Thompson oil and the western economic crisis (2017)

BoE Bank of Englandbpd barrels per day CPI Consumer Price Index ECB European Central Bank EEC European Economic Community EIA Energy Information Administration ERM Exchange Rate Mechanis

Economy: SPERI Research & Policy

Series Editors Colin Hay Centre d ’études européennes de Sciences

Sciences Po Paris France

Anthony Payne SPERI University of Shef field

Shef field United Kingdom

tion in higher education research and outreach It brings together leadinginternational researchers in the social sciences, policy makers, journalistsand opinion formers to reassess and develop proposals in response to thepolitical and economic issues posed by the current combination offinan-cial crisis, shifting economic power and environmental threat Building aSustainable Political Economy: SPERI Research & Policy will serve as akey outlet for SPERI’s published work Each title will summarise anddisseminate to an academic and postgraduate student audience, as well

as directly to policy-makers and journalists, key policy-oriented researchfindings designed to further the development of a more sustainable futurefor the national, regional and world economy following the globalfinan-cial crisis It takes a holistic and interdisciplinary view of political economy

in which the local, national, regional and global interact at all times and incomplex ways The SPERI research agenda, and hence the focus of theseries, seeks to explore the core economic and political questions thatrequire us to develop a new sustainable model of political economy at alltimes and in complex ways

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Oil and the Western Economic Crisis

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Cambridge, United Kingdom

Building a Sustainable Political Economy: SPERI Research & Policy

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seriously about politics

Over the past eight years I have written about different aspects of theeconomic crisis that has unfolded in the West since 2008 For much ofthat time I thought little about oil’s relationship to the crisis even though Iwas strongly conscious of the massive rise in oil prices that took place from

2002 to mid-2008 But the harder I tried to think through the idea ofwriting a book that captured the extraordinary nature of the post-2008economic and political world, I found myself coming back on issue afterissue to oil At first I thought it would be possible to add oil into ananalysis of the origins and aftermath of the 2008 crisis only to realise thatactually there is a story to tell about oil that can explain a significant part ofthe end of the pre-2008 world and something about the nature of the onewestern economies and states now inhabit The more I reflected on thatstory the more I saw parallels between the economic and political crises ofthe 1970s and today’s economic and political predicaments even as themonetary landscape has been transformed beyond recognition This book

is the result of that intellectual journey in which I have endeavoured to putthe present western economic crisis in its apposite historical context

As with any book I have incurred debts Tony Payne gave me theopportunity to turn what was a set of emerging thoughts into a bookand did so with an enthusiasm that overtook what would otherwise havebeen my caution Colin Hay encouraged me when I first mentioned tohim that I thought that oil was much more important to the 2008 crisisthan most scholars and commentators allowed Amber Husain andChristina Brian at Palgrave have been very helpful Josh Simons provided

me with excellent research assistance in collecting material on quantitative

vii

easing, the financial problems of the shale oil sector, and commodityprices He also offered acute insight in conversation on these subjectsand others Christopher Hill and Glen Rangwala gave me some guidance

on the issue of US and EU sanctions against Iran Matt King at Citigroupengaged with me with extreme generosity and analytical sharpness on thepost-2008 monetary andfinancial environment I have learned a great dealfrom him, and my understanding of the post-2008 monetary andfinancialworld would be significantly diminished if I did not know him

My debt to my late friend Geoff Hawthorn is long-lasting In thepenultimate conversation I enjoyed with him I articulated the main argu-ment of this book for thefirst time As I have set that argument to thewritten word, I have been strengthened by the memory of Geoff’s lifelongintellectual bravery in venturing into new subjects in the faith that one has

to try to get better and better at understanding the world and that our oldways of thinking never suffice Without his example I would not have gothere

1 Introduction 1

2 The Spectres of Peak Conventional Oil and Stagflation 9

3 Salvation and Damnation: The Rise of

Non-conventional Oil and Quantitative Easing 47

ix

BoE Bank of England

bpd barrels per day

CPI Consumer Price Index

ECB European Central Bank

EEC European Economic Community

EIA Energy Information Administration

ERM Exchange Rate Mechanism

EU European Union

FOMC Federal Open Market Committee

FRB Federal Reserve Board

G7 Group of 7

GDP Gross Domestic Product

HICP Harmonised Index of Consumer Prices

IEA International Energy Agency

IMF International Monetary Fund

ISIL Islamic State of Iraq and the Levant

MPC Monetary Policy Committee

NATO North Atlantic Treaty Organisation

NICE Non-in flationary consistently expansionary economic growth

NGPL Natural gas plant liquids

OECD Organization of Economic Development and Co-operation

OMT Outright Monetary Transactions

ONS Of fice for National Statistics

OPEC Organization of Petroleum Exporting Countries

PDVSA Petróleos de Venezuela

xi

Abstract For the best part of a century oil has been the material basis ofwestern economic life Given its huge economic importance, oil is ines-capably part of politics Yet from its onset the subject of political economyhas been curiously lacking in perspectives that engage seriously withenergy as an economic and political predicament Today with a few strik-ing exceptions oil has had a very limited place in macro-analysis of thepathologies at work in the present political economy of the West Thisabsence makes little empirical sense once we take a look at the visibleeconomic and political world we have inhabited since the turn of thecentury This book aspires to tell the story of the western economic crisisthat has developed since then through the lens of oil and in doing soconnect the present set of economic and political predicaments facingwestern countries to the older crises of the 1970s

Keywords Oil
Western economic crisis
Political economy

For the best part of a century oil has been the material basis of westerneconomic life It is the single largest source of the world’s energy supply,and more than 90 per cent of the energy used in transportation still comesfrom oil-based fuels, a proportion that has changed little since the1970senergy crisis (International Energy Agency (IEA) 2013, 510) Now the

© The Author(s) 2017

H Thompson, Oil and the Western Economic Crisis,

Building a Sustainable Political Economy: SPERI Research & Policy,

DOI 10.1007/978-3-319-52509-9_1

1

threat from climate change has created acute incentives to reduce the use

of oil, but at present most renewable energy generation is directed atreplacing coal in the production of electricity rather than oil in the trans-portation sector

Given its huge economic importance, oil is inescapably part of politics

As a limited resource unevenly distributed across the world, oil generatesinternational conflicts of interests between states In a world in whichmilitary power came to rest on oil-fuelled ships, submarines, tanks, andaeroplanes, access to oil fields was fundamental to the geo-political for-mation of the West in the twentieth century It in good part explains therise of the oil-rich United States (US), the ongoing relative military power

in thefirst half of the century of an economically declining Britain that hadaccess to oil in the Middle East, and the problems posed to the interna-tional order of an economically rising Germany that did not As Britain’sSecretary of State for the Colonies told the House of Common in 1917,

‘you may have men, munitions and money that you use, but if you do nothave oil, which is today the greatest motive power that you use, all yourother advantages would be of comparatively little value’ (Quoted in Yergin

1992, 177) Nothing made the geo-political potency of oil clearer thanthe Second World War In the age of air power, the ultimate alliance of theworld’s two largest oil producers in the US and the Soviet Union againsttwo states in Germany and Japan lacking any domestically-generated oilensured one eventual outcome Germany’s only conceivable chance ofwinning the war was to capture the Soviet oil fields in Baku on theCaspian Sea and protect the oil it controlled in Romania once it chose toend the Nazi-Soviet pact Yet Germany could not succeed in taking thatchance because the German army simply did not have enough fuel either

to capture Baku or defend itself at Stalingrad

Oil also generates acute domestic political problems for states Oilprices have a large impact on economic growth Of the recessions thatoccurred in the US between 1945 and 1982 all but one was preceded by asharp rise in the price of oil (Hamilton 1983) Since then all threeAmerican recessions – 1990–91, 2001, and 2007–09 – came after asubstantial oil price shock (Kilian and Vigfusson2014) The oligopolistictendencies of the oil sector and the difficulties in securing any kind ofequilibrium price between the interests of consumers and producers whenconditions of both relative scarcity and over-supply can abruptly materi-alise also create severe domestic distributional conflicts in countries wherethere is significant oil production or which are home to international oil

companies These conditions often allow oil companies the opportunity toexercise significant political influence and can give voters reasons tobecome suspicious that a political-business elite is pricefixing and gettingrich on foreign wars.

