The IEA cites the loss of 1.5 million barrels of Libyan production but that’s been going on since February. So why has it taken until July for them to respond?

Some will see the IEA’s move as a much needed slap in the face to OPEC price hawks such as Iran and Venezuela, which stymied a recent agreement to raise production quotas. But when have production quotas ever stopped OPEC producers from pumping more oil when they were so inclined?

Perhaps it is a vote of non–confidence in Saudi Arabia’s ability to ramp up production to its new 10 million barrel per day target.  But who in the IEA really believes Saudi Arabia could sustain that level anyway?  It hasn’t happened since the early 1970s. As I pointed out several weeks ago, the only country capable of producing oil at that rate is Russia, and it’s already doing it.

Still others will point to the use of the strategic reserves as nothing less than a macroeconomic stimulus measure akin to a tax cut, conveniently timed for an upcoming U.S. presidential campaign.

With the U.S. Federal Reserve Board’s quantitative easing and Washington’s fiscal stimulus winding down, will timely releases from strategic oil reserves become the new kid on the block in the Obama administration’s economic tool kit? But Washington may soon discover strategic oil reserves are a very dangerous instrument to use. It’s a lot easier to print money than it is to pump oil from the ground.

Other than the level of oil prices and the resulting weakness in oil consuming economies, what supply shock does the release redress?

There is no doubt the loss of Libyan production has made world oil markets even tighter but triple digit world oil prices aren’t really about supply shocks.  They’re about the growing imbalance between ever-surging world oil demand and little-growing world oil supply. And that imbalance is becoming bigger all the time.

While global inventories can still bridge the gap in the very near-term, they are hardly a sustainable solution. Even the U.S. Strategic Petroleum Reserve amounts to less than 40 days supply day for the U.S.’s 19 million barrel a day oil habit.

If inventories aren’t going to be depleted, tapping reserves today means restocking them tomorrow. When exactly does the IEA expect to take back into inventory to rebuild the 60 million barrels that they are now adding to the market?  What’s going to change in the world demand-supply balance that will allow inventories be rebuilt without stoking the price pressures that tapping reserves are supposed to relieve.

The only plausible time for restocking to happen is during the onset of another oil -induced global recession, which, of course, the IEA may think will occur sooner than most of us yet suspect.

Soaring oil prices also transfer billions of dollars of income from oil-consuming economies to oil-producing economies. Nearly one trillion dollars migrated from OECD economies to OPEC ones in the record run-up of oil prices preceding the last recession. Since savings rates in countries like Saudi Arabia, UAE and Kuwait are typically ten times what they are in major oil-consuming economies like the United States or Western Europe, the shift in purchasing power resulted in weaker global demand.

But by far the greatest impact that oil price shocks have on the global economy is the one they make on inflation and, hence, interest rates. This linkage is the means by which they have typically delivered a mortal blow to economic growth. Oil shocks have always given rise to growth-ending increases in interest rates as central banks are forced to respond to the inflationary fallout they leave behind.

The last recession was no exception. As oil prices soared from $35 per barrel in early 2004 to almost $150 per barrel in the summer of 2008, consumer price inflation in the US tripled to a rate of almost six per cent. It didn’t take long before interest rates caught up to inflation and, in the process, blew up the massively over-leveraged subprime mortgage market and the economy with it.

But lest we’d forgotten, it was the massive rise in energy inflation, and an associated rise in food prices (more on that in future posts), that catapulted the Federal Reserve Board’s federal funds rate from a nurturing one per cent setting in early 2004 to a level over five times that only a couple of years later. The rate of energy inflation rose from less than one per cent to as high as 35 per cent.

Oil prices caused the last recession, and oil prices will cause the next one as well. Energy inflation is already on the march. In fact, this time around oil prices are rising much earlier and much more rapidly than they did last cycle. Inflation is already running at nearly a five per cent rate in China; as oil prices go on to set new record highs, it’s only a matter of time of before we see those inflation rates in North America and in the rest of the OECD.

And when we do, get ready for another oil-induced global recession.

While the recent initiative signals a much more activist stance for the Environmental Protection Agency (EPA) than their virtually comatose profile during the Bush administration, raising corporate average fuel economy (CAFE) standards for vehicle manufacturers is nothing new.

Anyone who lived through the OPEC shocks of the 1970s can’t help but get a strong sense of déjà vu. We went down that route back then, when CAFE standards rose by over 30 per cent despite the auto industry’s contention that they couldn’t meet the new environmental standards without going bankrupt. To absolutely no one’s surprise, the auto industry was able to meet those levels and survive at the same time. But to virtually everyone’s surprise, we discovered that those impressive efficiency gains neither cut our fuel bills nor lessened our carbon trails.

