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Oil Prices

– in the House of Lords at 6:47 pm on 8th June 2005.

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Photo of Lord Skidelsky Lord Skidelsky Crossbench 6:47 pm, 8th June 2005

rose to ask Her Majesty's Government whether they will consider the effect of oil prices on the economic and political outlook.

My Lords, I welcome the opportunity to bring this important subject to the attention of your Lordships' House and thank in advance that small but select group of your Lordships who have chosen to take part in this debate. It is the fate of Unstarred Questions that they often miss their most topical moment. When I tabled the Question for debate in the autumn, the price of a barrel of crude oil was $55 and was widely expected to go on rising. Prophets of doom sprang up everywhere forecasting a price of $100 or more and the collapse of civilisation. Almost immediately, the price fell to $46 a barrel; since then it has fluctuated between $45 and $55.

Leave aside the fact that the forecasters were wildly wrong. The important point is that the virtual tripling of oil prices created scarcely a ripple in the economies of the West. There was no repeat of the stagflation of the early 1970s, when two oil price hikes led to rising inflation and unemployment simultaneously.

Let me stand back for a moment before considering why that is so and what it tells us about today's relationship between oil and the economy. Analysts of commodities have usually been either optimists or pessimists. The optimists emphasise the elasticity of supply in response to demand and human ingenuity in inventing substitutes. The pessimists point to the inherent scarcity of supply of commodities in relation to demand and the high cost of finding substitutes.

One of the most famous historical pessimists was the 19th century economist, William Jevons, who wrote a book called The Coal Question in 1862. In that book, he predicted the imminent exhaustion of coal supplies. The coal age, as we know, went on for 100 years or more after that. Jevons was also alarmed by the approaching scarcity of paper owing to deforestation and laid in such vast stores of writing and packing paper that 50 years after his death it had still not all been used up by his family.

That led Keynes into a disquisition on the psychology of hoarding, with what he called hoarders',

"readiness to be alarmed and excited by the exhaustion of resources".

In the early 1970s there was the famous Club of Rome, some of whose doomsday scenarios predicted the death of millions through starvation as population outstripped food supply. Then came the green revolution.

What is the situation with regard to oil today? Are we up against some absolute limit of supply that will push prices inexorably higher, forcing a drastic reduction in energy consumption and a revolution in our habits of life? Or are there enough supplies, including substitutes, to maintain existing levels of consumption and growth?

The pessimists can point to the fact that the bulk of the world's oil reserves is concentrated in two regions: the Persian Gulf and the Caspian Sea basin, with proven reserves good for only 60 years at present rates of production. Those also happen to be among the most unstable regions in the world.

Supply can be increased rapidly from the Persian Gulf, where production is still well below capacity. But the Middle East is a powder keg. Before the second Gulf War Iraq produced 3 million barrels per day, a level that it has not yet regained. The Saudi regime is insecure. Terrorism has plenty of opportunities to interrupt supply. The Caspian region is also politically volatile, as recent events in Uzbekistan have shown. In short, there is a high correlation between areas of conflict and lootable natural resources.

The great powers certainly act on a pessimistic assumption. The great game of foreign policy is security of oil supplies: the prize, political influence or control over reserves, oil fields and pipelines. A couple of weeks ago world leaders gathered in Azerbaijan to fete the first oil flowing from the Azeri oil fields through Georgia to a Turkish shipping terminal on the Mediterranean. That is part of a project to develop the Caspian as a secure alternative to the Gulf and to reduce Russian influence in the area, as the pipeline avoids Russia.

A little further ahead, we see the great game developing in the South China Sea, which also has reserves of sub-sea oil and gas. I avoid comment on the logic of the game, and whether it is well founded, but I would point out that in the near future supply is not the main problem. OPEC, which already pumps more than one-third of the world's oil, is capable of increasing its production if it wants to. The longer-term problem is not political but economic. It is that growing world demand is not matched by an increased rate of finding new oil to replace declining existing wells. Today's high prices are driven as much by fears of supply shortages in the future as by present events.

The main change on the demand side—with which your Lordships will be familiar—is the explosive growth of China and India. China has already overtaken Japan as the world's second largest oil consumer, with over 8 per cent of the world's oil consumption. Aggressive Chinese stockpiling has been adding to the pressure on prices.

In the United States, Europe and Japan economic growth is picking up after the recent recession. Rich countries' oil consumption is on an ever-rising curve, with energy-saving technologies being offset by more extravagant petrol use: witness the popularity in the United States of the gas-guzzling Hummers—or Humvee sports utility vehicles.

Both supply and demand factors are thus combining to push prices higher. Since 1973–74 it has been conventional to talk about a destabilising oil price cycle. Rapid growth pushes oil and energy prices higher; higher oil prices push the world into recession, leading to a fall in prices; the fall in oil prices pushes world growth and prices higher; and so the cycle continues.

However, the important fact about the present situation is that there has been little sign of any such cycle. Why is that? The following reasons seem compelling. First, today's high oil prices are not as high in real terms as the prices in the 1970s and have risen more slowly, giving time for adaptation. Secondly, our economies are more adaptable. In particular, labour markets have become much more flexible. Thirdly, our economies are more energy efficient: for example, the United Kingdom uses only half as much energy per unit of output as it did 30 years ago.

Finally, our economies are less vulnerable. There has been a major shift from industry to services, which are much less energy intensive. Energy consumption as a percentage of gross domestic product is at a historic low and oil as a percentage of total energy use in OECD countries has fallen from over 50 per cent to 40 per cent today.

All that means that our economic life is less sensitive to high oil prices than it used to be. The European Commission has estimated that the high recent oil prices are barely shaving economic growth in the euro-zone and their effect on inflation is negligible. The situation is of course different in the oil-importing developing world, which on average uses twice as much oil per unit of output as the OECD countries; those countries are indeed vulnerable to rising prices.

