BREAKINGVIEWS-Latest oil crisis readies hammer for demand curve

By Robert Cyran

NEW YORK, March 18 (Reuters Breakingviews) - It took two Middle East oil shocks for the world to really focus on energy efficiency. The result was a multi-decade, steady reduction in the amount required to produce a certain amount of wealth. If the region's latest crisis persists, it will accelerate the trend into a new gear.

Before 1973, crude held, in real terms, at less than $30 a barrel. The price was so cheap that consumers couldn't get enough. It replaced dirty coal for heating, catalyzed automaking and inspired scientists to develop new chemicals.

An oil embargo by OPEC members against the United States after the 1973 Arab-Israeli War caused the price per barrel to nearly quadruple, even though accompanying production cuts were only about 9% of total supply, according to the Center on Global Energy Policy at Columbia University. A few years later, the Iranian Revolution knocked out 7% of the world’s supply, leading prices to double.

Economies, naturally, reacted. Shoppers were more discerning and the quest for alternative energy sources intensified. The result has been a steady increase in efficiency, as laid out in the paper, “Oil Intensity: The curious relationship between oil and GDP.” Some 53 years ago, it took about a barrel of oil to support $1,000 of GDP, but now the same economic output comes from less than half as much. The world kept using more oil, as wealth was growing faster.

U.S. petrol demand exemplifies the story. It grew in tandem with GDP expansion until the 1970s, then detached as cars converted fuel into energy more effectively. Sustained improvements meant gasoline consumption plateaued at around 9 million barrels per day, despite the growing population.

A third crisis is now in the making. Prices are manageable, with $100 oil about half the inflation-adjusted 2008 rate. The sheer volume being cut off from consumers, however, invites further increases. Around 20% of crude, and petroleum liquids, or some 20 million barrels, flow through the Strait of Hormuz. Even if half finds its way to market, the percentage decrease in supply will be larger than the shocks in 1973 and 1979. Fallout from U.S. and Israeli attacks on Iran also affects about 20% of worldwide LNG exports, a nascent market in the 1970s.

Demand doesn't swing much in the short run. People need to keep driving to work, heating their homes and shipping goods by truck. Average folks also don’t buy oil by the barrel or cryogenically store natural gas. What they care about is end products. The mix varies by country, but about 43% of U.S. crude and related liquids are turned into gasoline. Another fifth goes into diesel and heating oil while much of the remainder becomes everyday items like clothes, soap, furniture and paint. They will all cost more, further squeezing shoppers still feeling the pinch from recent bouts of inflation.

Texas tells the tale. It's the heart of the U.S. energy industry, but heating oil off its own coast costs 50% more than a few weeks ago. Gasoline has jumped 75%. Prices for other goods heavily exported from the Middle East Gulf, like LNG and nitrogen-based fertilizers, also will spike. Because everyone from farmers to homeowners depends on such products, higher prices will spread across the planet.

Companies like Exxon Mobil and Chevron will reap supernormal profit now, but others stand to gain later. Chinese battery manufacturer CATL, solar panel maker JinkoSolar and EV producer BYD are among the potentially big beneficiaries.

Over the long run, high prices will weigh heavily on the demand curve. In 2007, the cost of Brent roughly doubled from January to December. Daily desire increased just 1.1% from the previous year, compared to 3.5% in 2003 when a barrel cost less than half as much, according to the Statistical Review of World Energy. While usage increased slowly in developing nations, consumption in rich countries fell. The higher that oil prices go and the longer they last, the more downward pressure on demand they'll exert.

The reasons are fairly straightforward. People don’t buy cars often, but consistently higher petrol prices make a smaller, more fuel-efficient one more attractive. This is also the first Middle East oil crisis since power generated by the sun, wind and batteries became cheap and widely available. Oil consumption in developed countries has been essentially stagnant. Sales of electric cars, heat pumps and solar panels should accelerate. Still, the United States only spent about 6% of GDP on energy last year compared to 13% in 1979.

More pronounced are changes for developing nations, where fossil fuel use keeps rising. Brazil, Russia, India and China consume more than 40% of the world's energy, and far less efficiently than the international average, according to Enerdata. Ecologically conscientious goods have boomed in recent years as prices fall, making the overall cost cheaper than those powered by fossil fuels. Spiking oil and gas costs in such countries makes the decision to switch even easier.

Solar installations are already growing rapidly in poorer countries. Electric-car sales from Indonesia to Uruguay are rocketing as well, and far outpace U.S. adoption. In India, sales of electric induction stoves have jumped, as people worry about access to cooking gas. Automaker VinFast is offering discounts to persuade owners of gasoline-powered cars to switch to its electric ones at home in Vietnam, as well as in India and Indonesia.

Governments will also adapt. Countries like China, Vietnam and Thailand will be hit hardest, according to the World Bank, because their economies are tethered to energy-intensive manufacturing, while others lean on either services or agriculture. Asia is also a big importer. About 80% of Qatari liquefied natural gas, for example, is sold into the continent. The situation in Iran can only motivate policy that weans from fossil fuels.

Pakistan is racing to do so. It has deployed solar quickly, going from a negligible amount of electricity generation to about 25%. The country’s power minister told Reuters he would double down on green power rather than risk energy security. Ethiopia, too, became the first country to ban petrol-powered cars to save money on subsidies and avoid pressure that imports put on foreign currency reserves. Sales of cheap EVs are now booming, providing a playbook for others to follow.

These sorts of choices have long-lasting effects, and are most likely to be embraced where much of the world's economic growth sits. Much the way emerging markets leapfrogged to mobile phone networks because they were cheaper and faster to install than landlines, those countries may see similar incentives related to oil and gas in a classic case of demand destruction.

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