Unwanted Offspring

Imagine that it is January 2000, and you are asked to look into a crystal ball and predict the course of the global economy over the next six years. The misty glass gives you some hints: the coming stock-market collapse, followed by suicide airliner attacks on the Twin Towers and two protracted wars, all leading to a quadrupling in the price of oil. Faced with these facts, no one would have foreseen the economy's response: between 2000 and 2006, global per capita GDP rose by 3.2 percent per year, the fastest six-year growth spurt in recorded history.

What explains this astonishingly resilient world? The two comparable periods are the first era of Western industrialization in the late 19th century, and the postwar period when Europe rebuilt itself and East Asia was rising from the depths of poverty. In other words, broad structural shifts created a tidal wave of growth that overwhelmed the business cycles and political tensions of the age.

Today the world is going through a similar shift. For the first time there is a genuinely global economy. Over the last 15 years, virtually all countries have come to govern themselves by the basic rules of open trade and markets. From India to China and Costa Rica to South Africa, the "emerging markets"--really, the emerged markets--now make up 30 percent of global GDP. More significantly, they now account for 50 percent of the growth in global GDP. The immediate effect of all this growth is rising demand, particularly for raw materials and energy. (Commodity prices are not simply high, they are at 200-year highs.) That's a big reason that this oil-price shock has not slowed the economy: the spike is the result of a boom in demand, not a sudden squeeze in supply. The growth spurring this demand is also having all kinds of beneficial effects that mitigate the impact of pricey oil.

Look around and you will see an odd phenomenon in this world of markets, capitalism and globalization. There is a group of countries that can flout all the rules, resist modernization, spout anti-Western sentiments, even anticapitalist rhetoric, and still keep going strong. The list is obvious: Iran, Saudi Arabia, Russia, Venezuela. These oil-rich countries are islands of exception to the new rules of the global economy; indeed, their exceptional existence is made possible by the success of the global market.

This is the yin and yang of the modern global economy. Global capitalism creates demand, which creates space for noncapitalists. Do not expect this phenomenon to pass any time soon. It is part of the structure of the new order.

Consider the political consequences: Venezuela has been engaged in the most spirited challenge to American interests in the Western Hemisphere in a generation. Iran is making a bid to become the regional hegemon in the Middle East. Russia, arguably the richest country in the world in natural resources, is attempting nothing less than the conquest of its old empire.

In the short term, power has moved to the petrol producers. The major Western oil companies are now bit players in the drama of global oil. ExxonMobil, the largest of the majors, ranks No. 14 based on the size of its oil and gas reserves. All the ones above it are national oil companies--from Saudi Aramco to PDVSA of Venezuela.

Oil supplies will stay tight for a simple reason. There are only five countries that matter in the world of oil--Saudi Arabia, Iran, Russia, Iraq and Venezuela. In none of these countries, with the possible exception of Saudi Arabia, are serious efforts and investments being made to increase and expand the supply of oil. Russian production is growing at less than 3 percent a year. Iran is flat, Iraq is in chaos and Venezuelan production has dropped 50 percent since Hugo Chávez took office.

What all these nations need is government that would invest the oil windfalls in expanding production and supply--but that would take 10 to 15 years to bear fruit. And all these dysfunctional regimes are too busy buying off their populations with cheap subsidies. Unless these governments cease to behave as islands of corruption and dysfunction, they will slowly but surely sow the seeds of their own long-term decline.

The necessary investments are huge. Goldman Sachs's Jeffrey Currie estimates that it would take $3.5 trillion (yes, trillion) in the next decade to keep up with rising demand. Actual investments are going to be much lower, suggesting that the price of oil will likely stay high in the medium term.

One could imagine ways that this price could be lowered. After all, there is a producers' cartel in oil, but no union for consumers. While the United States and China eye each other's oil deals warily, and India and China compete to lock up new supplies, there's no reason for this jousting. All these powers share an interest in steady supplies at prices set by the market, not cartels or speculative manipulations. Is it too farfetched to imagine informal cooperation among the key consuming nations?

One certain consequence of high oil prices will be to focus attention on technologies of extraction. In 1859, Col. Edward Drake struck oil at 69 feet. Today, as energy analysts Peter Huber and Mark Mills note, "it is not unusual to drill for oil through 10,000 feet of water, 20,000 feet of vertical rock, and another 30,000 feet of horizontal rock." And the cost of the 10-mile oil is about the same as Drake's 69-foot oil.

There's an even bigger shift underway, from fuel to electricity. In 1950, 20 percent of U.S. economic output came from industries powered by electricity. Today that number is 60 percent and rising fast. All the growth sectors, from technology to services, are powered by the grid, not gasoline. What will feed this grid--coal, nuclear power or new technologies--is another large subject, but one thing is certain: it will not be oil.

Petrol is increasingly confined to one pivotal sector, transportation. And even in this sector the future is electric. Within 10 to 20 years, depending on market forces and government efforts, hybrid electric motors will replace the internal-combustion engine. At that point, neither oil nor oil companies and states will disappear. But they will go from being the lifeblood of the industrial world to just one of its many sources of energy. After a century and a half, oil will be put in its proper place.