Yet from its onset the subject of political economy has been curiouslylacking in perspectives that engage seriously with energy as an economicand political predicament Thefirst political economists, like Adam Smith,treated energy as a free and unproblematic good, supposing that therecould be a calculus of economic gain independently of the energy required

to transport goods across land and sea or the political power required tokeep those trading routes open Whilst there were economists, especially

in the US, in the early twentieth century who made questions of naturalresources their fundamental subject matter, they lost the disciplinaryargument to both neo-classical and Keynesian scholars who largelyignored them (Mitchell2013, 131–32) For his part Keynes made aggre-gate demand the centrepiece of his analytical political economy withoutany explicit regard for either the impact of energy prices on that demand

or the possible impact of geo-political shocks on energy prices, attuned as he otherwise was to the power dynamics of internationalpolitics The Keynesians, who in part followed him, were then predictablyflummoxed when the oil price shocks of the 1970s generated a simulta-neous increase in unemployment and inflation, leaving their models ofhow western economies worked largely irrelevant in the face of the chan-ging balance of power in oil production and the international monetaryfallout

well-Undoubtedly oil in part has made an analytical reappearance in recentyears There has been considerable discussion of the causes of the recentrise and fall of prices (Hamilton2009; Lutz and Murphy2014) and thefinancialisation of oil markets (Gkanoutas-Leventis and Nesvetailova

2015; Kaufmann and Ullman 2009) US foreign policy scholars andcommentators have also explored the geo-political impact of oil (Morseand Richard2002; Bromley2008; Yergin2012; Blackwill and O’Sullivan

2014) Yet with a few striking exceptions (Hay 2011; DiMuzio 2012;Mitchell 2013) oil has had a very limited place in macro-analysis of thepathologies at work in the present political economy of the West Thediscourse of crisis rightly deployed in political economy scholarship since

2008 has focused on one or more of debt (Gamble2014; Streeck2014),the ideological victory of neo-liberalism (Blyth 2013; Crouch 2011;Gamble 2014; Streeck 2014), technological and demographic change

(Gamble 2014; Summers 2016), and productivity (Gordon 2016).Strikingly, even those who have extremely insightfully placed the contem-porary western economic crisis in a longer temporal crisis going back tothe 1970s (Gamble2014; Streeck2014) have said rather little about oil inmacro-economic and geo-political terms, despite the fact that the two oilprice shocks are routinely described in virtually all accounts of the crisis ofthe 1970s.

The relative absence of oil in the macro historiography of the westerneconomic crisis compared either to ideational or other material factorsmakes little conceptual sense once we acknowledge oil’s place in theunderlying material basis of western civilisation without which ideologicalpolitics as we know it would not exist It also makes little empirical senseonce we take a look at the visible economic and political world we haveinhabited since the turn of the century Quite conspicuously, the 2008crash was preceded by a third oil price shock that saw prices reach around

$150 a barrel in June 2008, 30 per higher in constant prices than the lastpeak they reached in 1980 The post-crisis world, meanwhile, has seen atransformation in oil production that has led to a resurgence of Americanoil production and the world’s largest holder of oil reserves to declare war

on the shale industry, throwing into tumult the geo-political axis that haslargely guaranteed western oil interests for the past four decades Bothbefore and after 2008 oil has posed massive problems for central banks andconfronted the West with geo-political predicaments from the MiddleEast to Russia Without a narrative that gives oil predicaments and theirconsequences substantial explanatory weight it is impossible to understandthe macro-economic landscape and geo-political world that western statesnow inhabit

This book aspires to tell the story of the western economic crisisthrough the lens of oil and in doing so connect the present set of eco-nomic and political predicaments facing western countries to the oldercrises of the 1970s It argues that the stagnation of conventional oilproduction around 2005 and the rise of non-conventional oil as a response

to that material reality has created a Gordian knot of macro-economic andgeo-political problems, the fallout of which pose a fundamental challenge

to the assumption of progress embedded in western expectations ofdemocracy Whether or not oil will be eliminated as an energy source inthe future in a revolution of solar power and battery technology, aspromised by entrepreneurs like Elon Musk, the problems generated byoil as the world’s present premier energy source have had a profound

impact in shaping today’s economic and political predicaments and theirlegacy will remain for the foreseeable future (Given the laws of thermo-dynamics and the enormous federal and state subsidies that Musk’s loss-making companies consume there is also little reason to think that analternative future will arise with any alacrity.)

In reflecting upon the place of oil in the west’s present economic andpolitical problems, I will not engage with the issue of climate change Thisomission is not because I in any way wish to minimise the threat that risingcarbon emissions pose to the sustainability of human life on this planet.Rather, it stems from the recognition that since the world now consumes

28 million more barrels of petroleum every day than it did in 1992 whenthe representatives of 166 states signed the United Nations FrameworkConvention on Climate Change climate change concerns have thus far notmade oil less important to western economic life or mitigated the pro-blems oil has generated (US EIA2016a,2016b) Explaining the reasonsfor that failure and the likely consequences of it that would be a differentbook Neither do I wish to suggest that oil dependency has only generatedproblems for the West Indeed, a significant part of the rise of oil con-sumption since the early 1990s has occurred in non-western countries, notleast in China leaving the Chinese economy vulnerable too to oil shocks Iconcentrate in this book on oil as an economic and political problem forwestern states alone because its role in the crisis afflicting western econo-mies since 2008 has largely been erroneously ignored

The book begins with the problems oil created for western states in thedecade leading up to the 2008 economic crash Chapter one explains howthe stagnation of conventional oil production under the weight of bothgeological and political pressures at time when the demand for oil fromChina and India was increasing substantially produced an extremely sharprise in oil prices It argues that this oil price shock created a spectre of thereturn of the stagflation of the 1970s and set in motion the recessions thatmarked the macro-economic side of the 2008 crash The second chapterconsiders the rise in supply of non-conventional oil as a response to thepre-crash oil price hike It shows how the American shale boom wasdependent on the monetary environment created by quantitative easingand zero interest rates and all that has come with them, including theperversion offinancial markets since 2008 It also explains how US shaleproduction produced a counter action from conventional oil producers,and analyses how the consequences of this reaction, which included asharp fall in oil prices from the middle of 2014, have produced huge

monetary problems for central banks and destabilised the US relationshipwith Saudi Arabia The third chapter reconsiders these macro-economicand geo-political problems in light of the oil crises of the 1970s and arguesthat the underlying causes of these crises have returned over the pastdecade in a more lethal form Thefinal chapter draws some conclusionsabout the implications for western democracies and the presumption inwestern politics that time ultimately guarantees progress.

REFERENCES Blackwill, Robert D., and Meghan L O’Sullivan 2014 “America’s Energy Edge: The Geo-Political Consequences of the Shale Revolution ” Foreign Affairs 93: 102–114.

Blyth, Mark 2013 Austerity: The History of a Dangerous Idea Oxford: Oxford University Press.

Bromley, Simon 2008 American Power and the Prospects for International Order Cambridge: Polity Press.

Crouch, Colin 2011 The Strange Non-Death of Neo-Liberalism Cambridge: Polity Press.

DiMuzio, Tim 2012 “Capitalising a Future Unsustainable: Finance, Energy and the Fate of Market Civilisation.” Review of International Political Economy 19:

363 –388.

Gamble, Andrew 2014 Crisis Without End? The Unravelling of Western Prosperity Basingstoke: Palgrave Macmillan.

Gkanoutas-Leventis, Angelos, and Anastasia Nesvetailova 2015.

“Financialisation, Oil and the Great Recession.” Energy Policy 86: 891–890 Gordon, Robert J 2016 The Rise and Fall of American Growth: The US Standard

of Living Since the Civil War Princeton: Princeton University Press.

Hamilton, James D 1983 “Oil and the Macro-Economy Since World War II.” Journal of Political Economy 91: 228 –248.

Hamilton, James D 2009 “Causes and Consequences of the Oil Shock of 2007–

08 ” Brookings Papers on Economic Activity 1: 215–261.

Hay, Colin 2011 “Pathology Without Crisis? The Strange Demise of the Liberal Growth Model ” Government & Opposition 46: 1–31.

Anglo-IEA 2013 World Energy Outlook 2013 Paris: IEA.

Kaufmann, R K., and B Ullman 2009 “Oil Prices, Speculation and Fundamentals: Interpreting Causal Relations Among Spot and Futures Prices ” Energy Economics 31: 550–558.