Your engine may be a lot more efficient that your dad’s old gas-guzzler from the 1970s, but chances are you burn just as much gasoline on the road over the course of a year as he did. You, like your fellow North American drivers, eat up all the energy efficiency gains made in engine and materials technology over the last thirty years by driving ever-larger, ever-faster vehicles loaded with more and more energy-consuming features. And to top it all off, you drive your vehicle about a third more than your parents did, in large measure because you commute so much further every day than they did.

Raising CAFE standards won’t force us to burn less oil or emit less carbon. But the pump prices that will come with the triple-digit oil prices that are just around the corner will make us do both. And, for good measure, those same pump prices should easily enable the auto industry to reach the new bar set for corporate average fuel economy.

That’s because the biggest factor affecting a vehicle manufacturer’s ability to meet the higher North American fuel economy standard is the company’s vehicle mix. When it costs you over $100 every time you fill up your tank, chances are there will be a lot more scooters than SUVs flying off the assembly line.

Three years ago, it would have told you that global oil markets were at record tightness. Back then, the US president was making a personal pilgrimage to Saudi Arabia to vainly plead for more production. And economists were worrying about the implications for global economic growth.

Today, it seems the goalposts have suddenly moved. After filling up on $4-per-gallon gasoline only two Memorial Day weekends ago, today’s $2.20-per-gallon average gasoline price doesn’t seem so expensive to American motorists anymore.

And suddenly, $80-per-barrel oil is no longer seen by the Saudis as threatening global oil demand, but is instead viewed as a minimum price for their nation to invest in new supply. And as far as my fellow economists are concerned, we’ve heard not even a peep from them about what these types of oil prices may mean for the global economy in the days ahead.

But how much longer can the world pretend that it won’t soon be facing another energy shock, one every bit as challenging as the one it met two years ago? Does anyone still believe the reassuring forecasts from discredited feel-good organizations like the International Energy Agency about new sources of cheap supply, like those that once flowed from places like Prudhoe Bay in Alaska or the North Sea? If so, where is that supply of new affordable oil coming from? Surely not from tar sands or from ultra-deep water fields six miles below the ocean’s floor.

And what will suddenly put the brakes on world demand over the next year that will pull oil prices back from the precipice of triple-digit range? Are car sales about to tank in China and India over the coming months, suddenly halting the otherwise insatiable demand from these countries for more oil? Will OPEC suddenly start charging its drivers and its utilities world oil prices and halt the explosive demand growth in their own economies for the very oil they are supposed to supply to the rest of the world?

Whether we are talking about supply or demand, there is nothing on the horizon to prevent the imminent return of the very same oil prices that put us into the deepest postwar recession yet in the first place.

By the fourth quarter of this year, oil prices will be back in triple-digit range, and by next year oil prices will rise to record highs, taking out the high-water mark of $147 per barrel that was set back before the recession began in 2008.

We’re barely out of the recession, and already we face prices that, just a few years ago, our government, our oil industry and our economists told us we would never see.

Where do you think oil prices will be trading in the future?

Exactly why oil traders and speculators think the data has anything to do with the state of world oil demand is beyond me. I suppose, like Pavlov’s dog, they’re only doing what they’re trained to do. But their training comes from a world that no longer exists.

While the US oil inventories data pertains to the largest oil-consuming nation on the planet, it is no more indicative of world demand than US oil production numbers are indicative of world supply. Both are in terminal and irreversible decline.

It certainly wasn’t US fuel demand that took oil prices over $100 in the first place, and it won’t be US fuel demand that will push them back into that range anytime soon. US oil consumption is almost 3 million barrels per day short of its pre-recession peak.

But the fact of the matter is that US oil consumption will never regain its pre-recession peak, just as US motor vehicle sales will never again see the levels that prevailed before the recession. Ditto for oil consumption in Canada, Western Europe, Japan, or, for that matter, anywhere in the OECD economies.

Back in the 1990s, that kind of demand contraction in the OECD would have foretold a big decline in oil prices, since those countries accounted for almost three quarters of global oil demand. Today, they account for barely half, and tomorrow they will account for even less.

Just as the developing world has long surpassed the developed world in terms of coal consumption, the same is about to happen with respect to oil. Between explosive growth in oil-thirsty economies like China and India, and OPEC’s voracious appetite for its own fuel, OECD fuel markets are becoming increasingly marginal. That’s why Saudi Aramco is far more interested in securing long-term supply contracts with rapidly expanding domestic oil markets in countries such as China and India than in supplying shrinking oil markets like those in the US.

In a world where affordable oil supply will soon peak, if it hasn’t already done so, global oil consumption quickly becomes a zero-sum game. As China moves from consuming 8 million barrels a day to 10 million barrels, and OPEC ramps up its own daily consumption from 10.5 million to 12 million barrels, somehow, somewhere else in the world, there must be a corresponding decline in oil consumption. That somewhere else just happens to be the US market and the oil markets of the other OECD economies.

So instead of thinking that a decline in US oil consumption means a build-up in global oil inventories, just think of it as freeing up another barrel to be guzzled in China or the Middle East.