Does The IMF Believe We Have A Peak Oil Problem?

Does the the hype over recent marginal gains in U.S. oil production , gains that have been offset by declines elsewhere in the world. Because oil can be shipped to wherever the price is highest, it is world output which matters.)

All of this begs the question about how record prices and oil supply constraints are affecting the world economy. Kumhof and his IMF colleague Dirk Muir modeled several scenarios in which oil supplies actually fall for the next 20 years in their paper, "Oil and the World Economy: Some Possible Futures." In their baseline scenario they assume a small, but persistent decline in oil supplies from year to year. As a result oil prices rise by 200 percent in real terms over a 20-year period. GDP shrinks at a rate of 0.2 to 0.4 percent per year in the United States and the Euro area. Surprisingly, the declines are steeper in oil exporting countries. It is a situation that is difficult but not impossible to manage.

The authors then imagine a world economy much more capable of adjusting to declining oil supplies through, for example, switching to other fuels. That scenario would be less distressing for all economies and could lead to continued economic growth in countries other than oil exporters, the United States and Euro area countries.

A third scenario posits just the opposite, an economy which has increasing difficulty substituting other fuels and feedstocks for oil. The assumption is that the easy and obvious substitutions will be made first and subsequent substitutions will be harder to find and deploy. Under these conditions, oil prices increase by 300 percent in real terms over 20 years.

A fourth scenario assumes that oil is so intertwined with the world economy that its contribution to world output is far higher than the 5 percent its cost contribution suggests for what are called "tradeables," items that are easily exchanged in trade (which is most of the things we make) or the 2 percent cost contribution for what are called "nontradeables," items not easily shipped across an ocean for trade. (Public drinking water supply would be an example.) Instead, Kumhof and Muir assume that oil's true contribution is 25 percent and 20 percent respectively. The authors argue that "oil is an essential precondition for the continued viability of many modern technologies." They believe that many processes simply won't work and many devices can't be produced below a minimum supply of oil. They also assume that substitutes are difficult to make. This outlook spikes the price of oil by 400 percent in real terms over 20 years.

The negative economic effects of scenarios three and four are indeed profound. But, the authors recognize that such price increases are probably not realistic, even under the scenarios they posit. They assume that such extreme price outcomes imply "nonlinear effects on GDP" which the model cannot express. Translation: The world economy crashes before prices ever get that high.

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There are other scenarios, each more grim than the previous, as problems detailed in earlier scenarios are essentially added to one another and to some new scenarios.

The point of the exercise is not to predict a specific outcome. Rather, the authors want to explore just how sensitive the world economy may be to oil supplies and highlight the uncertainties surrounding those supplies. While there has been much talk about how the world economy is becoming less oil-intensive per dollar of output, the researchers turn this observation on its head:

[I]f it really only takes a one third of one percentage point increase in oil supply per annum to support additional GDP growth of one percentage point, then it must also be true that it would only take a one third of one percentage point decrease in oil supply growth to reduce GDP growth by a full percentage point. And the kinds of declines in oil supply growth that are now being discussed as realistic possibilities are far larger than one third of one percentage point.

The IMF researchers also note that while an energy transition away from oil certainly seems possible, the extent to which oil is critical in the functioning in the world economy implies that such a transition will be costly and may require several decades. They wonder whether we have that kind of time, given that oil supplies have essentially been stagnant since 2005 and that some analysts believe a persistent decline in world oil production may begin within this decade

Written By: Kurt Cobb