In conclusion, let me come clean on the question of whether I am an optimist or pessimist. I place myself squarely in the optimistic camp, not only because I am not by nature a hoarder but because I have a great belief in human inventiveness and adaptability. Oil will not lead us into disaster unless governments are incredibly stupid, which is not impossible but fortunately not to be relied on.

There will have to be changes in our habits of life—I venture to suggest that the era of cheap air travel may be drawing to a close—but they will not be catastrophic. I have already referred to the decline in oil as a percentage of energy use. The fastest-growing alternative energy sources are nuclear and natural gas. Despite many worries, nuclear energy is growing in importance as a clean alternative to fossil fuels and use of gas is increasing as the result of the development of production of liquid natural gas.

The world is discovering sugar-based fuel such as cane-based ethanol. In Brazil, cars that run on either petrol or ethanol or some combination of the two are already popular and that could spread to countries such as India, which is the second largest sugar producer in the world. Countries such as Britain and America are capable of replacing automotive fossil fuels with hydrogen, which is produced from renewable resources.

The fact that most of the technologies that save on oil consumption simultaneously reduce the rate of carbon dioxide emissions and thus the rate of global warming gives an additional reason for both governments and the private sector to invest in their production. I particularly draw the attention of Her Majesty's Government to that fact and ask them what they are doing and planning to do to speed up the process of conversion.

To conclude, oil is still vitally important in the short and medium term, and its importance may be growing because of fear of disruption and the rapid growth in consumption, particularly in China. In the longer term, the age of oil, which replaced the age of coal, may be drawing to a close, as ever-inventive humanity develops and exploits alternative sources of energy.

Photo of Lord Desai Lord Desai Labour 7:00 pm, 8th June 2005

My Lords, it is a privilege and a pleasure to follow the noble Lord, Lord Skidelsky, who has introduced the evergreen topic of the price of oil. Like him, I am an optimist, but I am very pessimistic about the fact that, as he has said everything worth saying on the subject, there is not much left for me to do.

I am astonished that the price of oil is so high. I have always believed that the world was awash with oil, but I am sure that the noble Lord, Lord Browne, whose speech I am waiting to hear, will put me right because he knows the facts and I am just a theorist. Given the amount of oil discovered and the means of transportation, not just in the Caspian and the Middle East, but wherever you look—there is oil in Venezuela; exploration has now begun in China, India and Africa; and the South China Sea was mentioned—it is puzzling that the nominal price of oil is so high.

There are two possible explanations. First, a very small element is the depreciation of the dollar, with the result that looking at the dollar price of oil is slightly misleading compared to the euro or sterling price. Secondly, there has been short-term political scaremongering and people fear the instability of the Middle East. That is quite right, but apart from Iran, and lately Iraq, no ruler has changed for 50 years. The Middle East always looks unstable, but the House of Saud has stayed in power and so have the people in the United Arab Emirates and so on.

The more recent political changes—for example, in Venezuela and Iraq—have caused unease in the markets. We are all convinced that the next market crisis will be concerned with oil because the last one was. In Keynes's day people were obsessed about gold and how it would ruin the whole world, yet now we do not even think about it because we could demonetarise gold very easily and live perfectly happy ever after. Similarly, our concern with oil is very much to do with the fact that, as the Prime Minister said in another context, there are scars all over our back from what oil did to us.

As the noble Lord said, the real price of oil is lower now than it was in 1973. The reason is not only that we are more energy-efficient, which was a reaction to the high price of oil since 1973, but that manufacturing has shifted from the OECD countries towards mainly Asian countries. That has done two things: it has reduced our consumption of energy per unit of GDP, but the countries to which manufacturing has moved are not as energy-efficient as we are, therefore oil consumption has been artificially boosted. Consumption will return to a more normal level when those countries adopt energy-efficient technology, as they will, but that will require a lot of foreign investment in new technologies.

Although China is currently an oil-guzzling country, looking carefully at its miraculous growth numbers, one can see that in terms of how much it absorbs of its own domestic and world savings, it wastes a lot of capital to get its growth rate. Its capital wastage is partly caused by the fact that China's manufacturing industry is very energy inefficient, as is its domestic fuel consumption. If Chinese domestic heating could be improved, even by 10 per cent, the world would be much better off. Those improvements are yet to come, and when they do the price of oil will probably recede from its temporarily high level. It is difficult to say when it will happen—obviously, not in the next six months. But in the medium to long run, politics are less important than economics.

I may be wrong, but I believe that the long-term supply price of oil will be perhaps $25 dollars a barrel more than at present, so oil companies are very happy, but I do not think that the good times will last very long, especially once the various new sources deliver and when sources such as Venezuela and Iraq resume their former output.

The issue with alternative sources is not so much their relative cost compared to oil but their impact on carbon dioxide emissions. The case for nuclear energy has been overstated, not because of the risk factors attached to the disposal of nuclear waste and so on, but I have yet to see a calculation that shows the delivery of nuclear energy to be cost-efficient. When the Dounreay reactor was shut down, I tabled a Question asking the cost in pounds per watt of electricity generated. The amount was excessive. We all had high hopes that nuclear energy would deliver cheap fuel. As noble Lords remember, it was only when the Government tried to privatise that people looked at nuclear energy as a reality, but there were few buyers because nuclear energy requires enormous subsidies to be feasible.

Eventually global warming may get so bad that, even at an enormous subsidy cost, we would rather have nuclear energy than use dirtier fuels, but I do not think that that day has come yet. On reading the front page of the Independent today I came to the exact opposite conclusion from the one intended by the newspaper. It shows a diagram of how much carbon dioxide emission in parts per million has increased in the past 40 years. Over the past 40 or 50 years emissions have increased by 20 per cent, and are less than 0.5 per cent per annum, at which rate the carbon dioxide content will double in 150 years. I know that I should be worried about that, and I do not doubt that global warming will happen, but I do not think that we have to take the decision as urgently as people urge on us. There is plenty of time for all that, especially since, until India and China get their act together, we will not get much mileage out of what we do about global warming. That is not to say that we should not do anything but we must think about the flows of emission coming through all the time.