Kilian, Lutz, and Robert J Vigfusson 2014 “The Role of Oil Price Shocks in Causing US Recessions ” Board of Governors of the Federal Reserve System International Finance Discussion Papers, 1114.

Kilian, Lutz, and Daniel P Murphy 2014 “The Role of Inventories and Speculative Trading in the Global Market for Crude Oil.” Journal of Applied Econometrics 29: 454 –478.

Mitchell, Timothy 2013 Carbon Democracy: Political Power in the Age of Oil London: Verso.

Morse, Edward L., and James Richard 2002 “The Battle for Energy Dominance ” Foreign Affairs 81: 16–31.

Streeck, Wolfgang 2014 Buying Time: The Delayed Crisis of Democratic Capitalism London: Verso.

Summers, Lawrence H 2016 “The Age of Secular Stagnation: What it is and What to Do About it ” Foreign Affairs 95: 2–9.

US EIA 2016a International Energy Statistics Accessed on 14 October 2016.

http://www.eia.gov/beta/international/data/browser/#/?ord=CR&cy= 2015&v=H&vo=0&so=0 ι0&start=1980&end=2015&vs=INTL.44-1-AFRC- QBTU.A~INTL.44-1-ASOC-QBTU.A~INTL.44-1-CSAM-QBTU.A~INTL 44-1-EURA-QBTU.A~INTL.44-1-EURO-QBTU.A~INTL.44-1-MIDE- QBTU.A~INTL.44-1-NOAM-QBTU.A~INTL.44-1-WORL-QBTU.A&s=

US EIA 2016b “Short-term Energy and Winter Fuel Outlooks.” https://www eia.gov/forecasts/steo/report/global_oil.cfm Accessed on 14 October 2016 Yergin, Daniel 1992 The Prize: The Epic Quest for Oil, Money and Power London: Free Press.

Yergin, Daniel 2012 The Quest: Energy, Security and the Remaking of the Modern World revised and updated London: Penguin.

The Spectres of Peak Conventional Oil

and Stag flation

Abstract From 2001 to mid-2008 the price of oil rose from around $25 abarrel to around $150 This escalation of oil prices reflected both newdemand in a world where the Chinese and Indian economies were enjoy-ing high levels of growth and the apparent stagnation of conventional oilproduction from 2005 The ensuing difficulties of high-cost oil wereexacerbated by the weakness of the dollar in a world in which the US inthefirst half of the decade had turned to China as a structural creditor and

by increased volatility in oil markets as those markets became increasinglysubject to speculative capitalflows The consequence of these pressureswas a cumulative set of macro-economic and geo-political difficulties forwestern states These macro-economic difficulties were central to therecessions that began in western economies in 2007–08 even whilst centralbanks focused as much attention on the inflationary pressure the oil pricerise created Meanwhile the geo-political difficulties left the US increas-ingly unable to exercise influence in the Middle East where the majority ofthe world’s conventional oil supply remained In this sense the 2008economic crisis was much more than a crisis generated by westernfinancialsectors It was also a crisis arising from the resource basis of westerneconomies

Keywords Oil
Conventional oil
China’s rise
The Middle East
2008crash
Conventional oil production

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Building a Sustainable Political Economy: SPERI Research & Policy,

DOI 10.1007/978-3-319-52509-9_2

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In December 2001 the price of oil stood at $26 a barrel.1 By May

2004 it had risen to $50, its highest inflation-adjusted level since theautumn of 1990 during the Gulf war In July 2005 it rose above $70,

in April 2006 above $80, in September 2007 above $90, and inNovember 2007 above $100 In June 2008 the price peaked at

$151 This escalation of oil prices reflected both new demand in aworld where the Chinese and Indian economies were enjoying highlevels of growth and the apparent stagnation from 2005 of conven-tional oil production The ensuing difficulties of high-cost oil wereexacerbated by the weakness of the dollar in a world in which the US

in the first half of the decade had turned to China as a structuralcreditor and by increased volatility in oil markets as those marketsbecame increasingly subject to speculative capital flows The conse-quence of these pressures was a cumulative set of macro-economicand geo-political difficulties for western states These macro-economicdifficulties were central to the recessions that began in western econo-mies in 2007–08 even whilst central banks focused as much attention

on the inflationary pressure the oil price rise created Meanwhile thegeo-political difficulties left the US increasingly unable to exercise

influence in the Middle East where the majority of the world’s ventional oil supply remained In this sense the 2008 economic crisiswas much more than a crisis generated by western financial sectors Itwas a crisis arising also from the resource basis of western economies

con-NEW DEMAND

Total world oil consumption began to grow in the middle of the 1990s In

1994, a year when all the G7 economies were growing and all of themexcept Japan at an annual rate of more than 2 per cent, oil consumptionstood at 69 million barrels per day (bpd) (World Bank2016) By 2003 ithad risen to 80 million bpd and by 2008 to 86 million (US EnergyInformation Administration (EIA)2016a) Indeed, in the period between

2002 and 2005 it increased twice the rate it had done over the previousfour years

Most of this increased demand for oil came from China and India.India’s consumption rose by 106 per cent between 1994 and 2008 whilstChina’s grew by 152 per cent Almost a third of China’s increase occurredbetween 2001 and 2006 In 2004 China consumed 859,000 more bpdthan it had done the previous year (US EIA2016a) During thefirst half

of the 1990s China also became dependent on world oil markets Prior to

1993 the Chinese economy produced more oil than it consumed but by

2004 domestic production represented only 48 per cent of consumption(US EIA2016a) The total volume of China’s oil imports rose more thanfivefold from 1992 to 2008, increasing 55 per cent between 2001 and

2004 alone (US EIA2016a)

The contribution of China and India to the overall rise in demand fromthe mid-1990s to 2008 can be seen by comparing these countries’ oilconsumption with that of the G7 economies during the period For Japanand Britain the peak consumption year was 1996, for Germany and Italy

1998, for France 2001, for the United States (US) 2005 and for Canada

2007 Indeed, annual oil consumption over this period fell by 10 per cent

or more in Germany, Italy, and Japan and marginally in Britain Only inCanada was there a significant rise in consumption of 32 per cent (US EIA

2016a) Put differently, of the increase of 17.9 million bpd in oil sumption that materialised between 1994 and 2008 only 960,000 of thetotal came from the G7 economies

con-This huge increase in China and India’s oil consumption was driven byhigh levels of economic growth The Chinese economy grew at an averagerate above 10 per cent between 1994 and 2008, and between 2003 and

2007 the overall size of the economy grew by around 60 per cent For itspart, India saw an average growth rate of 6.9 per cent between 1994 and

2008 and 8.9 per cent between 2003 and 2007 (World Bank 2016).Nonetheless, the relationship between China’s growth and energy con-sumption from the 1990s to 2008 was complex Unusually for a develop-ing country, the Chinese economy prior to 2000 grew at twice the rate ofenergy consumption Then from 2000 the rate of increase in Chineseenergy consumption began to outstrip growth This change was primarilythe product of sharp increases in electricity consumption and coal usage(Shealy and Dorian2007, 2–3) Yet oil was also beginning to play a part

In 2000 and then again in 2004 China’s annual oil consumption increased

at a more rapid rate than growth (World Bank 2016; US EIA2016a).Consequently, looking forward the rapid growth in Chinese demand foroil in the mid-2000s appeared to be only in its infancy

This demand-side shock to oil markets demarcated the price hike of

2002 to mid-2008 from those that had happened in 1973–74, 1979–80,

1990, and 1999–2000 Whilst the earlier episodes of high oil prices werefundamentally driven by supply side issues, this period of escalating oilcosts had causes clearly rooted in demand as well as supply Moreover, this

demand-side shock was structural and ongoing Without a growthcrisis in China or India, demand for oil would continue to grow.Confronted with this reality, the International Energy Agency (IEA)(2007, 42) calculated in 2007 that on conservative assumptions, inwhich Chinese average growth fell to around 5 per cent between 2015and 2030, world demand for oil in 2030 would be more than a thirdhigher than in 2006 In this‘Reference Scenario’ projection for 2030,China and India’s overall primary energy demand would more thandouble, transportation-led demand in China would rise nearly fourfold,China’s oil import dependency as a proportion of total consumptionwould rise to 80 per cent, and India would become the world’s thirdlargest importer of oil (IEA 2007, 44–46, 62) Put differently, by

2030 China and India’s oil imports would, according to the IEA, behigher than the combined imports of the US and Japan in 2007 (IEA

