The speed has been breathtaking. Oil prices have moved from $87 per barrel in February to around $120 per barrel in April. Two years ago, in 2006, CERA envisioned such a dramatic shift in the oil price playing field in our Break Point scenario, which projected an annual average price of $120 per barrel (see Figure 1). To be sure, the future does not unfold neatly in line with any projection, and the time frame of the actual price surge has been remarkably short. But the factors leading to this turn of events and the world’s early responses to it are similar to what we described in our Break Point scenario—a world in which prices spike to $150 per barrel.

What we want to do now is look at what we conceived as the drivers of $120 per barrel oil—and compare them to the forces at work today. But there is another aspect to Break Point as well—the response on both the supply and demand sides. And we want to consider how that response is  unfolding, and may unfold in the years ahead. For we doubt that the laws of economics have been abolished. Nor have the pressures been abolished on politicians to respond—and to be seen as responding. Moreover, higher prices accentuate energy security concerns and reinforce market responses. In this case, the responses may well dovetail with increasingly significant climate change policies.

At the heart of the Break Point scenario is a slow pace of growth in liquids supply that reflects the range of aboveground risks. “Decision making to facilitate new development in oil-exporting countries loses its urgency,” we wrote. “Many countries with large oil endowments feel less pressure to expand production as the continued surge in revenues pours into their rainy day oil funds.” Current headlines about the future of oil production capacity in the world’s two largest producers—Saudi Arabia and Russia—have their own specific drivers, but the market’s interpretation is that supply growth is highly uncertain and may fall short. The amount of money flowing into the “rainy day oil funds”—now rechristened as sovereign wealth funds—has been enormous. Those mounting financial surpluses certainly reduce the urgency to expand capacity. Lower expectations for demand growth are having the same effect.

We have not seen a single massive disruption, but rather a series that adds up to what we have called the “aggregate disruption.” Venezuela’s output has fallen by more than 700,000 barrels per day (bd) since oil prices began to rise in 2003. In Nigeria close to 1 million barrels per day (mbd) is currently shut in. Iraq’s production, at least for now, remains stuck in a narrow range of 2 to 2.4 mbd—far below its potential. There are also demand-side disruptions such as the sidelining of nuclear power plants in Japan because of earthquakes. This has added up to 200,000 bd to oil demand. All these disruptions not only limit spare capacity but also build into the price of oil an almost-permanent security premium.

One factor that we see today was clear to us two years ago; and one was unanticipated. We could already observe the impact of rapidly rising development costs and were in fact at the same time developing our Upstream Capital Costs Index (UCCI). Rising costs for equipment, people, and skills have been a great drag on a supply response, at least so far. According to the UCCI, a new oil development today will cost essentially double what it would have cost three years ago.

What we did not envision in the scenario was the collapse in the value of the dollar. This has accelerated a flight to commodities and brought many more financial buyers into the oil markets. They treat oil—and other commodities—as a financial asset class. The dollar has lost nearly half its value against the euro since 2002—and trading in crude oil contracts on NYMEX is up 350 percent over the same period. This reflects more than just people hedging their own physical supply. The weight of noncommercial participants in the oil market is more significant and has a greater influence on price.

Demand is where the threads of different scenarios overlap. Yes, we see weaker demand in the United States. The European economy is beginning to show signs of slowing. But demand growth in Asia and the Middle East is continuing its high pace. This is more consistent with another scenario we refer to as Asian Phoenix—characterized by strong global economic growth led by Asian countries (see “Break Point, the Dawn of a New Age, and CERA’s Global Energy Forum”). Of course, in many of those countries, government price controls prevent the full impact of higher prices from flowing directly to consumers.

The move to $150 per barrel in the Break Point scenario is the world’s “fourth oil shock.” Prices at such levels create their own negative effects on the world economy. As we wrote in Break Point, “The price jump has a chilling effect on an already weak global economy.…Consumer confidence plummets and companies suspend decisions on major capital projects. Political leaders plead for energy conservation and driving restrictions are introduced in several major cities.” On April 22, 2008—when oil prices surged past $119 per barrel—the Bush Administration announced an accelerated adoption of the December 2007 higher fuel economy standards for light duty vehicles.

We are in the sixth year of an extraordinary run-up in oil prices. During the 1970s—a decade that saw two oil shocks—prices rose for eight  consecutive years before falling. Break Point envisages prices rising for more than a decade amid increasing industry costs and extreme competition for oil supplies and upstream assets. Only then does the world reach a  “break point”—the point at which policy, technology, and alternative fuels  everse the oil price rise and oil loses its near monopoly in transportation.

