VHeadline.com petroleum industry commentarist Andrew McKillop writes: The US economy attained it highest-ever postwar growth of real GDP, achieving what today would be the completely unthinkable rate of 7.5%, in the Reagan re-election year of 1984. At the time, in dollars of 2003 corrected for inflation and purchasing power parity, the oil price range for daily traded volume crudes was $57-$65/barrel.

Apart from regime change in the Middle-East, which is not producing an oil bonanza in Iraq, there is little avail and remedy on the supply side, to force down oil prices. This leaves 'demand destruction', through economic destruction by the interest rate weapon. The last time this was done, in 1980-83, the impact was surely to reduce oil prices (in today's dollars from $100/barrel in late 1979 to around $60/barrel in 1984), but the collateral economic damage was awesome. In addition, the world economy, and especially the OECD economy started from a position of growth, with balanced budgets, in 1979-80. The world economy could and did take the horse medicine of sky-high interest rates without imploding into a sequence like that of 1929-31, after which no way out from endless recession was possible...

Things are very different in 2003!

While oil prices even well above $60/barrel would do little to harm the world economy, any attempt at raising interest rates to double digit levels in the OECD countries would most surely have fast and devastating impacts. Extreme interest rates, today, would certainly entrain complete collapse of world stock market indices, runaway 'domino effect' bankruptcy of many major corporations, mass layoffs and unemployment, and grave problems for the financing of structural trade and budget deficits of especially the US and UK, now burdened with a 'non performing oil colony.'

The currently weakening US dollar, subjected to 'benign neglect' in its unequal struggle with the Euro, could perhaps suffer uncontrollable flight and fall to below €0.75. The declining petro-money status of the UK£ would unlikely shield the UK economy from somber sequels arising out of the interest rate weapon.

All European Union countries, and Japan would also face severe national budget financing difficulties, as tax revenues collapsed and spending to limit economic damage, including unemployment compensation, spiraled up as the crisis deepened. Financing of increased state spending through borrowing would then lock on the upward spiral in interest rates, the higher cost of borrowing itself intensifying recession and increasing the inflation itself due to constantly falling economic growth.

The bottom line would very likely be runaway, deflationary economic recession. Current near-zero economic growth in the OECD countries would be replaced by something akin to the 1929-31, or like the 1980-82 sequence of economic slump, but this time with no way out.

For a number of reasons, underpinned in final analysis by the approach of the ultimate peak in world oil production, oil prices are on an erratic, but upward trend since their 1998 most recent low (around $10/barrel).

Also, the interest rate weapon for reducing oil prices through entraining a so-called 'soft landing' or controlled fall in economic activity and leading to a fall in oil demand, at this time, is out of the question. Raising base rates to perhaps 10% or 15%/year, in 2003, and even if this was after a major bourse crash -- classically in October -- would be simple suicide. Thus the much-commented 'very high price of oil' that has held, off and on since 2000, of about $30/barrel or about one-half the real oil price in 1984, will likely be tolerated and accepted by economic and monetary deciders for the simple reason they have no other choice.

Authorized, that is fit-to-print finance and business commentators can console themselves, and any readers or listeners who believe their usually sloppy, even wild 'analyses' that oil from Liberated Iraq, like some mythic White Knight, is shaping up on the horizon of perhaps 2007-08 and will 'inundate' world oil markets.

Prices, in the mythic future, will maybe fall to $15-a-barrel, but in the present and real world trends are not shaping that way. In the mythic future, the New Iraq might produce 9 million barrels/day (Mbd) and export 8.4 Mbd, but at present and probably for the next 12 months it exports next to nothing.

World demand, in spite of near recession in the OECD and with the SARS epidemic now well contained and most unlikely to 'reduce Asian demand by 0.5 Mbd in 2003', is around 78 Mbd and growing at an annual rate at least 1.6 Mbd.

The special case of the US natural gas market, now exposed to a wealth of disinformation seeking to hide the essential fact of depletion, the simple fact that the US is 'drilled out', is a harbinger and outrider of natural gas markets in Europe, and the world.