2007, 48)

Under these demand conditions high oil prices appeared to be ing a permanent reality unless there was a radical increase in supply.However fast prices rose, it seemed in the short term they could rise fasterstill In November 2007 the IEA (2007, 43) noted ‘recent highs of over

becom-$75 per barrel’, and projected a fall in prices ‘to around $60 (in year-2006dollars) by 2015’ on the basis of production and refining capacity risingmarginally faster than demand and then a slow recovery‘reaching $62 (or

$108 in nominal terms) by 2030’ In reality the nominal price took untilApril 2008 to reach $108, and the inflation adjusted one was over $140but two months later The explanation for the final upswing in pricesbefore the oil crash that began in July 2008 went beyond any immediatesurge in demand in China and India Yet one underlying problem wasclear If this rapid hike could happen before China and India’s oil demandescalated, then the oil market two-and-a-half decades hence appearedterrifying

SUPPLY STAGNATION

As demand for oil from China and India began to rise in the mid-1990s,supply initially rose Between 1994 and 2000 total supply grew from 68.6million bpd to 77.7 million Thereafter the increase in production sloweddown, even though demand was rising more rapidly in the mid-2000sthan in the 1990s Between 2002 and 2007 annual consumption out-stripped annual production in 2002, 2003, 2006 and 2007 Indeed, in

2007 production fell and the world’s economies consumed 1.7 millionbpd more than they produced (US EIA2016a).

The causes of this supply stagnation were in significant part geological

By the late 1990s two fundamental physical constraints on supply wereevident First, world oil discoveries had peaked in 1963 (Heinberg2005,114) Of the world’s 20 largest oil fields operating in 1999 the last to bediscovered were Azeri-Chirag-Gunashli in Azerbaijan in 1985, Priobskoye

in Russia in 1982 and Cantarell in Mexico in 1977 The remaining 17were found in a four-decade period between 1928 and 1968 (IEA2008,226) At the macro level, the annual discovery rate for most of the 1990swas no more than half what it had reached even in the middle of the 1980s(Crooks2015) This fall in the rate of discovery occurred despite the factthat the high prices of the 1970s and 1980s hadfinanced substantial newexploration (Campbell and Laherrère 1998, 81) As a consequence, theworld’s economies were consuming three times more oil each year by the1990s than was being discovered (Campbell and Laherrère 1998, 80).Second, by the turn of the century production on most of the world’sbiggestfields was either declining or would soon decline Of the top tenfields, seven had passed their peak by 1998 and of the next ten, a furtherseven were also on a downward slope of output These 20fields produced

a quarter of the world’s oil (IEA2008, 225)

The geological pessimism about future supply generated by thesestructural issues led to renewed interest in Marion King Hubbert’s(1956) analysis of the physical limits of oil production In 1956Hubbert had predicted that the production of crude oil in the USwould peak between 1966 and 1972 When American oil productiondid peak in 1970 Hubbert’s model of a bell-shaped production curveappeared vindicated In the late 1990s a number of geologists, themost influential of whom was Colin Campbell (2004; Campbell andLaherrère 1998; Aleklett and Campbell 2003) adapted Hubbert’smodel to world production This interest in Hubbert’s work led to aspate of commentary about impending peak oil (Deffeyes2003, 2005;Heinberg 2005; Simmons 2005) These peak oil analysts argued that

by the end of the first decade of the twenty-first century the supply ofconventional oil would begin to taper off, leaving supply short-fallsand very high prices

Certainly some analysts of the oil market responded to these claims withscepticism (Holland2008; Lynch2003; Yergin2012, 229–43) But bythe middle of the 2000s supply side issues and rising prices ensured that

there was plenty of discussion of peak oil arguments in the Americaneconomic media (Holland2008, 61) Moreover, these arguments increas-ingly resonated in western policy-making circles, especially in the US Forexample, Matthew Simmons (2005), the author of a book titledTwilight

in the Desert: The Coming Saudi Oil Shock and the World, had served as anenergy advisor to George W Bush during Bush’s first administration.Simmons told the American Association of Petroleum Geologists in June

2001 that ‘a simple check of the facts quickly reveals that almost everyscrap of spare energy [production] capacity around the globe is now eithergone or just about to disappear’ (Quoted in Heinberg2005, 110) In thesame spirit the US Department of Energy published a report at the start ofBush’s second administration, known as the Hirsch report, that began bystating that‘even on optimistic forecasts world oil peaking would occur inless than 25 years’, presenting ‘the US and the world with an unprece-dented risk management problem’ (Hirsch et al.2005, 13, 4)

Whatever the persuasiveness or not of the argument that oil productionwas reaching a geological peak, – and the claim would have beenmore accurately rendered as an approaching peak of conventional oil pro-duction– the anxiety generated in the West by the supply issues that werepalpably already in play by the late 1990s were compounded by a set of geo-political issues around the geography of oil production and its politicalreliability In the 1980s andfirst half of the 1990s total western oil produc-tion had risen, driven primarily by new supply capacity in Alaska and theNorth Sea But from the second half of the 1990s it began to fall Between

1990 and 1995 total oil production in the US, Canada, Britain and Norwayrose from 15.4 million bpd to 17.6 It then peaked in 1997 at 18.2 millionand had fallen to 17.7 million by 2000 (US EIA2016a) In the case of the

US, Alaskan production peaked as early as 1988 and by 2000 daily tion had fallen by 50 per cent from that height (Alaska Oil and GasConservation Commission 2015) As a result, half of American oil con-sumption by 1995 came from imports (US EIA2016a) In the North SeaNorwegian production peaked in 2001 and British production in 1996 By

produc-2008 Norwegian production was nearly one million bpd below its peak andBritish production two million Only in Canada did production in the Westcontinue to rise after 2001 through non-conventional production from thetar sands in Alberta In 2000 Canada produced 600,000 bpd of tar sandsoil, representing 22 per cent of Canada’s output By 2005 this productionhad risen to 1 million, constituting a third of Canada’s total output (IEA

2006, 92; US EIA2016a)

Looked at in terms of reserves, the supply picture was even less tious for western states In the estimates of reserves in 2000 made by theIEA (2001, 49–52), the US was the only western economy to feature inthe top ten countries and Canada did not appear in the top 20 because ofdoubts about the economic viability of extracting ultra-heavy oil and tarsands Indeed, the IEA reported, more than 50 per cent of proven reserveslay in Saudi Arabia, Russia, Iraq, and Iran (IEA2001, 49).

propi-Each of these non-western states either confronted political limits onproduction and/or posed political problems to the West as suppliers of oil.Through the 1990s the US had directly constrained oil production in two ofthe three Middle Eastern states by sanctions In the case of Iran, thefirstClinton administration and Congress had extended the sanctions put inplace after the 1979 revolution to include a ban on the involvement of anyAmericanfirms in the Iranian oil sector and a mechanism for action againstnon-US companies investing more than $20 million Consequently, whilstIranian oil production had increased from 2.3 million bpd in 1988 duringthe last year of the Iraq war to 3.7 million by 1995, production fell again inthe second half of the 1990s, standing at 3.6 million in 1999 (US EIA

2016a) In the case of Iraq, the Bush Sr administration had imposed tions prohibiting trade with the country after Iraq’s invasion of Kuwait.These sanctions largely destroyed Iraqi production in thefirst half of the1990s with output falling from around 3 million bpd a day in 1989 to600,000 in 1996 In the second half of the decade the United Nations(UN) authorised the Oil-for-Food programme, which allowed Iraq to selloil in exchange for food and medicine and to make reparation payments toKuwait Although this relief led to a sharp increase in production, by 2000production stood still below what it had been before thefirst year of sanc-tions at the end of the 1980s (US EIA2016a) Certainly, the US’ economicand political relationship with Saudi Arabia was an entirely different proposi-tion Economically and militarily, Saudi Arabia was an American and westernally Nonetheless, the direct influence of western states and oil companies onSaudi production was extremely limited As in Iran and Iraq, no foreigncompany was allowed to explore for, or develop, oil except as a sub-con-tractor or supplier of technical services to the state-run Saudi Aramco (IEA

sanc-2008, 335–36) Moreover, after the Bush Sr administration had expandedAmerican military bases in Saudi Arabia during the Gulf War therelationship between the House of Saud and the US had become abecome a potential source of political instability in the country capable

of generating guerrilla attacks on oil installations (Klare2005, 87–88)

