Strategy blog: Oil again

Kevin Gardiner, Global Investment Strategist

Could the world manage without 10% of its oil output?

Yes: we already did. To do it again would be costly, but possible. Global oil production was roughly a tenth lower a decade ago.   

Global GDP (in real terms) was of course also lower then, by roughly a quarter. But GDP would not need to fall that far, because much of its growth since will have reflected rising productivity, a shift towards other energy sources, and an ongoing move towards less energy-intensive economic activity.

In 2020, and in very round numbers, a peak-to-trough decline in oil output of around 15% was associated with a fall in GDP of 'only' around 9%, but this was lower economic activity causing oil production to fall, rather than the other way around.   

Needless to say, the adjustment would nonetheless be massively disruptive. To compress oil demand by a tenth would require a huge relative price increase, and a much bigger hit to consumer incomes than we've seen to date.  

The reason for posing the question of course is that Western public opinion is being galvanised by the attack on Ukraine. Direct military involvement is still unthinkable, but Russian oil and gas supplies are being shunned in global markets. Now the US seems poised to announce a ban on Russian oil imports, and Europe may yet be willing to shoulder the economic pain that would come with a more formal embargo (or Russia's decision to curtail supply, should it decide to act first).   

In the event, the actual shortfall would be smaller than Russia's 10% share (roughly) of the global oil market (its share of the gas market is higher, but that doesn't change the point). Russian supply would not be completely lost to the world, not least because Russian demand would not be. Some buyers would continue to buy from Russia, whatever the West does. Other oil-producing countries would increase output and partially fill the gap. US shale output would revive. Stockpiles would be run down. Longer-term, the ending of the oil age would be accelerated.

A shortfall of (say) 5% would be serious, but not so wildly outside the range of 'normal' experience. The economic damage would still be big, and some mechanism for compensating those countries and consumers hit hardest might be needed. We guess that the hit to global GDP might be of the order of 3%. Markets would be (more) volatile.    

Then again, 3% is just one year's normal economic growth.