Supply will have increasingly to switch to LNG from exotic locations, at prices that will be exotic relative to those of the Cheap Energy Interval that underpinned ... even enabled ... the now long dead Clinton Boom of 1992-2000. Inside national markets, led by the USA, fuel switching away from expensive gas to cheaper oil will, by 'contagion effect' ratchet up the oil price.

Real world oil prices are relatively firm inside a perspective and price outlook that is at best opaque, but OPEC, under any scenario, will most certainly play a growing role. In the war of communiqués between OPEC (understating both production and demand), and the big consumer nation economic and energy agencies like IEA and EIA (overstating demand, and especially production to incite 'de-solidarization' among OPEC countries) the game-plan uses a supposed 'ideal price range of $22-$28/barrel'. This has already been surpassed, but no new 'target price range' is emerging.

Conversely, each time the Euro gains against the US dollar, oil exporters lose buying power. An open shift to the Euro by more members of the cartel, but no doubt without Saudi Arabia in the very near term, will by the magical irony of the oil market translate to considerably higher prices. Under almost no possible scenario can we return to oil at $18/barrel (or about €15.50).

Oil price crashes can spark stock exchange routs Through 1986, from December 1985 through August 1986, oil prices were nearly divided by three, that is fell by about 65% in 8 months, to a low of around $11.50/barrel in dollars of 1986, for many light blends.

Expressed in dollars of 2003 the price fall was from a year peak of about $52-per-barrel to around $19.50/bbl. Absolutely no spontaneous, self-reinforcing and of course non-inflationary increment to economic growth was recorded in any OECD country. The energy economic myth concerning oil prices, that 'high prices hurt economic growth', which has little or no truth, also has no logical corollary in 'lowered prices favor growth.'

Conversely, unrestricted double-digit growth of stock market 'value', without corresponding growth in the real economy certainly has strong impacts. While the 1986 oil price crash was a non event in economic growth terms, exactly as the fall in prices after Desert Storm in 1991, unrealistic growth of stock market indices in 1986-87 were fuelled and comforted by the oil price crash (or 'Anti Shock').

• Both in bourse mythology and in fact any long bull market always has its Dark Twin waiting, and this took the shape of the October 1987 US, and then world stock market crash.

Bourses experienced their largest one-week falls in index numbers since the 1929 Wall street crash. Stock market capitalization losses in 1987, that is loss of nominal or paper 'value' were estimated at around $ 2,400 billion in today's dollars. This amount of 'lost value' was well exceeded by nominal losses of around $ 6,500 billion in today's dollars from the slow motion crash that occurred on world stock exchanges through 2000-2002.

It is however very unlikely that regular grade finance and business analysts can understand that any oil price falls, now, may in fact destroy the last line of defense for the world economy, right on the brink of a runaway deflation spiral, with a classic October (2003) bourse crash to give it the royal send off it merits.

Deflation in nearly all OECD economies, recession openly admitted in some, and a weakening dollar with the real US economy weakening (and not its fantasy twin reflected by the DJ index), all create a perspective of vintage bourse meltdown never being so plausible or possible.

While the flimsy rationale for 'growth fed by cheap oil' never translated to reality in the past ... and will not in the present, an oil price crash at this time could enable or accelerate not a treble-dip recession, but a non reversible collapse of world bourse indices, followed by a real economy collapse.

There are no easy alternatives: It is possible to attribute the extreme, that is highest-ever one-year growth of the US economy in 1984 as due to equally extreme budget deficits operated by the Reagan administration with the aim of securing Reagan's re-election.

Such desire can easily be attributed to the current Bush administration or regime (elected on a minority basis), but conditions for financing yet further increase of already spiraling US budget deficits are distinctly different, and less permissive and feasible than those of the Reagan era.

Conversely, oil price rises to levels close to those of 1984 are probably inevitable. They therefore should not be thought of as assuring an economic apocalypse, and meriting resistance by extreme measures.

• Higher oil prices in fact might save the US and world economy from almost unlimited rout.