Russia, for its part, posed a different kind of problem to the West Afterthe collapse of the Soviet Union, Russian oil production had fallen by 1.75million bpd between 1992 and 1998, a decline of 22 per cent (US EIA

2016a) During these years the old state-run oil sector was privatised andfive large energy companies materialised These firms became dominated

by the oligarchs who emerged out of the Russian economic and politicalcrises of the 1990s This structural transformation of the Russian oil sectorand an increasing openness of the Russian economy to foreign capital inthe middle of the 1990s appeared to offer the opportunity to westernstates and oil companies to cultivate an energy alliance with Russia.However, by the end of the decade hopes of co-operation with Russiaover oil were evaporating In part this was the result of a general deteriora-tion in US-Russian relations from 1999 produced by the expansion ofNATO to include Poland, Hungary and the Czech Republic, and NATO’sbombing of Serbia It was also though the product of Vladimir’s Putin’spolitical ascent in Moscow at a moment when the international oil marketwas changing in ways advantageous to Russia A near trebling of the price

of oil between December 1998 and November 2000 immediatelystrengthened the Russian economy after the nadir reached in the summer

of 1998 when Russia defaulted on its sovereign debt In this changedeconomic context Putin wrote an article in a publication issued by the StPetersburg Mining Institute arguing that Russia’s route to becoming a

‘great economic power’ ran through state control of the country’s vast oiland gas resources (Quoted in Yergin2012, 37) When Putin then assumedthe presidency in the last days of 1999, he did so with the clear aim of re-establishing the Russian state’s control over the energy sector to financethe repayment of foreign debt, facilitate economic growth and restoreRussian geo-political power (Balzer2005; Hill2004) This reconstructedRussia represented a new and acute geo-political problem for westernstates It had large reserves of both oil and gas, it retained much moresignificant military power than Iran or Iraq, and, unlike Saudi Arabiawhich bought large volumes of arms from Europe and the US, it wasnot dependent on the West in other spheres

The best hope for western states in the 1990s of new future supplies lay

in the Caspian Sea, in particular in Azerbaijan and Kazakhstan In thisrespect the demise of the Soviet Union had had extremely fortuitousconsequences for the West The large onshore fields in Baku inAzerbaijan had produced oil since the last decades of the nineteenthcentury and were in decline, but in the last years of the Soviet regime oil

engineers had discovered the vast Azeri-Chirag-Gunashli fields off theAzerbaijan coast They had also found large quantities of oil and begun

to develop production in Kazakhstan When Azerbaijan and Kazakhstandeclared independence in 1991 these apparently oil-rich states becamepotential western allies Securing future supply from this part of the world,however, was both physically and politically problematic The Caspian Sea

is land-locked and oil has to be transported across or under land to reachthe open sea Azerbaijan is then bordered around the sea by Iran to thesouth and Russia to the north, and Kazakhstan shares a long border withRussia

Whilst both the Kazakhstan and Azerbaijan governments encouragedinvestment from western oil companies, deciding on pipeline routes todeliver oil westwards proved a complex geo-political issue for most of the1990s In the case of Kazakhstan, the oil had to be transported throughRussia, which led to protracted negotiations over what became theCaspian Pipeline Consortium between western oil companies and theRussian and Kazakh governments that were not resolved until 1996 withthe first oil delivered to the Russian Black Sea port of Novorossiysk in

2001 To complicate matters further, the Kazakhstan government alsoreached an agreement with China in 1997 to build a pipeline to deliver oil

to Xinjiang Meanwhile early production through the AzerbaijanInternational Operating Company used two low-level pipelines to theBlack Sea, one that went through Russia and the other through Georgia.This, however, was not a long-term solution to the transportation pro-blem By the end of the 1990s, as production in the Azeri-Chirag-Gunashli fields was intensifying, the Clinton administration was deter-mined to reduce Russian influence in the southern Caucasus, and theshipping route out of the Black Sea through the Bosphorus was becomingincreasingly congested The most practical method for carrying theimpending large volume of Caspian oil would have been to construct apipeline through Iran to the Persian Gulf, but the Clinton administrationwas no more willing to strengthen Iranian influence in the region thanRussian Instead it eventually supported an extremely long and expensivepipeline from Baku to Ceyhan on the Turkish Mediterranean coast thatran through Georgia

Procuring oil via these new pipelines had potentially profound term geo-political consequences Securing access to the energy resources

long-of the Caspian Sea involved managing confrontational relations withRussia, Iran, and potentially China at the same time as increasing the

premium on economic and political support for the Turkish and Georgiangovernments From the point of view of the US, this requirement exposedthe fundamental geographical vulnerability it faced in a world in whichmost of the world’s energy resources were becoming concentrated on theEurasian land mass and its waters To secure this oil, the US had to ensurethat the most powerful Eurasian states did not ally with each other against

it (Heinberg2005, 215) Meanwhile the notion that the western mies shared ongoing energy interests was weakening As supply side con-straints tightened, there were now considerable incentives for someEuropean states, including France, Germany and Britain, to cultivate orstrengthen energy alliances with one of the large Eurasian producer stateseven when the US had hostile relations

econo-By the turn of the century this growing clash of interests within theWest was increasingly evident in the internal politics of American andEuropean relations with all of Russia, Iraq and Iran In the case ofRussia, a number of European economies, including Germany, werenow become dependent on Russian oil and gas, leaving their governmentsless willing to antagonise Moscow than American Presidents In the case ofIraq, the French government in particular became a vocal critical of thesanctions regime It moved to re-open its embassy in Baghdad and allowedFrench oil companies to sign contracts in Iraq that would come into effectonce the sanctions regime was terminated (Malone 2007, 123) Mostdramatically, in the case of Iran, the EU reacted furiously to the provisions

of the 1996 Iran-Libya Sanctions Act that allowed the US to imposesanctions on any foreign company investing more than $20 million inthe Iranian oil sector In 1997 the French company Total reached anagreement for a $2 billion investment in the South Pars gasfield in Iran

in partnership with the Russian energy company Gazprom without regardfor American concerns Illustrating the underlying tension between theperception of American and European energy interests Total’s chairmandeclared that‘[US sanctions] would have only very minor consequencesfor Total It is more important for an oil company to be in the MiddleEast than the US’ (Quoted in Clawson1998) Showing the US’s growingweakness on energy matters in internal western relations, the Clintonadministration ultimately did nothing to retaliate against Total after the

EU threatened to take the US to the World Trade Organisation over theIran-Libya Sanctions Act (Patterson2013)

In this changing and difficult geo-political environment, the Bush Jradministration appeared from the onset to conceive of oil supply as an

urgent strategic problem In his second week in office Bush set up anEnergy Task Force This group was chaired by vice-President Dick Cheneyand included the Secretary of State, Colin Powell, the Treasury Secretary,the secretaries of Energy, Commerce, the Interior, Transportation andAgriculture, and a number of Bush’s personal advisers The group’sreport, known as the Cheney report, was published in May 2001 andbegan by stating that the US faced an‘energy crisis’ in which there was

a‘fundamental imbalance’ between supply and demand that threatenedthe American economy and the country’s national security (White House

2001, viii) In regard to oil, the Cheney report argued that the tration needed to encourage investment in the oil sector in the westernhemisphere in Latin America, to advance non-conventional production inthe US, to precipitate drilling in the Alaska National Wildlife Refuge, toreview the unilateral US and United Nations’ sanctions regimes in theMiddle East, to support initiatives to open up energy sectors in the MiddleEast to foreign investment, and to deepen US relations with the CaspianSea states (White House2001, appendix 1)

adminis-In the short term the most consequential of these recommendationswere the ones pertaining to US policy towards the Middle Eastern statesunder sanctions regimes Of these only in Libya was the Bush administra-tion willing to end sanctions and do so without regime change The UNSecurity Council lifted sanctions on the country in September 2003 afterthe Libyan government accepted responsibility for the Lockerbie bombingand set up a compensation fund The Bush administration then restoreddiplomatic ties with Tripoli and ended US sanctions in 2004, with thefirstshipment of Libyan crude arriving in the US in the same year (IEA2007,435) In the case of Iraq, the Bush Jr administration’s decision to removeSaddam Hussein from power in Baghdad by military force could perhaps

be seen as a significant policy manifestation of the Cheney report Whether

in fact the invasion of Iraq was in whole or in part motivated by tions of oil is not easy to resolve as a historical question But certainly theBush administration’s move to an active policy of regime change securedthe immediate end Cheney’s task force desired when in May 2003 the UNwithdrew most of its sanctions against Iraq By contrast, the Bush Jradministration proved less able to act on Iran In this case it ruled outregime change Indeed, it appeared for a short time to wish to improverelations with the aim in time of lessening the sanction regime depending

considera-on Iran’s approach to the acquisition of nuclear capability From the onset,however, it faced domestic and external difficulties in achieving that end