I remain a cheerful optimist. There may even be changes in automobile technology, as the noble Lord, Lord Skidelsky, pointed out. We may have electric cars, which I have been reading about since the 1950s, and all sorts of things. The growth in demand, even when it comes, might have less impact on energy consumption than at present, but in the mean time supply will go up. I remain very, very cheerful. I do not think that we need to panic at all.

Photo of Lord Selsdon Lord Selsdon Conservative 7:10 pm, 8th June 2005

My Lords, it is always a pleasure in your Lordships' House to know that you are an unfortunate amateur surrounded by professionals. When they are also professors, it causes one a little embarrassment. Knowing that I have no qualifications, I shall speak from my practical experience.

I began in the oil business 60 years ago. There was a desperate shortage of petrol at the time. Part of my job on a farm where we had workers who included Land Girls, conscientious objectors and German prisoners of war was to make sure that they got their lunch. I had been advised that, at the age of seven, I could drive the green van to take the food to lunch, provided that I could find the fuel. Fortunately enough, there was an American airborne division camping in one of the fields. I quickly found out that they had fuel.

I would walk out in a long coat with two hot water bottles on the front and two on the back—a hot water bottle, as noble Lords will know, takes a pint of petrol—to arrange an exchange for eggs collected from the hedgerow. The young colonel would say, "The jeep's outside, Malcolm", and I would put the eggs on the seat, stand by and siphon out the petrol. Then, I could run the green van without a licence. That was my experience.

Things moved on when my great-aunt Jenny died and left money to her great-nephews and great-nieces. We got £500 of War Loan, which was not the same as £500, and £500 of shares in British Petroleum, which, we were told, was half government and would always remain half government. The covenant was that they could never be sold. We tried hard, when we were 21, to see whether they could be sold, but there was some restriction. As a result, they have never been sold. They have been pledged for substantial borrowings by me.

Then I come to your Lordships' House at the time of the referendum. I was treasurer of the Conservative Group for Europe, trying hard to finance the parliamentary delegation that went over there. With the referendum coming up, we were trying to raise money. Then, in 1974, the oil price surged. I wrote a nice paper for the government and my noble friend Lord Carrington to say that there was a bit of a crisis. But the government said that it would be all right. They completely ignored the paper, and there was a bit of a crisis. That was the next thing.

I move on a bit further to a committee that I served on in your Lordships' House—Sub-Committee B of the European Communities Committee, under Lord Aldington. I was the youngest by a long way and was told that we would be dealing with the North Sea and what would happen when the oil ran out. They said that it was a good thing to have a young chap like me there because, by the time things got difficult, I might be the only one alive. There are three or four of us still alive. The government rubbished our report and said that there would be no problem when North Sea oil ran out. That will be part of my theme today. That was about 20 years ago.

One of our worries, as we ceased to be an industrial economy and were relying so much on revenues from the North Sea, was what would happen if those revenues ceased. Those revenues are ceasing fairly rapidly. As noble Lords know, we used to talk about the "seven sisters"; now we talk about the "three nuns"—white, perfect, glorious and doing good in the world. Most of them are pulling out of the North Sea. They are selling out to smaller oil companies and reinvesting abroad. Can the professors tell me whether that matters?

We have a highly taxed product. I believe that petrol bought at the pump at 90p gives 6p to 8p to the oil company and 1p profit. Presumably, the rest disappears into the Exchequer somehow or other. With the regulated tax on North Sea oil, which is, I gather, pretty complicated, you need more tax advisers than geologists. That is strange. Can the Government tell me simply how much revenue they expect upstream from the North Sea and from the pumps over the next five or 10 years? Does it really matter?

It worries me that, unlike Norway, we have set aside no reserves. Norway has built up a substantial reserve of funds to pay for a rainy day. I do not believe that we have any reserves. Who will clean up the North Sea, if it needs cleaning? It does not matter: as an amateur, you do not have to disclose whether you are pessimistic or optimistic.

I move on to the other part of the well phrased Question asked by the noble Lord, Lord Skidelsky, and to the question of politics. We are told wherever we go that oil is all about politics and that the oil companies are trying to do this and that. For six years, I chaired the government's Middle East trade committee and had the job of going to the more doubtful countries when Ministers were unacceptable. They included Libya and Iraq—many times, even during the sanctions period, when I had permission to speak. I sat in the oil minister's room looking through a window at foreign oil companies—not the one in which I am still an investor—sanctions busting and making presentations about what they would do when the war was over. Those were companies whose countries did not have many natural resources.

That did not worry me, but then, when I went on to Iran, I found the same sort of thing. The concern there was political. For political reasons, the Iranians moved an enormous steel mill from Bandar-e Abbas right up to Isfahan, which cost five times the amount, in case they should be attacked.

As a banker, I used to be asked to speak at oil conferences. I do not know why. I believed that one of the greatest values of oil was the added value that it could create for the host country that could be used for internal investment and to support expansion. Obviously, it did quite a lot for Scotland, but the oil no longer comes ashore at Aberdeen in the quantities that it did. It is now wet dollars somewhere off Brazil or the coast of Africa, where I used to go. One wonders whether the revenues accrued in those countries will be put to good use.

I also wonder whether it is right and proper for the three nuns to give money back to their shareholders. It should be further invested. It seems to me that they have no good ideas about what to do with it. I think of Saudi Arabia. At one time, I was flown up to Scotland for an international petroleum conference by Sheik Yamani, who explained to me that the biggest worry was politics. He said that Saudi Arabia had the only reserves that could be brought on-stream immediately and that, if there were a crisis, it might stir up political feeling against the regime. I do not know whether that is true, but I can see the potential of Iraq, which can produce 8 million barrels a day. Even Libya, where they were limited to 1 million barrels by sanctions, has suddenly become everybody's great friend. They are the people who have surrendered their weapons of mass destruction. I believe that they sent part of the information to the Americans by courier and the waybill got lost, so they had to send it again. Such are the fun stories that you hear.