In the present context of very low real oil prices ... comfortably 50% below their level of 20 years ago in real terms ... and lowered levels of consumer confidence in OECD countries due to fears of job losses, terrorism, climate change and other worries in what are essentially consumption saturated economies, there are few possible strategies for restoring conventional economic growth.

Lower interest rates at this time, and apart from symbolic playacting with quarter-point cuts, can be discarded as any kind of rational, or even possible strategy for the simple reason that US, European and Japanese base rates are at historic lows.

Most OECD countries, in 2003, have their lowest, or close to their lowest nominal (but not real) interest rates for 50 years!

Further cuts in US interest rates, notably, will most surely increase the slowly but surely building movement away from the dollar, turning it to a classic flight.

Even the recent fall in US dollar purchasing power against other moneys will aggravate US trade deficits; conversely, increased trade deficits due to higher oil prices may well be limited if confidence in the dollar can be maintained.

Only economic growth in the US economy, in final analysis, can underpin the US$.

Higher oil prices restore world economic growth: Higher oil prices operate to stimulate first the world economy, outside the OECD countries, and then lead to increased growth inside the OECD. This is through the income or revenue effect on oil exporter countries, then metals, minerals and agrocommodity exporter countries, many of them Low Income (GNP per capita below $400/year).

Almost all of these countries have very high marginal propensity to consume. That is any increase in revenues, due to prices of their export products increasing in line with the oil price, is very rapidly spent, mainly on purchase of manufactured goods of all kinds.

In the 1973-81 period, in which oil price rises before inflation were of 405%, the New Industrial Countries of that period ... notably Taiwan, South Korea and Singapore ... experienced very large and rapid increases in demand for their exports. These three countries increased their oil imports, through the 1973-81 period and despite the 405% price rise, by 50% to 80% in volume terms.

This demand 'elasticity', and above all the macroeconomic mechanism of higher revenues for poorer countries quickly increasing world economic growth (the very simplest type of Keynesianism, but at the global level) requires an explanation by excited analysts and 'experts' who tell us that higher oil prices 'hurt poorer countries the most'. They go on to inform, or warn the 'greedy' oil producer countries that they also will be 'hurt' by the inevitable recession that higher oil prices must inevitably cause. According to the fact-free doctrine of these well-paid 'experts', that is.

Concerning the myth, or propaganda that 'high oil prices hurt poorer nations' we can note that through 1975-82, when oil prices in today's dollars were never at any time below $40/barrel, and achieved a peak of $100/bbl, the number of Low Income countries unable to repay sovereign loans, and therefore forced to accept structural adjustment as a condition for financing by the IMF, was almost zero.

From 1986=2002 the number of Low Income countries (LICs), mostly in Africa, that have experienced so-called 'structural adjustment' and then collapsed into civil and ethnic war, has never ceased to rise. Probably 7-10 million persons have died through the direct or indirect effects of 'structural adjustment' through 1986-1999, the Cheap Oil interval, mostly in Africa but also in Latin America.

Today's New Industrial countries (NICs) include China, India, Pakistan and Brazil ... all have either big or immense internal or domestic markets, and large potentials for military Keynesian spending, that is reinforcing domestic economic growth through deficit financing of modernization and expansion of their military systems, using labor-intensive projects securing rapid growth of employment.

The relative lack of integration of these behemoth economies in the world system, particularly India and Pakistan, provides them with some cover or shelter from the effects of world recession, when or if the current, continuous but slow degradation of economic performance in OECD countries tilts to all-out recession.

Conversely, whenever any increase in world solvent demand for manufactured goods occurs, these countries will rapidly increase output.

China is without question the world's leading industrial power for medium- and low-value consumer manufactured goods. Under almost any hypothesis, therefore, fossil energy demand ... particularly oil ... will increase in China and India, and in the other large population NICs in the short run at rates close to their rate of economic growth.

World oil demand pressure, tending to increase prices, will therefore be maintained.

Demand pull and supply pinch: According to many analysts, there are increasing reasons to believe that maximum possible world oil production increases through the 2003-2008 period may be no more than 1.5% per year on average, bringing maximum possible world oil production to perhaps 83 million barrels/day from today's 78 Mbd.

