Getting ready for $200/barrel oil

By Robert Presser on September 4, 2008

Perhaps it seems foolish to suggest that oil will head to $200 US in the wake of a $4 per barrel decline in the price of oil (to $110) on Monday, since Hurricane Gustav caused less damage than expected to offshore oil rigs in the Gulf of Mexico. However, if we look at demand for oil from a long term perspective, $200 per barrel is more of a certainty than conjecture for the following reason; in the long run, demand will certainly outstrip supply as China and India ramp up their industrial development.

In his 2006 book, “The Coming Economic Collapse” Dr. Stephen Leeb argues that as the world depletes deposits of light sweet or intermediate crude, replacement fields will either be of lesser quality, requiring greater expense for extraction, will not have the proven reserves of current fields, or both. A supply gap will emerge that will not subside through reduced consumption by the developed world which will push the barrel past the $200 mark. Considering that we saw oil approach $150 a barrel in mid-July, it would not be hard to imagine that an international crisis in the Middle East, or a serious interruption of supply due to a natural disaster could cause oil to surpass its recent highs. What Dr. Leeb is concerned about is the virtual certainty that oil will sustain prices at the $200 level without the effects of natural or political disasters due to the classic effects of not enough supply and too much demand.

What happens to Canada if the world actually sees $200 oil? Could you imagine the Canadian Dollar at $1.50 US? This is not as far fetched a prediction as you may think. Since the fall of 2002, the Canadian dollar (as expressed in USD) has done a remarkable job of tracking the rise in price of a barrel of light sweet crude.

This relationship weakened somewhat in 2008 as the Bank of Canada tried to “talk down” the Canadian Dollar and stopped increasing interest rates, in the face of a manufacturing recession in Ontario and sluggish manufacturing performance in Quebec.

Should international oil demand outstrip supply on a sustained basis, the US, along with many others in the developed and developing world, will beat their way to Canada’s Tar Sands as a source of supply and will have to trade their currencies for $CAD as a result. Central Canadian manufacturing will face job implosion; given the rapidity of the rise in the dollar there will be little time to adjust.

We already witnessed the outcry from Canadian manufacturers when the dollar briefly touched $1.10 in the fall of 2007. There would be little that the Bank of Canada could do to mitigate the situation—cutting interest rates to zero is not an option, given that inflation would be rampant in the Canadian West and even in the Maritimes as workers scrambled for accommodation and the oil firms for equipment.

Central Canada could face a mass migration to the east and west         as dispossessed factory          workers headed to where opportunity lies. The financial community could decamp from Toronto and head to Calgary, Edmonton or even Regina (!) since that’s where the money would be. Equalization payments to Ontario could hit $10 billion or more a year. It would be the greatest reorganization of people and wealth even seen in an industrialized nation.

Is there any way to avoid this economic calamity? I fear not – since China and India are not attempting to reduce their oil consumption. Actually, China is securing long term sources of supply by investing in promising fields in Africa and seeking better relationships with oil-producing nations like Venezuela.

Even if a new US President wholeheartedly embraces alternative energy and invests hundreds of billions in solar, wind, nuclear, clean coal and natural gas, it will take 10 years at least to see the results. In the meantime, any reductions in US (or Canadian, or European) consumption would be gobbled up by the developing world.

Unless we can convince China and India to invest in partnership with developed-world governments in the quest for alternative energy, we will see $200 per barrel oil at some point in the next decade. As consumers, investors and workers we must all consider how we may be impacted by this upcoming economic catharsis and develop personal financial and career plans to live through it. 

It will create tremendous riches for some Canadians and completely destroy the lives of others. Dr. Leeb sincerely hopes that world leaders will avert this crisis and make a fool of him and his prediction; but he fears that our inability to change our ways fast enough will make $200 oil a virtual certainty. 

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