We considered the fact that 34 per cent of the world's reserves were in the Middle East, and then someone said, "What about the 'tans'?". I did not know the "tans". I knew of Azerbaijan because of the earthquake. Not so long later, I was asked to help in the establishment of a bank in Baku that might recycle the oil moneys into other things. Then, the other "tans" began to emerge. One of the tricks that one would use when talking to someone about eastern Europe was to say, "Have you been to Ruritania?". People would nod and say, "Not yet", forgetting that it was a Peter Sellers country.

Then there is the politics of some of those areas. I had to go to a conference in Geneva to talk about oil financing. All the "tans" were there. They wanted to know whether the British could tell them where the pipelines were that ran through their countries. Russia was not prepared to tell them. They understood that we had a certain form of thermal imaging equipment and asked us to fly low over the countries and tell them where the pipelines were.

Such things have given me tremendous enjoyment, but I worry about the next stage: the ultimate use of fuel. There are only two fuels really: fuel for motor cars and fuel for energy. Some energy fuels, which have already been mentioned, pollute the atmosphere with carbon dioxide throughout, whereas nuclear energy concentrates potential pollution in a particular area. If you are clever, like the French, you install your nuclear power stations on the north side of your country, where the prevailing winds carry the pollution to somebody else, and you can apologise afterwards.

I have no fear about the future for energy, but I have a fear about the distortion of taxation. The Government's idea of getting rid of tax on fuel and applying it to the use of the motor car as it moves along the ground is an excellent one. I wish everybody well. There is a little company in Wales that managed to produce a steam pump. It is a single-cylinder pump that uses dried camel—I must think of the polite word—excrement and is sufficient to pump water. You have to give it a bit of a push when it gets going. The inventiveness of our nation is so great that maybe we should have a few more problems and we might be more inventive.

Photo of Lord Browne of Madingley Lord Browne of Madingley Crossbench 7:20 pm, 8th June 2005

My Lords, I must first declare an interest as chief executive of BP—a company based in Britain which earns its living from producing and trading oil around the world. This morning the price of a barrel of crude oil was $51. In real terms that is nearly double the price of just two years ago, but still much less than half the peak that was reached in November 1979.

So why has the price risen so much in the past two years? The answer lies in the growth of demand, particularly in China and the United States. The Chinese economy has grown by 50 per cent in the past five years and primary energy consumption by 80 per cent. While most of that increase has been met by domestic coal, oil consumption has also risen with demand supplied by increasing imports, which rose by nearly 1.2 million barrels per day over the past two years.

The growth of global oil demand has outstripped supply, reducing the level of spare capacity from the past decade's average of 3 million barrels a day to just 1 million barrels a day at times last year. That has been the fundamental cause of the price increases that we have seen. It has been compounded by concern that the level of spare capacity was less than the production of countries still afflicted by conflict and instability, such as Iraq. It is important to note that there has been no physical shortage of supply. The market has operated effectively.

The international oil industry has succeeded in matching supply and demand without disruption, and the industry is investing for the future. More than US$450 billion has been invested over the past five years to develop new resources and to put in place the necessary infrastructure—the pipelines and terminals—which are essential if the projected growth in demand is to be met over the next decade and beyond. That investment is important because for many years to come oil and gas will remain central to the global energy economy.

One day alternative and renewable fuels will supply a significant share of the world's energy needs. But developing commercial alternatives will take time. Taken together solar, wind and all the other commercial renewables provided just 2.5 per cent of world needs last year. For the moment, oil and gas are indispensable. The imperative is to ensure that they can be developed and supplied at a reasonable cost and in ways which do not damage the natural environment.

There is no shortage of oil, or gas, to meet the world's needs. On the best estimates, proved oil reserves are sufficient to meet current production levels for at least 40 years, and more than 65 years for gas. That does not include future discoveries or all the known unconventional resources, such as most of the heavy oil, notably in Canada and Venezuela.

For the immediate future the expectation must be that prices will stay relatively high, perhaps at something more than $40 a barrel. Once spare capacity is restored—and there is a reasonable expectation that that will be the case—over the next three or four years as new supplies from the Caspian and Angola and some of the OPEC member states come on stream—prices might moderate.

But, given the starting point, that does not mean a return to the world of $20 a barrel oil that characterised most of the past 20 years. Over the longer term, the abundance of resources, inter-fuel competition, and the potential to employ more energy-efficient technology suggest that prices much above $35 a barrel are not sustainable for very long periods. Those numbers perhaps indicate the longer-term price range that we might expect to see and the level which can provide the oil producing countries with sufficient revenue to meet the needs of their young and growing populations.

So what is the impact of all this on economic prospects? Perhaps it is less than one might initially expect. We use energy more efficiently than ever before. Twenty-five years ago when oil prices peaked the world produced $360 of goods and services for each barrel of oil equivalent of energy consumed. Today, that figure is nearly $470—an increase of 30 per cent. It is worth noting that the United Kingdom has remained more efficient in its use of energy than the world as a whole. In 1980 we produced $590 worth of goods and services for every barrel equivalent consumed: now the figure is $950 worth, an increase of 60 per cent—double the world increase. Here and across the world advances in technology have made substitution possible. In power generation in particular, natural gas has become a natural cost-effective alternative to oil.

Despite the increased oil price, global economic growth last year was more than 4 per cent—the highest level achieved since 1989. The most authoritative independent analyses suggest that the impact of increased prices over the past year will be a reduction of economic growth of roughly 0.25 per cent per annum over a year or two.

So the impact is manageable in economic terms. High prices and the instability in the world oil market have, however, inevitably raised concerns about energy security. Those concerns are legitimate but it is crucial that the concern does not produce a response which makes the situation worse. Public policy in the United Kingdom, in Europe and elsewhere should be designed not to create the illusion of security behind protective barriers and the false grail of self-sufficiency but rather to support the workings of the international market and to remove the barriers to investment which still remain.

