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The Actuary The magazine of the Institute & Faculty of Actuaries
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Economic risks from constrained global energy supply

In this article I will aim to describe the problems with exponential growth in the economy, the link between the economy and fossil energy, the possible effects of oil scarcity and resource depletion on the global economy and the actuary's role in these hugely important issues. 

Energy constraints
Fundamentally, the economy depends on fossil energy, with oil being the most important component. Fossil energy drives essential sectors of the economy including transport, aviation, food production, construction, mining, heating and lighting. Most developed economies consume huge amounts of energy. For example, in the UK, on average a person consumes 125kWh of energy every day! 

During the last five years there have been two oil price spikes above $100 a barrel. However, the overall volume of oil produced globally has been roughly flat during this period. There is a risk that this supply constraint might now be permanent. According to Munich Re Foundation Report (2009) "Discoveries of new deposits peaked as far back as the 1960s and 1970s. Now a number of countries in addition to the UK and the USA, for instance, have reached their production limits. The quantity of oil being pumped out of the earth exceeds new discoveries." In February 2010, the UK Industry Task Force on Peak Oil, stated in their second report that, "The next five years will see us face another crunch - the oil crunch... the era of cheap oil is behind us." 

Oil Price and Global Oil Production 2004-present

bettis-reg-oil-graph

 

 

 

 

 

 

 

 

Sources: Oil Price - United States EIA
Oil Production: BP Statistical Review of World Energy 2011

There are plenty of alternative hydrocarbons, which could be used, such as tar sands, oil shale, shale gas, coal (which can be converted to synthetic oil). However, none of these are easy substitutes because of various problems with using these alternatives; for example, transport needs liquid fuel. Most importantly, the alternatives emit more carbon, which is extremely dangerous. As historic data proves, there is a very strong correlation between temperatures and atmospheric carbon dioxide. Current atmospheric Co2 is extremely high at an unprecedented level. 

There is of course a huge amount of renewable energy available, such as wind, wave, tidal and solar. However, these energy sources are diffuse and it is difficult to capture, concentrate and store energy from these sources. Renewable energy requires significant investment. The key question is whether investment can be ramped up quickly enough to avoid a decrease in per capita energy availability. 

Impact on economy
The constraint in the global oil supply is very likely to constrain global GDP growth. If economic growth depends on expanding the oil supply, then there is a risk that economic growth forecasts may not be fulfilled. Some economists and organisations have started warning the markets of the effect of oil scarcity and resource depletion. In April 2011, GMO, an asset management firm controlling over $100 billion of assets, stated in a letter to investors that it was "Time to wake up: Days of abundant resources and falling prices are over."

In this climate, western economies are likely to deleverage, but this process has hardly started yet. Deleveraging is unlikely to occur in an environment of rapid GDP growth. Some very unusual developments have already occurred in the economy. For example, the price of iron ore jumped from a 100 year low to a 110 year high within 8 years! Oil and food prices have seen two huge spikes in the last four to five years. Growth in the US is very negligible. The price of gold has doubled since 2009 and Bank of England rates are at their lowest since 1694! Debt levels in developed countries are very high. If economic growth is constrained, the high level of debt becomes even more problematic.

In such a climate, severe austerity measures, defaults on debt, very high inflation or deflationary scenarios are likely.

How can actuaries help?
Actuaries seek to ‘make financial sense of the future', hence they have a significant role to play in making financial sense of the problems of exponential growth, resource constraints and the possible adverse effects on the economy.

We need to make sure that we do not miss the big trends, which could potentially have enormous economic and social effects. We need to make sure that our economic assumptions are fit for purpose. The world needs unbiased forecasting - not optimistic or pessimistic and actuaries are ideally suited for this role.

Actuaries are trained in long-term thinking and in basing decisions on data using a scientific approach. We are also experts in risk and modelling and work with issues of exponential growth. Importantly, we are also used to giving bad news! This is potentially a huge area of work for actuaries and we can be leaders in this field.

Find out more
One way of getting involved in the issues raised here is by joining the UK Profession's Resource and Environment Member Interest Group.

The Institute and Faculty of Actuaries has called for proposals on research on limits to growth (closing date in mid-August 2011) and a networking event will be held on 13 September at Staple Inn Hall on opportunities for actuaries in this area of work.