Oil's New Rules: Sovereign Producers Change The Game

I read last week's Wall Street Journal article on the changing nature of oil supply and demand with great interest, and I am sure I am not alone in that regard.

The picture painted by the piece is quite dark. America experiencing both the loss of substantial, easily-accessible quantities of oil, while also remaining a major consumer of oil, though by no means now necessarily the only large one. Add to this the knowledge that several other major consumers, India and China, are also paying up for access to, or ownership of, oil reserves, and the picture gets almost totally black.

Or does it?

Back in the 1960s and before, the era with which the article contrasts the present situation, the phrase "global economy" had nowhere near the same meaning it does today. Without repeating a lot of economic history which can be found elsewhere, suffice to say that the world's major economies are far, far more intertwined today than they were even 30 years ago, let alone 40+ years ago.

I suspect this matters in the case of oil supply and demand. Oil is an industrial input, as well as a consumer good. Suppose China gained ownership of most of the oil reserves needed to slake its thirst, to the exclusion of America. What then? Would not the corresponding slowdown in US industrial production and consumer consumption boomerang right back onto the very China which had caused the shortage? And would this not ratchet down their own economic activity level, wealth, standards of living, etc?

When the Saudis had that kind of power, all they would lose was money they didn't really need to spend. The Saudi economy didn't so much depend upon selling non-energy goods to the Americans, as the Indian and Chinese economies currently do. Now, the Saudis want to develop energy-related industries, but here, too, it's not clear they will benefit from this in the long term. The Chinese and Indians are different. If their exploitation of the ownership of oil reserves gets too draconian, the global economy will come crashing down on everyone's head, not just the the victim countries who don't own sufficient oil reserves.

Furthermore, those countries paying for long term oil supplies at nearly $70/bbl are now locked into those energy costs. So are their petrochemicals, and other goods and services downstream which require the oil feedstock or refined petroleum. Doesn't that mean that, if oil were to decline just to, say, $60/bbl, those countries are now at a $70/60 price disadvantage? Are not the sectors of their economies which used oil all going to be overpriced, relative to those countries acquiring supply on the spot or more near term forward markets?

How is locking in oil reserves at a high price different from: S&L's locking in deposits with high long term rates on the liabilities, or; insurance companies locking in investment product customers with unsustainable rates on GIC (guaranteed investment contracts), or; utilities securing long term natural gas supplies at historically high prices? Haven't we seen each of these three scenarios wreck a sector or some companies in the US sometime in the last 30 years?

If so, why shouldn't China and India meet similar fates if their recent acquisition of oil supplies prove to be at historically unsustainably high prices?

I may be wrong, and the US may truly be on the economic skids, thanks simply to its dependence on oil which it does not own nor to which it is not buying access. But something about the interlocking nature of the current global economy leads me to suspect that the end game is not as simple as the WSJ article makes it out to be.

For everyone's welfare, let's hope I'm onto something, and that the article's author overlooked some key differences between the 1960s' and today's global economy.