International co-operation through investment in resources and infrastructure, and through the application of technology, is the key to energy security for this country and the world as a whole.

Photo of Lord Newby Lord Newby Spokesperson in the Lords, Treasury 7:27 pm, 8th June 2005

My Lords, I thank the noble Lord, Lord Skidelsky, for introducing such a fascinating debate, although, rather like the noble Lord, Lord Desai, I feel that it may come to be an example of the adage: everything has been said but, as yet, not everyone has said it. I was particularly interested to hear the contribution from the noble Lord, Lord Browne. As environmental issues move up the political agenda, as they undoubtedly will during this Parliament, I hope that we will have the opportunity, increasingly, to have the benefit of the noble Lord's experience as we discuss these issues in your Lordships' House.

There is obviously agreement that oil prices are relatively high, but not, as it were, disastrously high. They are not at their real-term peak. There is equal agreement on why that is. The principal reason is demand. With the economies of China and India and other countries with very significant populations increasing significantly year-on-year, demand for oil has been unsustainably high. We know that there is a premium in the price. People disagree about how large that is because of security concerns, not least in the Middle East, which are unlikely to diminish in the short to medium term.

I understand that there is also a minor element in the equation that relates to refinery capacity in some places. If yesterday's Financial Times is to be believed, that has led to some pressure, co-ordinated by the International Energy Agency, to push the G8 at Gleneagles to give tax breaks for new refinery construction. Given the state of the finances and the recent profits made by the oil companies in contrast with the other items on the agenda at Gleneagles, I suspect that that proposal will be quietly dropped. For it to be discussed at the Gleneagles summit would be seen widely by the consuming public as little short of obscene.

However, it points up a role which has been very significant in energy and environmental policy over the decades; namely, that of the success of the US oil companies in influencing US public policy. We saw once again over the past few days clear evidence of how oil company pressure in the US has helped to scupper any chance of the American Administration signing up to the Kyoto Protocol. The whole question of the lobbying role of American oil companies could form the basis of a debate of its own, but suffice it to say that their influence in the US appears undiminished and, certainly for anyone concerned about our environmental future, deeply depressing.

I shall look mainly in my contribution at the consequences for the UK economy of the current oil price level and oil prices in general. As other noble Lords have pointed out, fluctuations in the oil price have rather less significant immediate consequences than we feared and saw during the 1970s. Over recent years, we have seen that when on one or two occasions petrol and diesel prices rose quite rapidly, there were immediate political consequences in the form of fuel protests. We did not really see that in the 1970s, but more recently we have seen a process which has led to the Government probably quite sensibly not maintaining the fuel price escalator. But in a week when we are discussing how to constrain traffic congestion, I do not think that the prospect of ongoing high levels of both fuel duty and oil prices more generally is necessarily all bad.

One of the principal beneficiaries of high oil prices, particularly if those high oil prices do not lead to a significant slowdown in the economy, is the Government. Over the years the Government have been reluctant to give figures for the VAT or duty collected on retail sales of petrol and other oil products, but when prices rise without any significant reduction in demand, government income also rises. Given these sensitivities and the consequences for petrol duty, I am tempted to ask the Minister if he would care to speculate on possible future petrol duty increases in the UK if the oil price remains at or above its current level. But I suspect that he will not care to do so.

As a result of higher oil prices there have no doubt been large increases in North Sea taxes, royalties and corporation tax levies on oil company profits. Last year the Financial Times calculated those in the order of a number of billions of pounds as the oil price rose. Can the Minister tell the House what would be the consequences for government revenue, compared with the figures in the Red Book, if the oil price remained at between $50 and $55 for the remainder of the financial year? There has been a lot of talk about black holes in the economy. Perhaps this is a ray of sunshine for the Chancellor, one that is an uncovenanted boon to the government coffers.

On inflation, the rise in the oil price has not been a major factor in recent Monetary Policy Committee decisions. But if we were to see a severe shock that temporarily pushed up the rate of inflation, I hope that the MPC would not respond by raising interest rates significantly, but rather would write to the Chancellor saying that it was a temporary shock which should be met in the short term with flexibility on inflation.

The noble Lord, Lord Selsdon, in looking at the economic consequences of oil prices, said that he wished we had done the same as Norway and set up a separate fund to deal with North Sea oil revenues. As a young civil servant in the late 1970s, a private secretary, I saw a draft White Paper on this subject cross my desk. I believe that Tony Benn was the Secretary of State for Energy at the time. The draft paper set out the pros and cons of having such a fund. Only one word was set in square brackets, and it was in the final paragraph. The paragraph effectively said that, "Taking everything into consideration, on balance we have decided"—and then in square brackets was the word "not"—"to establish a fund". In the event, the square brackets were taken out. The Treasury won and those oil revenues were not hypothecated. I think that that is possibly rather a pity, at least for some of them.

So the effect of the oil price rise in the UK has not been dramatic. It is interesting to note that according to the IEA, which last year produced rather high figures for the impact of a rise in the oil price on GDP growth, the effect here on the growth in GDP of a $10 per barrel increase would be about 0.5 per cent of GDP. The figure rose to 0.8 per cent in Asia and to 3 per cent in sub-Saharan Africa because they use oil much less efficiently. Here is another example where poor Africa loses out when there is a general shock to the world economy.

To conclude, should I be an optimist or a pessimist about the future of oil prices and oil supplies? I am sure that in the longer term oil prices will not subside to the levels we have seen over the past two or three years, a point also made by the noble Lord, Lord Browne. I was reinforced by the noble Lord, Lord Skidelsky, in my thinking that I am really an optimist on this. However, when the noble Lord, Lord Desai, was so unabashedly cheerful about the prospects for oil, a little light went on. Economics is too gloomy a science to be quite so cheerful. So I have become slightly less cheerful during the course of the debate. For a raft of reasons, the lesson here is that whatever the exact oil price might be and whatever the precise supply levels and constraints, as the world population grows, looking for alternative sources of energy, developing them and putting the money in—whether for hydrogen, wind power or whatever—is a sound policy and one to which we need to give more priority. To coin a phrase, we do indeed need to go beyond petroleum.

