The G8 finance ministers met in Japan last weekend, where they confirmed what we have been saying for some time: "Elevated commodity prices, especially of oil and food, pose a serious challenge to stable growth worldwide, have serious implications for the most vulnerable, and may increase global inflationary pressures." Forget about credit problems, housing, and the financial sector. Oil and other commodities are the big crisis now.
It seems clear that if oil were to rise much higher than $150 a barrel, its impact on the world economy would be severe. Probably, growth would short-circuit.
On the other hand, if oil prices fell back under $100 (as most drivers currently pray), everyone might breathe a sign of relief. But that relief would be short-lived.
Cheap oil now would only discourage new oil projects from coming online. It would put serious alternative energy development on hold. In the long run, energy would become even scarcer and more expensive.
Petrobras, as you should know by now, is a Brazilian oil producer. In fact, it is the fastest growing major oil producer in the world, and the 2nd largest after Exxon Mobil, in terms of market capitalization.
Petrobras made headlines in recent months when it announced potential production of tens of billions of barrels of oil from deposits located five miles under the ocean, and under a further mile or so of heavy salt that constitutes the ocean floor. Wall Street analysts were less optimistic. Some suggested Petrobras would be lucky to extract one billion barrels of oil. Bringing this oil to the surface represents an enormous challenge from an engineering and geological standpoint.
Even if the company is lucky enough to pump two billion barrels of oil, oil prices would have to be above $120 before Petrobras could cover its costs. Add a fair profit to that, and oil prices would probably need to be closer to $200.
Developers of this sort of project face a clear dilemma. If oil were to fall back to near $100 and remain there, deposits like this would not be profitable and will not be developed. The world would then be in greater danger from growing oil shortages.
On the other hand, if oil prices rose to $240, another set of risks takes over. When Petrobras' estimated it would cost a quarter trillion dollars to develop this oil field, it assumed oil prices would be closer to where they are today. But what everyone forgets is that oil prices add to the cost of producing all commodities. Oil at $240 would drive Petrobras' costs for materials and energy considerably higher, possibly making this project unaffordable.
Let's hope oil prices decline a little from their current heights in the mid $130s -- perhaps to $110 or $120 -- and stay there for a while. We would be less troubled by dreams of an immanent economic disaster.
At the same time, we don't want oil to remain stable so long that the world becomes even more complacent about the energy squeeze. Even at today's high prices, people aren't nearly worried enough about oil.
Much has been made over the fact that Americans have cut back a little on gasoline consumption. Sure, some people are driving less due to high gas prices, but not most people. What's more, while oil consumption is down year-over-year, so is supply. And, unfortunately, supply has fallen faster than demand. So we are less secure, rather than more. Besides, conservation alone will not ultimately solve the energy problem. It will take strong leadership and a vast amount of research and investment to do that.