Gathering Storm II: get ready for a potential Category 5 energy hurricane, political instability included.

• Author: Verleger, Philip K., Jr.

Eleven years ago, I wrote "Energy: A Gathering Storm" for a volume edited by Fred Bergsten and published in early 2005 by the Peterson Institute for International Economics. The book highlighted the issues Bergsten and others at the Peterson Institute thought would be critical in the next decade. I was concerned that crude oil might rise from $40 per barrel, the price at that time, to an unbelievable $160. The key paragraph in my paper spelled out this warning:

Crude prices could climb from the present average in the $40s to perhaps $55 by mid 2005 and as high as $70 in 2006 should "shortage conditions" occur in those years. Even higher prices might be seen later in the decade. In theory, crude prices might reach $160 per barrel if history follows the 1973 script precisely [emphasis added]. As already noted, conditions today are propitious for such an increase. This does not imply, though, that prices will go up in 2005 or 2006. Circumstances are favorable, but that is all that can be said. Looking back, only one of the potential problems identified by Bergsten materialized. To borrow a baseball phrase, the Peterson Institute went one for five. My analysis was correct. Oil prices did rise to almost $160 for the very reasons I described: underinvestment in supply, environmental regulations that limited diesel fuel supplies, and growth in Asian demand.

The International Economy published a much shorter version of the 2004 paper in its Winter 2006 issue. There, I noted again that conditions were propitious for very high prices. I also cautioned that higher oil prices would depress global economic activity. In fact, the 2004 paper presented a formula for calculating the impact, one that proved remarkably accurate given the trend in oil prices, as can be seen from Figure 1. This graph shows the actual change in real U.S. GDP from the prior year for 2005 through 2014 as well as the impact of higher prices on GDP projected in the 2005 paper. With the exception of 2007, 2008, and 2009, the predictions were remarkably on track.

Today, a new storm is on the horizon. It will form out of the collapse of investment in oil and gas production. A year ago, the International Energy Agency projected that the oil and gas industries must invest as much as $800 billion per year in exploration activities to develop the capacity needed for future demand. Today, it is clear that such investment will fall 50 percent to 60 percent below this level in 2015 and 2016. Furthermore, investment in future years will probably not reach the necessary levels. Figure 2 shows the growing gap between the forecasted investment requirements and the exploration and production spending that can be expected.

This...