Photo of Baroness Miller of Hendon Baroness Miller of Hendon Spokespersons In the Lords, Trade & Industry 7:38 pm, 8th June 2005

My Lords, with the leave of the House I want to digress for just one moment. While waiting for the debate to begin, standing at the back of the Chamber, I heard the noble Lord, Lord Adonis, and the noble Baroness, Lady Walmsley, pay kind tributes to Lady Blatch. I should like to put on the record my thanks to them and to all those who paid tributes yesterday and on Monday. Unfortunately, many of her friends were in Huntingdon for the funeral and therefore were not able to participate. But this debate has given me an opportunity to say only one thing: I consider it a privilege to have been such a close friend of Lady Blatch and see at close hand not only her warmth and to feel her friendship, but also to witness her courage, the like of which I am sure that we shall never see again.

I say to the noble Lord, Lord Skidelsky, that when he opened the debate he thanked all those who were chosen to participate, referring to them as a select band. However, I want to tell the noble Lord that I did not actually choose to do so. Fate dictated that I was chosen to stand here and respond, and I was right to be somewhat intimidated. I feel sure that I am the only amateur, given that the noble Lord, Lord Newby, was a civil servant with experience in this area. My noble friend Lord Selsdon said that he is an amateur, but by the time he had so luckily benefited from the bequest of his great-aunt Jenny, he turned out not to be such an amateur after all.

We should all be grateful to the noble Lord, Lord Skidelsky, for having introduced today's debate. Close and continuous scrutiny is needed over all aspects of the Government's present policies on fuel supplies and over their often repeated assurances that everything is under fingertip control and going according to some strategic plan. Many experts consider that to be ill conceived, in so far as they can see what the plan is.

That is not just my view. One has only to look at the numerous Questions, both Written and Oral, reported in Hansard, to see that the topic is of considerable and constant concern to Members of both Houses on both sides of the aisle. Only this Monday we had a Question about clean coal technology. The noble Lord, Lord Dubs, has a Question on the Order Paper next Monday on wind power, on which the Government are placing so much confidence.

The Labour Party, when in opposition, and largely at the behest of the mining unions, constantly berated the Conservative government for what it derided as a "dash for gas". Yet faced with the realities of actually being in office, the Government are putting ever-increasing reliance on gas as the principal source of our energy supplies, especially for the purpose of generating electricity.

Supplies of oil, the basic subject of the debate, and supplies of gas have one thing in common. So far as Britain is concerned, in the near future our gas and oil supplies will be coming from overseas, often, as the noble Lord, Lord Skidelsky, and other noble Lords said, from unstable regimes. In Venezuela, for instance, there has been an unsuccessful attempt to remove President Chavez who, in consequence, seems to be becoming progressively more anti-American and closer to Cuba. Only today we hear that the government of Bolivia have fallen, amid popular demands for nationalisation of natural gas.

Our gas supplies from unstable regimes such as in the Caspian area which the noble Lord, Lord Skidelsky, mentioned, are vulnerable to terrorist attacks, as we see happening on an almost weekly basis in Iraq. In Saudi Arabia, attacks on foreign workers have increased tensions and fears about interruption to oil supplies.

However, it is not only the availability of supplies and their safe delivery that is the problem. There is the question of price. The elementary laws of economics—and I hate even to mention this in such a distinguished gathering—tell us that the scarcer the commodity or the greater the demand for it, the greater the price.

As many noble Lords have said tonight, two new major consumers have entered the market. Two sleeping giants have awoken and are now to become major industrial zones. Their immense populations, amounting to about one quarter of the people living on this small planet, are about to become prosperous enough to join the car-owning consumer society. I mean, of course, India and, especially, China.

China's demand for oil has increased by 20 per cent in the past year alone. One IMF economist forecasts that the number of vehicles driven by the Chinese will skyrocket from 21 million in 2002 to 390 million in the next 25 years. China's projected demands for power are so great that they are proposing to build some 200 coal-fired power stations in the next couple of decades. I should like to return to that in a moment. China is also trying to secure its future supplies by buying up whole oil fields.

I asked the Government about the effect of these acquisitions on oil supplies and prices in a Question for Written Answer as recently as March. The Government's reply which, to be frank, I found rather complacent, was:

"Growth in China's demand for oil . . . has been factored into current oil price levels . . . it is unlikely that the additional effect these deals will have on the availability and price of oil will be significant in the short and medium term".—[Hansard, 16/3/05; col. WA 138.]

How long is the short and medium term, and what about the effect in the long term on price and availability? Perhaps the Minister will tell us whether he shares his noble friend's optimism about the future on that score.

Have the Government noticed that the price of Brent crude has risen from $35 a barrel last September to $55 at the beginning of this month? The noble Lord, Lord Browne, mentioned $51, but I did not feel like crossing my figure out at that late stage because I could not find the place.

The United States of America is, as always, a factor in such matters, as the world's most prolific user of oil—a situation made much worse by the current fashion for gas-guzzling sports utility vehicles. The noble Lord, Lord Desai, mentioned that. The oil companies, ever in search of financial economies, are reducing stocks, which means that fluctuations in price caused by what Harold Macmillan called "events" cannot easily be smoothed out.

Oil companies used to increase their stocks during periods of weaker demand, but an increasingly aggressive marketing policy by OPEC is now inhibiting this, while in this fertile field, hedge funds and other professional speculators are betting on the possibility of still higher prices, and their activities have exacerbated price pressures on the market. The noble Lord, Lord Skidelsky, mentioned that as well.

In April, the IMF said:

"In such a tight market, any supply disruptions or unexpected movements in demand can cause sharp changes in the price of oil".