When in 2001 Congress reconsidered the Iran-Libya Sanctions Act, thefive-year legal term of which expired in August 2001, Bush was defeated inhis desire to limit renewal to two years (Katzman2003, 4) Then after 9/

11 Bush’s policy towards Iran became subsumed with terrorism, leadingthe President to deem Iran part of the‘axis of evil’ in his 2002 State of theUnion address

Ultimately, for all the aspiration of the Cheney report, the Bush Jradministration’s energy strategy did little to increase the supply of oil overthe first eight years of the twenty-first century In the Middle East,production stagnated by the middle of the decade Whilst production inthe region increased by 4.5 million bpd between 2002 and 2005, it fell inboth 2006 and 2007 In Iraq, the Bush administration’s attempt tochange the conditions of supply by regime change led only to Iraqproducing around 500,000 bpd fewer in 2007 than it had between

1999 and 2001 under the Oil-For-Food sanctions regime (US EIA

2016a) Whilst the end of sanctions in Libya did lead to increased tion, the increase in Libyan supply between 2003 and 2008 of around390,000 bpd was insufficient to compensate what was lost from Iraq (USEIA2016a)

produc-In Saudi Arabia and Kuwait the Bush Jr administration was unable toopen up the countries’ oil sectors to foreign investment, and productivecapacity on ageingfields ultimately proved unresponsive to rising demand(IEA2008, 337) Most strikingly, Saudi production fell from 11.5 millionbpd in 2005 to 10.7 million bpd in 2007 (US EIA2016a) In significantpart this fall was a product of difficulties at the Ghawar field, the world’slargest oilfield that in the early 2000s accounted for a quarter of total oiloutput in the Middle East (IEA 2003, 160) Annual production atGhawar peaked in 1980 and between 1997 and 2007 production fell byaround 200,000 bpd (IEA 2008, 237) Oil in Ghawar is extracted bypumping sea-water into the reservoir, leaving part of the outflow as water,

a problem exacerbated by surge production to meet shortages (IEA2003,160) Geological analysts estimated that by 2004 around half the outflowfrom thefield was water, leaving the supply of oil from the field droppingeach year whilst production costs were rising sharply (Gerth 2004;Kunstler2005, 78)

By 2008 the volume of Saudi oil production was also more than apractical question of the capacity of ageingfields Since the early 1980sthe Saudi government had been largely willing to act through OPEC tokeep the price of oil in a range acceptable to Washington But as the 2000s

wore on US-Saudi relations deteriorated in the cumulative aftermath of 9/

11 and the Iraq war, and the Saudi government proved much less biddable

on production levels As the oil price approached $50 in May 2004, theSaudi government did, under pressure from the Bush Jr administration,try to persuade OPEC to increase production, and then having failed tosecure any collective agreement unilaterally pumped an additional twomillion bpd (Ottaway 2009, 125) Thereafter, the Saudi governmentwas much less willing to accommodate American price concerns Indeed,

in the face of the trajectory of rising prices in the middle of the decadeOPEC announced production cuts in November 2006 and February 2007(IEA2007, 75) When prices rose above $100 a barrel in early 2008, theBush Jr administration renewed pressure for increased production toreduce prices In response the Saudi government eschewed any attempt

to persuade OPEC to act in the cartel’s meetings in February and March

2008 The next month King Abdullah announced that he had orderedsome new oil discoveries in the kingdom to be‘le[ft] in the ground’ forthe wealth of future generations (Reuters2008a; IEA2008, 327).Beyond the Middle East the politics of supply from other larger OPECproducers by the second half of the 2000s was even more problematic.Nigerian production rose from 2.1 million bpd in 2002 to 2.6 million in

2005 only to slump back to 2.1 million by 2008 as the country becameembroiled in violent sectional conflict in which militias in the Niger Deltaregion attacked oil facilities, destroying infrastructure and kidnapping andkilling workers (US EIA2016a) Meanwhile in Venezuela production alsodeclined, falling by 25 per cent from 2000 to 2003 Between December

2002 and February 2003 a strike at the state oil company, Petróleos deVenezuela (PDVSA), called by the opposition to try to force PresidentChavez from power reduced production to around 200,000 bpd com-pared to the 3 million pumped in 2001 After the strike ended PresidentChavez removed almost half the work force of PDVSA and diverted capitalearmarked for investment to social programmes Although productionrecovered in 2004 from its nadir in 2003, it then fell 6.5 per cent between

2005 and 2007, leaving output 800,000 bpd lower than the volumereached in 1997 (US EIA2016a)

Caspian Sea production also proved something of a disappointment By

2008 Kazakhstan and Azerbaijan were together producing only one sixth

of Middle Eastern output (US EIA 2016a) Moreover, the Kashaganoffshore oil field in Kazakhstan that had been discovered in 2000, andrepresented the largest oil discovery since the 1960s, was mired in

practical, political andfinancial difficulties These problems ensured thatlow-level production would not begin until 2013 and then only after acontinuously changing international consortium had invested $40 billion

in development (US EIA2013)

Only Russian supply soared in the decade leading up to 2008, ing by 64 per cent (US EIA2016a) In terms of aggregate supply, thisresurgence of Russia as an oil producer was certainly a partial check on therising price of oil between 2002 and mid-2008 Nonetheless, it also had asignificant geo-political fallout for the West First, and foremost rising oiland gas revenues allowed Putin to make Russia financially independentfrom the International Monetary Fund and consequently to act morefreely from the US in international politics Second, Russia was able touse discriminatory oil and gas prices as an instrument of its foreign policytowards a number of former Soviet states Third, in responding to Putin’sreassertion of Russian power, the western states divided between thosewho were significant importers of Russian oil and gas and those that werenot Although US imports of Russian oil did rise through the 2000s theywere insignificant in relation to the US’s oil needs, representing in 2008only 1.5 per cent of oil imports (US EIA 2016a; US EIA 2016b) Bycontrast, a number of EU states, led by France and Germany, importedrelatively large amounts of Russian oil at a time when the supply of oilelsewhere was stagnant With imports representing 98 per cent of con-sumption in each case, around one third of Germany’s crude oil importsand one sixth of France’s in 2008 came from Russia (IEA 2012a, 6–7,

increas-2012b, 5) Unsurprisingly in this context, American policy towards Russiadiverged from French and German After a short period of co-operationafter 9/11 the US’ relations with Russia deteriorated again over theinvasion of Iraq, the entry of the three Baltic states into NATO, recogni-tion of Kosovo, events in Ukraine, the US military bases in Kyrgyzstan andUzbekistan, the American plan for an anti-ballistic missile defence base inPoland, and Russian military action in Georgia (Sestanovich2008; Simes

2007) By contrast, the French and German governments were muchless willing to allow confrontational relations to develop with Moscow.Most dramatically, the two European governments vetoed Georgianand Ukrainian membership of NATO at the NATO summit in April

2008 with the then French Prime Minister, François Fillon, declaringthat entry for two states was not‘the correct response to the balance ofpower in Europe, and between Europe and Russia’ (Quoted in SpiegelInternational2008)

In this context of simultaneously stagnant production in the MiddleEast, where American influence had proved ineffective, and risingproduction in Russia from where no American President could con-template import dependency, the viability of non-conventional produc-tion from shale, tar sands and extra-heavy oil became increasinglyimportant The IEA (2008, 215–17) estimated in 2008 that therewere between 1 and 2 trillion barrels of recoverable tar sands andextra-heavy oil in the world, most of which was located in Canadaand Venezuela, and around 1 trillion barrels of recoverable shale, 60per cent of which was in the US In the case of all non-conventionaloil the costs of production were, and still remain, significantly higherthan conventional oil In this respect the rising price of oil from 2002

to 2008 was extremely advantageous Yet by 2008 there was littleevidence of any positive effect of high prices on the non-conventionalsectors outside Canada At the aggregate level the IEA (2008, 251)reported in 2008 that non-conventional oil production, excludingVenezuelan extra-heavy production, stood at 1.6 million bpd, repre-senting only 2 per cent of total production Of this production around1.2 million bpd came from the tar sands of Alberta (CanadianAssociation of Petroleum Producers 2015)

