Contraction and Convergence

As Oil Peak is reached, we can expect an increase oil price volatitlity. As Robert L. Hirsch, Roger Bezdek and Robert Wendling write in “Peaking of World Oil Production, Impacts, Mitigation and Risk Management”, their February 2005 report to the US Department of Energy:

Oil prices have traditionally been volatile. Causes include political events, weather, labour strikes, infrastructure problems, and fears of terrorism. In an era where supply was adequate to meet demand and where there was excess production capacity in OPEC, those effects were relatively short-lived. However, as world oil peaking is approached, excess production capacity by definition will disappear, so that even minor supply disruptions will cause increased price volatility as traders, speculators, and other market participants react to supply/demand events. Simultaneously, oil storage inventories are likely to decrease, further eroding security of supply, aggravating price volatility, and further stimulating speculation.

While it is recognised that high oil prices will have adverse effects, the effects of increased price volatility may not be sufficiently appreciated. Higher oil price volatility can lead to reduction in investment in other parts of the economy, leading in turn to a long-term reduction in supply of various goods, higher prices, and further reduced macroeconomic activity. Increasing volatility has the potential to increase both economic disruption and transaction costs for both consumers and producers, adding to inflation and reducing economic growth rates.

The most relevant experience was during the 1970s and early 1980s, when oil prices increased roughly six-fold and oil price volatility was aggravated. Those reactions have often been dismissed as a “panic response,” but that experience may nevertheless be a good indicator of the oil price volatility to be expected when demand exceeds supply after oil peaking.

The factors that cause oil price escalation and volatility could be further exacerbated by terrorism. For example, in the summer of 2004, it was estimated that the threat of terrorism had added a premium of 25 - 33 percent to the price of a barrel of oil. As world oil peaking is approached, it is not difficult to imagine that the terrorism premium could increase even more.

In conclusion, oil peaking will not only lead to higher oil prices but also to increased oil price volatility. In the process, oil could become the price setter in the broader energy market, in which case other energy prices could well become increasingly volatile and unpredictable.

In the Fair Shares scenario, the governements have learnt the lessons from the 1972 and 1979 oil price shocks when the oil producing countries were quite unable to spend the huge amounts of money they received and loaned it back to the western banking system. But no-one in the rich countries wanted to borrow it because the high oil prices had caused a recession. It was borrowed instead by a lot of poor countries and led to the debt crisis which has blighted those countries since.

Accordingly, the risk that the vicious cycle discussed in Localisation will establish itself plus the dangers of volatility will lead the oil-and-gas buying countries to establish a buyers' cartel to negotiate with the producers' cartel, OPEC, and with other major producing countries such as Russia. The two sides agree a fair price for whatever amount of oil is produced each year and also for a fixed amount of gas, and the buyers' cartel then allocate those fuels among its member countries.

In a particularly farsighted move, the cartel also negotiate a similar fixed-price-for-a-fixed-quantity deal with coal producers for climate change reasons. This would be intended to head off the danger that, as oil and gas supplies decline, the world economy will turn to coal as its main replacement energy source. This would be disastrous for the world’s climate because greenhouse gas emissions per unit of delivered energy from coal are very much greater than from the other two fuels. So coal use has to be restricted if climate change is to slow and including coal in the oil-and-gas buyers' cartel provides a convenient mechanism for bringing that about.

The cartel distributes oil, coal and gas using the leading proposal for an international framework to limit climate change. This is Contraction and Convergence (C&C), a surprisingly flexible plan advanced over the past ten years by the Global Commons Institute in London.

C&C holds that everyone has an equal claim to be able to use the atmosphere as a dump for his or her greenhouse gas emissions. Consequently, the cartel calculates the total amount of greenhouse gases that could be released into the atmosphere without causing catastrophic climate change. This amount is then shared out among the people of the world on an equal per capita basis. The cartel supplies each person with an individual ration coupon which entitles them to release a certain amount of greenhouse gas that quarter or that year. In other words, everyone gets a permit entitling them to burn whatever amount of fossil fuels would result in the release of a certain weight of gas. They would not, of course, be entitled to the fuel itself.

Each year, the amount of gas they were permitted to release - and consequently the amount of fossil fuel they can burn if they wished to buy it and can afford to do so - falls until the atmospheric concentration of greenhouse gases is no longer rising and humanity was consequently no longer causing the planet to warm.

The details of the system are as follows

1. All countries would supply the cartel with projections of their potential fossil fuel production whether for internal use or for export. The cartel would compare these figures with the level of emissions that would not cause damaging climate change and issue buying orders to the producers accordingly. The higher prices set in the price negotiations would compensate the producers for any loss of output.

2. Permits entitling the bearer to a share of the emissions from whatever quantity of fossil fuel the world was going to produce that year would be distributed by the cartel to everyone on the planet on an equal per capita basis although certain temporary inequalities might have to be permitted to secure the participation of powerful countries. The permits would go to people, not to their governments, because the right to emit is a personal entitlement.

3. On receiving their permits, the recipients would normally sell them straight away to a bank or post office, just as if they were a foreign currency. The permits could not be hoarded as their validity would lapse after, perhaps, a year.

4. Companies distributing oil, coal and gas, or requiring these fuels for, say, electricity generation or to make their products, would need to buy enough permits to cover the emissions from the amount of fuel they wanted from the financial intermediaries which had bought them from the original recipients. The companies would then pay over to the coal mine, or to the oil producer, the purchase price agreed by the cartel plus the necessary number of emissions permits.

5. In return for their contracts, the oil, gas and coal producers would undertake not to sell to anyone who did not hand over the right number of the cartel’s emissions permits at the time of purchase.

6. The cartel would maintain a corps of inspectors to ensure that the oil, gas and coal producers:

• did not exceed the agreed output,
• sold their goods at the agreed price, and
• insisted on getting the required number of permits for each purchase.

The inspectors would check the permits just as if they were banknotes and, having reconciled the number with the output figure, send them away for destruction. While the total price anyone wishing to buy fossil fuel might have to pay could be just as high under this system as it might be in an unregulated market, the effect would be quite different because the money paid for the emissions permits would go, not as a not-immediately-spendable windfall profit to the energy producers, but to individuals in poorer parts of the world who would spend it immediately. Their demand for goods from the richer countries would soar. So, although the higher energy prices would cause consumer demand in wealthier countries to fall, export orders from the poorer countries would increase to compensate. The higher fossil energy prices which are needed to encourage energy efficiency and the switch to renewable energy sources, would not cause a depression. Instead, they would preserve employment in the richer countries and bring prosperity to the poorer ones.