The CBI published its own economic forecast in May, showing a slight deterioration in the economic outlook if the oil price remains at the present level, but in fact there are predictions that it will rise still further. What is the Government's prediction of global consumption if the present prices continue or even rise? Already OECD predictions are for a downturn in GDP growth over the next two years. What effect will that have on the United Kingdom export trade? What effect will the downturn have on the Government's predictions about the potential tax take and their ability to finance their plans for expenditure?

Over the next few years, the United Kingdom will become increasingly dependent on imported supplies of both oil and gas. What effect will the increasing price of both these commodities have on our balance of payments, and, indeed, on our whole economy? I have asked this particular question several times in the past but have not as yet had a reply. Perhaps this time, as this is a debate specifically targeted to an economic subject, the Minister will be able to reply.

A few moments ago I referred to the use by China of its vast coal supplies to meet its rising demands for power. I understand that the Government are to make a Statement about clean coal technology next Tuesday. I hope to hear that they will encourage the development of this strategy not only for the benefit of our own fuel supplies and to meet our Kyoto obligations but also to enable us to export that technology. If anyone can benefit from it, it would be the Chinese, with a consequent lessening in their demand for oil.

As I said before, the noble Lord, Lord Skidelsky, has raised very important questions today. I fully realise that the Government have no control over supplies of oil and gas, or the price of them. However, we are entitled to hear what their views are on the economic situation arising from both these factors. We also need to hear what positive and practical steps the Government will take now—not in the long term—to reduce this country's almost total dependence on imported supplies. I hope that the Minister will tell us of firm, practical and immediate steps that the Government will take to protect this country's interests.

I thought while I was listening to the debate earlier that it was like attending a lecture given by experts. I very much hope that the Minister will be able to continue in that vein and answer my questions.

Photo of Lord McKenzie of Luton Lord McKenzie of Luton Government Whip 7:49 pm, 8th June 2005

My Lords, I thank the noble Lord, Lord Skidelsky, for initiating this debate and all noble Lords who have spoken it. I thank them too for the collective optimism which they have by and large shown. We have had input of the highest quality and expertise, as a number of noble Lords have recognised.

It has been an interesting and stimulating debate, and certainly a topical one. Oil prices reached all-time highs in April in nominal terms, and I welcome the opportunity to review their economic and political effects in this House.

Concern about oil prices is deeply rooted in the crisis of the 1970s, when we learnt, to our cost, of the far-reaching economic and political consequences that an oil price shock could entail. But I reassure the House that recent high oil prices have not had, and are not likely to have, the detrimental economic impact, either domestically or globally, that has been associated with rapid oil price rises in the past. The noble Lord, Lord Newby, recognised that point.

That is so, first, because the underlying factors that drive today's high oil prices are fundamentally different from those in the 1970s; and, secondly, because the domestic stability that has been delivered by the Government's macroeconomic framework means that the UK is well placed to respond to global economic challenges. Finally, it is because the Government have taken action to reduce pressure on oil prices and to mitigate the impact of high oil prices on the economy.

During the 1970s, the increases in oil prices mainly reflected supply-side constraints. In the UK, higher oil prices led to higher inflation as firms passed the increase in production costs through to prices. At the same time, higher production costs led to lower output growth. Therefore, the UK in the 1970s experienced stagflation; that is, weak economic growth and strong inflation.

In contrast, increases in oil prices during the past year have reflected demand-side pressures. The impact of strong demand from China and other rapidly growing emerging economies has been a key driver of the marked pick-up in oil prices from mid-2004. The noble Lords, Lord Skidelsky and Lord Browne, and the noble Baroness, Lady Miller, referred to that. My noble friend Lord Desai made an interesting point about the relative inefficiency of China's manufacturing sector and the extra demand that that is putting into the system.

Although China's demand has been rising for a number of years, it coincided in 2004 with stronger demand from advanced economies. This strong growth in demand absorbed supplies, causing oil stocks and spare production capacity, which were already at low levels as an overhang of the oil price slump of the 1990s, to fall still further, which in turn magnified market concerns about geopolitical risks to supply. The noble Lord, Lord Skidelsky, and the noble Baroness, Lady Miller, referred to those risks. My noble friend Lord Desai emphasised the political perspective and said that sometimes these things are overstated.

These tight supply and demand conditions triggered upward pressure on prices, which have risen significantly during the past year. In April, they reached record nominal levels of more than $56 per barrel. With demand growth from Asia now representing a significant addition to more established demand from the major industrialised countries, and as the margin for spare capacity in oil production has dwindled during the past couple of years—increased pressure on refining capacity was also mentioned—the oil market may be more volatile in the future than in recent years, and average prices are expected to remain higher in the medium term. The noble Lord, Lord Browne, referred to this in his contribution. He had an interesting view on the longer-term price range as well.

Recent oil price rises have not had the detrimental economic impact that has been associated with rapid oil price increases in the past. Both global growth and domestic growth have remained resilient despite high and volatile prices. Three factors explain this. First, the high oil prices have been driven by strong world demand, rather than by an exogenous supply shock as in the 1970s. As a result, positive demand effects have offset negative supply effects. Secondly, while oil prices have reached nominal highs, they have remained below historical peaks in real terms at less than half the levels experienced in the late 1970s and early 1980s. A number of noble Lords recognised this. Thirdly, lower energy intensity means that the global and UK economies are today less exposed to oil price shocks. For the UK, energy use as a proportion of GDP has fallen by more than 40 per cent since 1970.

Moreover, the UK economy today is founded on stability, in contrast to the volatility and high inflation that has dogged it in the past. The UK is therefore better placed to deal with the challenges of the global economy, including those posed by higher oil prices. In fact, the net short-term impact on UK GDP of recent high oil prices is judged to be broadly neutral, as the demand-led nature of price increases has meant that positive demand effects have offset negative supply effects. Furthermore, thanks partly to the credibility of the new monetary policy framework, increases in oil prices have not led to significant wage or general inflationary pressures. Macroeconomic stability with low inflation is a key to the UK's continued successful economic performance, and the Government will continue to be vigilant to the risks in order to secure this hard-won stability.