In an example of what was becoming the growing dysfunctionality

of oil markets the very price rises that made non-conventional tionfinancially viable in the first instance were also indicative of one ofthe problems the whole oil sector faced during these years Between

produc-2003 and the first half of 2008 the costs of the construction ofproduction facilities, oil equipment and services, and energy soared ingood part in response to the overall commodity boomed produced byChina’s economic rise IEA (2008: 304) Consequently, whilst futureoil supply was becoming ever more dependent on large-scale capitalinvestment both to extract more from decliningfields and to open uphigh-cost non-conventional production, the capital available was alsorequired by 2008 simply to cover rising existing costs (IEA2008, 320)

In sum, by thefirst half of 2008 the prospects for the supply of oil wereunpropitious, especially given rising demand from China and India.Indeed, in November 2008, four months after the price had begun itstemporary crash, the IEA (2008, 37) warned that the world energy systemwas at a ‘crossroads’ where ‘current global trends in energy supply andconsumption are patently unsustainable’ Without huge flows of capitalinto the sector, not least to make non-conventional oil production

financially viable, there was, the IEA continued, ‘a real risk of an oil-supplycrunch in the medium term’ For the western states, the risk of a such acrisis was made worse by the number of conventional oil producing statesthat either were less stable than they had been at the start of the decade, orwith whom the western states, and in particular the US, had worse rela-tions than they had at the start of the decade.

DOLLAR WEAKNESS AND FINANCIALISATION

The problems created by the supply and demand dynamics in the yearsleading up to 2008 were exacerbated by oil’s relationship to the dollar asthe premier currency of the international monetary order and the growingfinancialisation of oil as a commodity Both dynamics reinforced the pricetrajectory of oil and the volatility of oil markets Whilst the consequences

of oil’s emergence as a financial asset and, in particular, the tighteningcorrelation between the dollar and oil would become more significantfrom 2009, the underlying capacity for further dysfunctionality for wes-tern economies from the concurrent problems generated by oil wasalready in evidence by 2008

Since the 1970s the dollar and oil prices have generally had an inverserelationship in that a falling dollar usually corresponds with higher oilprices and a rising dollar with falling oil prices, the clear exceptions tothis correlation being the early and late 1980s (IMF 2008, 48) Theprecise causal mechanisms of this relationship are not entirely clear(Verleger2008, 46) Most obviously, given that oil sales are transacted

in dollars, when the value of the dollar declines oil producers lose ing power from their earnings unless they simultaneously push up theprice by restricting supply Meanwhile when oil producers recycle theirearnings into dollar-denominated financial assets a falling dollar willreduce the domestic currency value of those investments In the case ofthe oil price hike from 2002 to mid-2008 there was for all but thefirst year

purchas-of the rise a clear correspondence between the oil price and the dollar’schanging value Having risen from March 2000 to February 2003, thedollar was in near continuous decline from March 2003 to July 2008,falling around 20 per cent, of which half the fall in value occurred betweenJanuary 2007 and June 2008 when the oil price climbed most rapidly(Macro trends2016b) In March 2008 oil hit a then record high and thedollar a record low against a number of currencies (IMF2008, 48) Boththe dollar and oil then dramatically changed direction at exactly the same

time in July 2008, with the dollar beginning a sharp rise that lasted untilMarch 2009 when oil prices began a resurgence.

Meanwhile in the decade leading up to the 2008 crisis oil became anincreasinglyfinancialised commodity Whilst there was some financialisation

of oil markets in the 1970s, this phenomenon intensified in the 1990s whenGoldman Sachs created a commodity-basedfinancial asset based on futurescontracts (Gkanoutas-Leventis and Nesvetailova 2015, 893) Between

1998 and 2006 the notional value of outstanding over-the-counter modity derivatives, which represented around 90 per cent of all oil deriva-tives, increased around 14 fold (Domanski and Heath2007, 53)

com-In thefirst instance it would seem reasonable to suppose that large andgrowing flows of funds into oil markets would in themselves produce arising oil price (Domanski and Heath2007, 61) But evidence of a specificimpact of thefinancialisation of oil on the price hike between 2002 and

2008 is inconclusive Some scholars have concluded from empirical lysis of the specific chronology of the oil price hike between 2002 andmid-2008 that the latter part of it, in particular the period from late 2007

ana-to July 2008, was the product of a speculativefinancial bubble that, aswould be expected with any bubble, suddenly collapsed (Khan 2009;Gkanoutas-Leventis and Nesvetailova2015; Davidson 2008) But othershave been more sceptical, arguing that theflow of investment capital intothe oil markets from late 2008 added at most a littlefire to the primarycauses of the price rise generated by the supply and demand dynamics(Hamilton2009; Kilian and Murphy2014) Indeed, the absence in 2007and 2008 of either any significant difference between the spot and futureprices for oil or an increase in US oil inventories– the number of oil barrelsheld byfirms – may well suggest that oil speculation contributed little ifanything to the price hike in this particular period (Hamilton2009, 232,

236–37) Nonetheless, the surge in financial activity in oil markets duringthe 2000s undoubtedly added volatility to oil markets It also cruciallycreated the clear potential for a speculative bubble to develop around oil at

a time when the dynamics of supply and demand were already puttingunprecedented pressure on the price (Kaufmann and Ullman 2009).Whether speculation partially drove thefinal climb of oil in 2008 or not,oil markets by this time had become systemically vulnerable to capitalsurges andflight as events would soon show In this sense the problemsoil was creating for western economies ran even deeper than the supplyand demand dynamics that reached their initial culmination in 2008 Oilmarkets could be separated neither from the fate of the dollar

nor international capital flows Consequently, they had the capacity todestabilisefinancial markets and the dollar-based international monetaryorder.

THE SPECTRE OF STAGFLATION

Sharp rises in oil prices inherently create difficulties for macro-economicpolicy since the price elasticity of demand for oil is low This reality poses aparticular problem in monetary policy, not least when central banks havelegal remits focused on achieving price stability Oil price rises directly add

to household and business costs and can create second-round inflationaryeffects including on wages, none of which rule-based central banks aresupposed to ignore Meanwhile price rises also depress overall demand ineconomies by reducing the income available for non-oil consumption andinvestment, which accentuates the consequences of any monetary tighten-ing as a response to the oil-generated inflationary pressure Consequently,

it was extremely predictable that the oil price hike from 2002 to mid-2008would cause western central banks considerable difficulty, although thesedifficulties received rather little political attention at the time outsidemonetary policy-making circles

2004–05Thefirst evidence of the impact of rising oil prices on monetary decision-making by western central banks came in the US In May 2004 WTI crudereached $50, surpassing the peak reached in November 2000 of $47 Thenext month the Federal Reserve Board (FRB) raised interest rates by 0.25per cent This was the first time the Federal Open Market Committee(FOMC) of the Fed had raised rates since May 2000 Strikingly, theFOMC was keen to downplay the significance of the increase in oil prices,noting that it expected the inflationary effect of the rise to be ‘transitory’and to‘wane’ Nonetheless, citing ‘solid gains in output and employmentalong with indications of some increase in inflation’, the FOMC votedunanimously to act and take the ‘first step in the process of removingpolicy accommodation’ (FRB2004a) Over the next nine months the Fedraised interest rates a further six times Throughout this time, a tensionbetween the Fed’s stated optimism that the increase in oil prices wastemporary and its policy of monetary tightening was evident For example,

in November 2004, after oil had risen to $66 a barrel, the Committee put

the further price increase down to damage from hurricane-related damage

to oil infrastructure in the Gulf of Mexico and projected a‘flattening out

of oil prices’ (FRB2004b)

The Fed’s concerns about oil-generated inflationary pressure escalatedfrom January 2005 After oil prices briefly fell in late 2004, they rosesteadily again, reaching around $68 barrel by June 2005 Faced with thisrenewed price hike the FRB became significantly warier about the futuredirection of oil price than it had hitherto been, noting in May 2005 that

