Oil still has the power to humble leaders who fail to hedge their bets

The price of oil can still upset the scheme of the great and powerful

The sun sets behind an oil well sited in the middle of a soybean field
How should politicians cope with volatile oil prices? Credit: Photo: Getty Images

Oil and gas matter. They provide about 50pc of the world’s total energy needs (coal provides about another 30pc). The ten largest oil and gas companies, including Sinopec, Royal Dutch Shell, Exxon Mobil and BP have combined sales of $2.6 trillion.

This is nothing new. In his classic history of the oil industry – The Prize – Daniel Yergin described the role of oil in deciding the Second World War. Better 100-octane aviation fuel gave the Spitfires an edge in the Battle of Britain; victory in the Battle of the Atlantic kept the oil flowing and Britain fighting. The destruction of synthetic fuel plants doomed the German war effort to slow defeat and shortages stalled the Afrika Korp.

The successful restriction of oil supplies to Japan meant its fearsome military was, in the end, unable even to defend the cities of the home islands against American bombers, let alone maintain its imperial ambitions. Its people resorted to collecting pine roots in a vain attempt to keep the planes flying with an awful home-brewed aviation fuel.

Oil has been a constant strategic challenge since the war, as producing countries try to use their natural resources to extract money or strategic concessions from the West. Until recently people mistook a combination of political obstacles and a cyclical rise in oil prices for a fundamental and lasting shortage. The world was going to have to adjust to an imminent “peak oil”. Now the taps are well and truly open and the international benchmark oil price has fallen from over $100 a barrel to barely $40.

You need to be brave or foolish to bet too much on where the oil price might go next but, for now, it looks likely to remain depressed. Saudi Arabia has let the price fall in order to try and starve out marginal supply from new sources in the US. If Iranian supplies re-enter the markets that price might fall further and the increasing technological sophistication of the US shale industry could put a lid on any rise.

The amazing thing is to watch live as a changing oil price does its traditional job upsetting even the most carefully laid political plans.

The Scottish National Party did incredibly well at the election in May. They could have another go at holding an independence referendum, but what would happen if they won?

The North Sea is generally an expensive place to extract oil and gas these days and at anywhere near these sorts of prices it is not going to supply the revenue on which the already-tenuous economic case for Scottish Independence was based. A great triumph for Nicola Sturgeon might soon look like a reprise of the ill-fated Darien scheme, which first led a ruined Scotland to seek the security of the United Kingdom.

Not so long ago, there were many people on the left and right of British politics who saw Vladimir Putin as a brilliant “grandmaster”, humiliating our own bumbling politicians. That was never the reality. Losing your legitimacy in the rest of Ukraine and getting stuck in an ugly and expensive proxy war, for the sake of an impoverished client in East Ukraine and a Crimea your navy already dominated is no masterstroke. It looks downright dangerous now as the impact of Western sanctions, the enormous problems facing Gazprom and particularly the fall in the oil price have sent the Russian economy into a nasty recession.

This is not the first time the fate of Russian strategic ambitions has turned on the oil price. The Soviet Union’s final decline and fall resulted, in part, from a similar fall in the oil price in response to the Saudis turning on the taps in the 1980s.

Our own leaders have their own problem with low oil prices. The climate change policy implanted by Labour and Conservative ministers, which is based on a mix of carbon pricing and subsidies for expensive renewable energy and green taxes, is going to be even more expensive if it is trying to displace relatively cheap fossil fuels.

Ministers and officials quietly hoped that the high costs of attempting to shift to alternative sources of energy like offshore wind would be covered by rising oil and gas prices. Instead, they might need to adjust to a world where new technology means there is almost a bottomless well and it is even harder for renewable energy to compete.

The UK only produces a tiny share of global greenhouse gas emissions. Our green policies have always been about taking the lead in the decarbonisation of energy to encourage other countries to follow suite. That now looks like hubris.

What should politicians do in the face of such uncertainty? The answer is that we need to hedge our bets.

Scotland is better off for being able to pool its fiscal risks in the United Kingdom. The larger UK is less dependent on oil and gas revenues and can develop new shale gas resources to offset the slow decline of North Sea production.

Russia’s leaders need to stop throwing their weight around and relying on the oil and gas sector to pay the bills. They will need to develop the kind of robust market institutions that have been the foundation of prosperity elsewhere.

Finally, our own politicians should try a new approach to climate change policy not so easily upset by changes in international markets or politics. Alternatives to fossil fuels need to be properly developed before they’re ready to scale up, rather than being pressed into action when they’re hopelessly uncompetitive in the delusional hope that costs will fall enough if the subsidies create a big enough market.

Then we can have better alternatives ready if prices do rise, but domestic and industrial consumers won’t face punishing costs while fossil fuels remain cheap. At the same time we can use the windfall from lower energy prices, while they last, to strengthen our societies to adapt to whatever the climate throws at them.

The oil price can still ruin the grand schemes of the powerful. We are witnessing vivid examples of how important it is to be adaptable in the face of that uncertainty.

Matthew Sinclair is a senior consultant at Europe Economics