2004 was a year of particularly fast global growth. The domestic stability delivered by the Government's macroeconomic framework has allowed the UK economy to benefit significantly from robust global conditions. Unemployment rates are at record lows; UK GDP has grown for 51 consecutive quarters; the UK is enjoying the longest period of sustained low inflation since the 1960s; and interest rates, at 4.75 per cent, remain low by historical standards.

Not only have this Government delivered sound economic performance to date, but they are confident that the UK economy will remain stable and prosperous going forwards. The Treasury's forecast range for GDP growth in 2005 has remained unchanged since Budget 2003 at 3 to 3.5 per cent. To those who question the forecast, and some have, I say that the Treasury's forecasting record is excellent.

Turning aside from the effects of oil prices on the wider economy and to their direct effect on UK households, I should say that it is a fact that the cost of motoring has become cheaper for an average household as a proportion of income. It is significantly less than it was 25 years ago, and around 5 per cent less than it was in 1997.

None the less, the Government are aware that high oil prices are a cause for concern for consumers. It remains government policy to raise fuel duty at least in line with inflation each year as we seek to pay for essential public services and to meet our targets for reducing polluting emissions. However, in recognition of the sustained volatility in the global oil market, the Chancellor did not go ahead with the planned Budget 2004 increase and has deferred this year's inflation-only increase until 1 September.

Finally, when considering the impact of high oil prices on the UK economy, we should not forget that the UK differs from most other major industrialised economies in that it is a small net exporter of oil. The high price of oil was a significant contributory factor to the record upstream profits recorded by the major oil companies during 2004. This in turn had a direct beneficial impact on the UK Exchequer. That has been recognised today.

The increased profits generated from North Sea oil production resulted in increased UK oil tax revenues in 2004–05 of £1.75 billion over forecast. This is to be welcomed.

The high oil price has helped to stimulate investment in the North Sea, which will benefit the UK going forwards. Industry reports that the number of exploration and appraisal wells drilled in 2004 was the highest since 1998, and a 15 per cent increase in investment expenditure is planned for 2005. The Government actively encourage this investment. 100 per cent capital allowances are given for virtually all capital expenditure in the North Sea, and a 6 per cent exploration expenditure supplement helps to preserve the value of these allowances for companies without profit cover.

The noble Lord, Lord Selsdon, asked about the full projections of tax revenues. I do not have those figures to hand or the current level. If I were to hazard a guess, they would be of the order of £4 billion to £5 billion a year, but I do not have the official figure.

The noble Lord asked whether we stockpile oil in UK. The answer is "No", except that we comply with our EU obligations in that regard.

There were references to decommissioning costs, which is a significant issue for oil companies; but I know that the Government are in discussion with them, particularly on the tax treatment.

The noble Lord, Lord Newby, tempted me to project the impact of tax revenues on high oil prices. It is important to recognise that it does not all go one way; yes, if prices go up, tax revenues from the North Sea directly increase, but there is an impact on a lower demand for petrol hitting fuel duty revenues, and higher pump prices feeding into inflation and affecting the indexation of tax thresholds. Those interactions need to be taken into account as well.

As for the advice to the Monetary Policy Committee on high oil prices, monetary policy decisions are for the committee, and the Government do not comment on its individual decisions, as doing so would damage hard-won credibility for monetary policy.

While the effect of high oil prices on the economy has so far been relatively benign, the Government have not been complacent. In October 2004, the Chancellor proposed new measures to bring stability to oil markets and to help to ensure that high oil prices did not undermine global growth. The Chancellor called for OPEC to take action to return prices to levels consistent with global economic prosperity; for action to improve the functioning of the oil market to ensure lower and more stable prices over the medium term; for more to be done to encourage investment; and for all countries to do more to promote greater energy efficiency and develop new sources of energy.

Several noble Lords referred to the need to develop different sources of energy. The noble Lord, Lord Browne, in particular stressed the point about the long lead time to making sure that they can be developed commercially.

During the UK's G7 presidency in 2005, we have worked to gain consensus in the G7 to ensure that these measures be taken forward. G7 Finance Ministers have called on energy producers to ensure that sufficient supplies are made available; stressed the importance of transparency in the oil market in reducing volatility and facilitating investment, and so called for international institutions to work together to improve oil market data, including on reserves; called on international institutions to work with oil producing countries to ensure a climate conducive to investment; highlighted the role of the extractive industries transparency initiative in increasing fiscal transparency and improving the use to which oil revenues are put; and stressed the importance of strengthening medium-term energy supply, increasing energy efficiency, and the role of technology and innovation in ensuring energy security.

The G8 will be progressing the energy efficiency measures through the climate change agenda. A UK objective for the 2005 G8 presidency is to raise the profile of climate change as a matter deserving the urgent attention of heads of state in the G8 and outside it, so as to gain international consensus on the need for further action to control greenhouse gas emissions. When the UK holds the EU presidency in the second half of this year, an objective for the presidency will be to continue to develop an EU medium to long-term strategy to tackle climate change.

The noble Baroness, Lady Miller of Hendon, pressed me on a matter with regard to the effect of oil prices and the longer range projections, to see whether I could give a more positive response than the one she had previously received in writing. All that I can promise her specifically on that is another follow-up in writing—but I promise her that I shall get on to that.

Over the past year, oil prices have risen rapidly and reached record nominal levels. It is therefore right that we are aware of, and alert to, any potential negative economic or political effects that such prices could precipitate. While the Government judge high oil prices to be a downside risk to global and domestic growth prospects, our assessment is that their impact has thus far been benign. Nevertheless, the Government have not been complacent. We have worked with the G7 to ensure that work to improve the functioning of the oil market and to mitigate the impact of high oil prices is being taken forward by international financial institutions. The Government will remain vigilant to the risk that oil prices pose, in order to secure our hard-won stability and unprecedented growth performance going forwards.

House adjourned at five minutes past eight o'clock.

The first four Statements should have been printed on Tuesday 7 June.