumps and to heat their homes. On a continent where there are more than two-thirds as many vehicles as people, higher petroleum prices hit people where it hurts.
• Personal debt levels, already high in both Canada and the U.S., could be driven dangerously higher. The current boom has resulted in only meager income gains for most people. Higher oil prices will definitely mean less consumption of everything else.
• Petroleum company profits will soar, a fact that will quickly spark resentment among consumers who are forced to pay higher prices.
• Particularly, in the U.S. there could be panicky line-ups at gas pumps this summer as supplies run low.
• Expect the value of the Canadian dollar, still a commodities based currency, to appreciate against the U.S. dollar.
• Politicians from oil producing regions, such as Alberta and Texas will find the going much tougher in national politics. Preston Manning, and George W. Bush will have to learn how to placate angry consumers while defending the oil patch on their home turf. Joe Clark, whose fledgling government lost office in 1979 when he tried to mount a huge new tax on gasoline prices, already knows about this.
• If sustained higher petroleum prices lead to slower growth, the outlook for government revenues (except, of course, in Alberta) will be dramatically affected. Politicians, who are now on a high about their surpluses, will have to be told the sad truth by their deputy ministers.
• More speculatively, slower economic growth would test the value of high flying tech stocks, putting the virtual world into unwelcome contact with the real world. If the consequence is that the tech bubble bursts many of the dot.com companies could go broke. Their assets would be taken over by those who remembered the virtues of liquidity. The consolidation would be much like the one that occurred in the auto industry decades ago.

One potential victim of higher oil prices could be the new economic paradigm, with its claim that boom and bust is now a thing of the past. Welcome to the 21st century.