International Energy Agency head urges "revolution" to fight oil crisis

An "energy revolution" to cut demand is necessary to combat the world's third energy crisis in 35 years, the head of the International Energy Agency (IEA) said on Monday.

IEA Executive Director Nobuo Tanaka said the current oil price shock was unique because demand has remained robust despite prices climbing to $135 a barrel two weeks ago.

In contrast, global consumption fell after the 1973 Arab oil embargo and the Iranian revolution of 1979 as countries turned to more energy efficient transportation and power plants.

"We are in a third energy crisis," he said during the Reuters Energy Summit.

"Our response should be an energy revolution. We have to change dramatically the demand side by efficiency and new technologies."

The IEA sees an increase in world oil demand this year as consumption in emerging economies outweighs a slowdown in the United States and Europe.

"In China, India the Middle East, demand is very, very robust. We haven't seen any indication that there is a slow down," he said.

In the IEA's outlook report last month, the adviser to 27 industrialized nations forecast global demand will rise by 1.03 million barrels per day.

But that is down significantly from its estimates a year ago due to the economic slowdown in the United States.

Tanaka has urged industrialized countries to speed up plans to boost automobile fuel efficiency standards, improve efficiency of power plants and take hard action on heat trapping greenhouse gases.

Even with these changes, he believed oil prices were likely to remain at historically high levels because of a variety of factors, including limited spare capacity and stock levels.

"Oil prices may not easily go back to the level of two, three years ago, probably that is very unlikely," he said.

End of NICE decade is rude shock for investors:James Saft

The demise of the NICE decade of low inflation and steady growth, mourned by Bank of England Governor Mervyn King, means tough times are ahead for most financial assets.

Calling it the "most difficult challenge yet" for Britain's 11-year-old Monetary Policy Committee, King last week declared the decade of non-inflationary consistent expansion (NICE) over and done, as tight credit and rising inflation force a rebalancing from consumption and borrowing to production and savings.

That is bad news for King and Britain, as the bank will have little freedom to ease the economy's transition by lowering interest rates.

But it will be bad news for financial markets as well, and not just in Britain. Inflation and economic growth will be choppier and less predictable, and so therefore will be company profits.

And if there is one thing investors hate, quite rightly, it is unpredictability. They will react, almost mechanically, to this new volatility by demanding an extra risk premium for holding stocks and bonds.

That extra premium implies, all other things being equal, lower prices for the same earnings power in a stock or a bond.

"We are at the start of the decade of great instability for both real economies and asset markets," said Lena Komileva, an economist and strategist at brokerage Tullett Prebon in London.

"At a time when the cost of finance is decided in asset markets, outside the control of central banks, increased macroeconomic instability and rising asset price volatility as a result will compound the effects of the credit crunch.

"With cheap leverage no longer available, an adverse macroeconomic environment will make the correction of asset valuations in line with real fundamentals that much more painful."

The NICE decade is a manifestation of the broader phenomenon that economists have dubbed the Great Moderation.

Since the 1980s the economies of the West, led by the United States, have enjoyed fewer and less severe downturns, a period characterized above all by less volatility in the economy both in terms of growth and inflation.

There has been a lot of debate about what caused such an extended period of predictability, but what is clear is that the benefits have been huge. It has made it easier for governments, companies and individuals to plan their investment and consumption.

It has also probably contributed to a fall in savings in the English speaking economies, as rainy days have been few and far between.

All that seems to be changing.

THE HIGH VALUE OF PREDICTABILITY

If the Great Moderation is on the way out, investors will simply have to get used to more volatility.

To get a sense of how important this is, look at the premium investors paid for General Electric shares during its period of steady earnings expansion. Or conversely, look at the very low multiple of earnings shareholders are willing to pay to hold investment banking shares, which historically experience huge volatility in earnings.

And though Britain has gone longer without a recession, there is no doubt that the United States has also benefited from low and stable inflation and is now seeing rising inflationary pressure.

More than 20 percent of Britons polled in a survey by the Bank of England and GFK expect inflation to rise by five percent or more in the next year.

In the United States, the Reuters/University of Michigan survey of consumer sentiment, released on Friday, showed that median year-ahead inflation expectations jumped to 5.2 percent in May from 4.8 percent in April, the highest since the dark days of February 1982, when inflation was raging and the Great Moderation just a gleam in Paul Volcker's eye.

The latest bout of inflation is being caused by skyrocketing prices for agricultural commodities and energy. And whereas emerging markets like China were only one or two years ago supplying disinflation to the west through competition and cheap manufactured goods, these countries are now themselves in the grip of rising wages as well as commodity prices, making them a source of inflation.

Russell Jones, a fixed income strategist at Royal Bank of Canada in London, thinks that rising volatility won't just hit asset prices across the board.

"Volatility also heightens risk aversion as well," he said. "People are frightened off by volatility and they will keep their money in less risky asset."

Jones thinks Britain faces a period he characterizes as "evil," for Exacting period of Volatile Inflation and Low growth.

Quite possibly it won't be that bad, but two things are reasonably sure: central banks will not have the same freedom to lower rates they have used in the past to dampen economic volatility, and investors will have to grapple with the costs.

At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.