‘these higher prices may persist for some time’ (FRB2005a) Meanwhile

by mid-2005 growth was weakening and consumer confidence ing Indeed, the FOMC noted that the decline in consumer confidencewas most likely a consequence of the increase in energy prices (FRB

diminish-2005a) As it concluded, ‘increases in energy prices seemed to be animportant factor contributing [both] to an uptick in core inflation and aslower pace of economic activity.’ Strikingly, in deciding upon the balance

of policy in the face of this upward risk to inflation and downward risk togrowth, the FOMC prioritised inflation, arguing that the present rate

‘remained too low to be consistent with sustainable growth and stableprices in the long run’ (FRB 2005a) In the second half of 2005 the

inflationary picture deteriorated further with the oil price hitting $78 inAugust and remaining over $70 for the rest of the year At its Septembermeeting the FOMC began to express concern that the rise in oil pricescould lead to a rise in overall inflationary expectations and tightenedmonetary policy again, noting that‘further rate increases probably [will]

be required’ (FRB2005b)

Rising oil prices in the summer of 2005 extended these growingmonetary concerns beyond the US In Britain the Bank of England(BoE) had raised rates twice– in November 2003 and February 2004 –before the Fed began its monetary tightening In thefirst case the Bank’sMonetary Policy Committee (MPC) had cited the impact of rising con-sumption growth, household borrowing and housing activity on inflation(BoE2003, paras 27–28) and the second ‘domestic inflationary pressure’and the‘unexpected resilience of household consumption’ (BoE2004a,19) for its action Although oil rose from $26 in January 2002 to $44 inFebruary 2004, the rise did not appear to be on the Bank’s radar Indeed,

in February 2004, with the price beginning another hike towards $66eight months later, the Bank judged the probability of another $10 rise inthe price at less than 1 in 50 (BoE 2005a, 23) In August 2004, twomonths after the FRB made its first interest rate increase, the Bank of

England did raise the base rate, but again without particularly dwelling inits deliberations on the impact of oil on the inflationary outlook Indeed,the MPC argued that ‘if oil prices remained at their current levels, thedirect consequences for activity, income and retail prices in the UnitedKingdom (UK) would probably not be great, given relatively low UKreliance on oil imports, the prevalence of less oil-intensive productionmethods than two decades ago and the large tax wedge between crudeoil prices and retail petrol prices’ (BoE2004b, para 10).

However, by the autumn of 2005, the Bank had become clearly dividedabout what to do about the ongoing oil price rise At the meeting of theMPC in August 2005 the issue was an obvious concern After a 20 percent increase in oil prices in the three months preceding the meeting, theConsumer Price Index (CPI) inflation rate stood above the 2 per centtarget Yet at the same time the Committee noted that domestic demandwas‘sluggish’ and output growth ‘subdued’ (BoE2005b, 6) Five mem-bers voted at this meeting to reduce interest rates to boost confidence(BoE 2005b, 9) Four members, including the Governor and the twoDeputy Governors, voted against, worrying, among other things, thatwith ‘oil prices likely to remain strong it was too early to concludethat inflationary pressures had abated’ (BoE 2005b, 9) This split ofopinion represented the first time a Governor had been outvoted in aninterest rate decision (Daneshkhu2005)

The Bank’s loosening of monetary policy in August 2005 stood in directcontrast to the stance of the Fed and left the Governor of the Bank, MervynKing, unhappy at the direction of travel Whilst there is no evidence Kingsought to reverse the cut at the next MPC meeting, the minutes of theSeptember meeting were markedly hawkish about inflation and focusedquite directly on oil prices Now the MPC warned that given rising demandfrom China and supply side constraints oil prices‘could remain high forsome while and might even rise further in the near term, present[ing] adilemma for monetary policy’, first and foremost in keeping ‘inflationexpectations well-anchored’ (BoE2005c, 2) There were, the MPC con-tinued, now two options: either accommodate the‘first-round impact ofhigher oil prices’ and allow inflation to rise ‘temporarily’ and only respondwith monetary tightening if there were ‘second-round’ consequences inwage settlements; or immediately increase interest rates and accept theconsequences for growth and employment (BoE2005c, 3)

Soon after the September meeting, King made clear his preference forthefirst option The next month he gave a speech in which he argued that

the rising price of oil was ending what he termed‘NICE’ – a period of

‘non-inflationary consistently expansionary economic growth’ that began

in 1992 (King2005, 2) In this new environment, King continued, higherprices meant real disposable incomes were rising more slowly and thegrowth of supply side capacity would decrease leaving inflation and output

‘more volatile’ than in the recent past (King2005, 3–4) In these stances, he argued, it was an illusion to think that the Bank could usemonetary policy to deliver quarter-by-quarter growth or even stability,especially when the Bank’s only deliverable responsibility was to set mone-tary policy to control inflation (King2005, 6) In the same spirit he told theHouse of Lords Select Committee on Economic Affairs in December 2005that over the previous 12 months the British economy had experienced a

circum-‘supply shock’ that had both weakened demand and raised inflation (House

of Lords2005, Evidence, 2) Once again he suggested that in these ged conditions people had to be disabused of prevailing ideas about whatmonetary policy could achieve (House of Lords2005, Evidence 3).For all King’s concern the Bank in practice did little With the CPIindex falling below the 2 per cent target in November 2005 the MPC keptinterest rates steady until August 2006, by which time the oil price hadreached $85 and CPI inflation had been above the target for threemonths In part this stasis was the consequence of the absence of sec-ond-round effects on wages It might in part also have been a product ofthe apparent weakness of King’s position within the MPC Yet even inKing’s own terms there was a sense within the MPC’s deliberations thatthefirst-round inflationary problem would in part take care of itself Whilstoil prices rose, the MPC argued, growth would be constrained, whichwould then through falling demand for oil subdue the price In this sensethe Bank continued to make significantly erroneous projections about oilprices even after King had deemed them responsible for the end of NICE.Although the Bank’s Inflation Reports regularly added caveats about thedegree of uncertainty ahead around oil prices, it is clear from the MPCminutes that the MPC took its decisions from the summer of 2005 onthe optimistic forecasts and not its musings on the unpredictability ofenergy costs

chan-For its part the European Central Bank (ECB) also eschewed followingthe Fed’s early lead, leaving rates unchanged from June 2003 toNovember 2005 Like King, the President of the ECB, Jean-ClaudeTrichet, expressed concern in late 2004 about rising oil prices, warningthat the price hike was a‘sizeable adverse shock to the euro area economy’

and that as a result inflation was ‘likely to remain significantly above 3 percent in the coming months’ (ECB2004) Again, the stated rationale fornot acting in response was the absence of immediate evidence of secondround effects on wages The ECB, Trichet said, would though insist to alleconomic agents that it would not‘let secondary effects materialise’ (ECB

2004) In September 2005 Trichet again said that although inflationremained above 2 per cent the ECB saw no‘significant evidence of under-lying domestic inflationary pressures building up in the euro area’ (ECB

2005a) He did though say that the ECB believed that higher oil priceswere depressing growth and that‘risks to the economic growth projec-tions continue to lie on the downside, and relate to higher oil prices, lowconsumer confidence and concerns about global imbalances’ (ECB

2005a) Even when three months later the ECBfinally changed course,increasing rates by 0.25 per cent on the basis that the immediate risk to

inflation from higher oil prices outweighed the risk to growth, Trichet waskeen in his press conference to stress that the ECB did not see this rise asthe beginning of a series of interest rate increases (ECB2005b)

In sum, by the middle of the decade oil posed a significant economic problem Western central banks tried both to respond to theproblem in their policy decisions and public pronouncements and to down-play it In part their caution reflected what appears to have been a genuinehope that each particularly sharp rise in the price over a period of a fewmonths was temporary and a new plateau would emerge But they were alsoconscious that the more they drew attention in their decision-making towhat was happening to oil prices and other commodity prices the more theyfuelled inflationary expectations and risked the second-round consequences

macro-of the price rise that they were focusing their attention on preventing Thisstrategy, however, was not without negative consequences In keepingpolicy tilted on balance towards growth, the Bank of England and theECB in particular effectively asked households to maintain consumptionunder conditions of at best stagnant disposable incomes through increasedhousehold borrowing that would invariably become problematic whenthese central banks did turn monetary policy towards the inflationary risk

2006–08Through 2006 and 2007 the dual pressure of oil on both inflation andgrowth mounted As it did the Fed openly struggled with the dilemma ofwhich risk to prioritise In June 2006 the Fed raised interest rates for the