World oil demand increases through 1990-2000 averaged out at a total of about 1.7% per year. Current and recent growth trends are considerably higher than 2% annual. This situation, logically, should entrain very large or nearly unlimited increases of oil prices, perhaps after a delay of several years, and with or without various military adventures in Iraq or elsewhere, and whatever is done with 'strategic' petroleum reserves, the constitution of which will require increased demand.

Taking current world regional per capita oil consumption rates, and economic output per barrel or barrel equivalent of commercial energy, the effectively price elastic OECD North, and price inelastic NICs and LICs can be compared and contrasted. That is, relatively large and rapid falls in oil demand in the OECD North, and increasing demand in the NICs and LICs can be expected whenever oil prices break through the current, artificially low range of no more than $30-$35/bbl in 2003 dollars.

Energy choices and energy transition: It is in no way obligatory that fossil energy intensive infrastructures and development, with harmful environment impacts, should be the automatic norm. LICs, from a base of low energy infrastructures, 'extract' considerably more economic wealth per barrel of oil or equivalent of commercial energy than either OECD countries or the NICs.

By conserving this energy-economic advantage, and addressing their real needs rather than that of the so-called Global Market, these countries will be in a stronger position than the OECD North to face the coming era of energy penury. Their very low per capita consumption of commercial energy ... entire continental oil demand of Africa is about 3 Million barrels/day or less than a third of either EU-15 or US oil imports - in fact indicates that LICs will, should or could increase their oil consumption for some time.

Conversely, in the OECD North and particularly the USA, oil price rises to $60-$70/barrel will firstly provide the 'wake up call' not only for their stagnant economies, but for needed restructuring of the economic system and cultural values.

• Apart from hand-wringing and tub-thumping, and of course military adventures, there will be little margin of action and few options open to political and economic decision makers.

As noted above the 'interest rate weapon' at this time is more than a double-edged sword; cranking interest rates to double-digit levels will almost certainly bring about another 1929 crash and Great Depression.

However, within about 12 months from what will certainly be called an Oil Shock, increased solvent world demand will trickle up to the OECD North, in the form of increased demand for higher value manufactured goods and sophisticated services supplied by the industrialized countries.

Maintained higher levels of world oil and energy prices, and prices for energy-intensive metals, minerals and plantation agro-commodities will then operate to enable and facilitate the long-delayed, but inevitable structural changes of firstly OECD North economies, and restructuring of their social and cultural value systems.

These of course include fundamental change of habitat and transportation systems towards more collective and energy efficient modes and methods for satisfying real human needs, de-urbanization, and entirely different agriculture and land use systems. Maintained, and then increasing fossil energy prices will supply much-needed market signals to the self-styled 'market conscious' decision making elites of the rich countries ... energy systems, by necessity and by urgency will shift to energy conservation and renewable-based approaches.

Conclusions

For various economic doctrinal and mythical 'reasons' Cheap Oil is seen by the decision-making elite in the richer nations as the 'passport to economic growth'. This is a pure fantasy.

Cheap oil necessarily reduces the price, and value of real resources relative to services, information and the ritual forms of 'wealth' created and maintained in the old, and aging democracies, whose urban industrial lifestyle is now the reference format and framework for economic development and social progress anyplace in the world.

Physical depletion is either rejected or ignored as a price setting factor for any good or service in the economic doctrine and mythmaking apparatus of the so-called First World. Because of this, various 'shocks' are entirely necessary and inevitable as increasing demand presses on finite resource bases.

In the case of conventional or classic economic growth, this will be enabled and facilitated at the world or 'composite' level by rising oil prices up to and probably above $70/barrel in today's dollars.

Also because of depletion, but in addition because of environment and terrestrial limits, energy transition away from fossil fuels must and will happen. Price signals, in the existing economic system and framework, are needed if this is to start, and to build from the immediate near term.

Andrew McKillop  is a former expert, policy and programming, Divn A - Policy, DG XVII-Energy, European Commission, founder member, Asian Chapter, Intl Assocn of Energy Economists. You may contact Mr. McKillop by email at andrewmckillop@onetel.net.uk