The massive scale of the oil industry and the infrastructure to deliver oil products means that any paradigm shift in liquid fuels supply and  consumption will take many years to unfold, not months. Few transitions are smooth—and certainly not one that involves a commodity that is the cornerstone of personal mobility and the enabler of global trade. But the seeds of change are being sown. And, as the swift arrival of Break Point prices has proved, some of the results may come sooner than anticipated.

Turbulent times create the opportunity for structural change in geopolitics and markets. Today’s astonishingly high oil prices are catalyzing a new mix of government policy, market response, and technological innovation—all on a global scale. Biofuels have seen explosive growth in the past year. The increase in ethanol production in 2007 was 200,000 bd. If compared with countries, this rate of growth would have placed ethanol at number five—just behind Azerbaijan—among those countries that saw oil production rise last year. The past few months, however, have also seen a growing backlash against biofuels on environmental grounds and, more significantly, because of inflation and shortages of food around the world.

Coal-to-liquids (CTL), although expensive and capital intensive, is attracting investment capital, particularly in China, where CTL production capacity is set to rise from 240,000 bd in 2007 to around 1 mbd in the next decade or so. Given China’s vast coal resources, that number could be even higher if energy security concerns prompt greater government support for CTL.

Although no single fuel can unilaterally blunt the oil price rise, the “great bubbling” of innovation and experimentation can, in aggregate, lead to a meaningful increase in liquid fuel supplies over the next decade—even if growth in conventional oil supply remains tepid.

On the demand side, the slow turnover of capital stock means that changes today will only have a large impact many years later. But that impact can be huge. The new US vehicle fuel economy standards combined with advances in battery technology could lead to a reduction in gasoline consumption before 2020. When including the mandated growth in biofuels, the drop in conventional gasoline demand could be significant by 2015. Here is where the interactions get more complicated, because the possibility of lower future demand is cited by some exporters as the reason not to expand capacity.

Is change simply confined to the supply and demand for liquid fuels? The rise of new centers of wealth in Asia, the Middle East, and Eurasia highlight the challenge for the global institutions of the twentieth century to adapt to the emerging realties of the twenty-first century. Major change is most likely to occur during a crisis. Could the world’s energy and environmental challenges lead to new stage of development for international cooperation and global institutions?

In the Break Point scenario, the world’s leading energy-consuming nations “after years of muddling through—and struggling—to meet the challenges posed by skyrocketing oil prices…acknowledge the inadequacy of a disjointed approach to coping with oil supply disruptions.” Linked to this is the rising concern about climate change that has “grown with each passing year.” Not only have European leaders reaffirmed their commitment to limit carbon dioxide emissions, but the European Union has also raised its reduction targets. In the United States, regulation of carbon emissions now appears inevitable—a significant change from just a few years ago. China and India are looking at energy and environmental issues as an integral part of national development objectives—a very different viewpoint from three years ago.

Concern about energy supply is not the only factor in the reshaping of global affairs in Break Point. The economic slowdown, in which high oil prices are a key player, leads to “weak Western demand for imported manufactured goods and offshore services.” This eventually slows growth in China, India, and other major emerging markets. What is not in the scenario is the current heating up of inflation, which is leading some countries to try to cool their economies.

After years of painful adjustment, major powers recognize the reality that a global response to energy woes is not only effective, but essential. In Break Point, leading consuming and producing countries widen and deepen their cooperation.

Very high oil prices will change the world. The Break Point scenario has many similarities with what is happening today—especially in the oil market. The early twentieth century saw the transition from an economy dominated by coal to one with oil at the center of its most dynamic and strategic industries. As Break Point posits, “The first part of the twenty-first century sees the beginnings of a similar transition.” But in this case, the transition will not be “from one dominant fuel to another.” Rather, we will see “a migration toward a more complex mix of multiple energy sources.”

In the Break Point scenario, oil loses its almost total domination in transportation. By 2010, as we anticipate in CERA’s new Driving the Future Forum—which is focused on the interaction of energy and transportation—we will start to see signposts about the timing and the extent to which such a transition will actually occur. What the Break Point and the scenario process continue to do is open our eyes and sharpen our sight to the changes that may lie ahead.

CERA’s Dawn of a New Age Multiclient Study was the result of a year-long study completed in 2006. Participants included over 70 companies from around the world along with a number of experts across a range of fields. The objective of Dawn of a New Age was to create a framework for evaluating strategy, testing investment decisions, and understanding the underlying forces of change in the world. This was accomplished by developing three distinct and sharply etched global energy scenarios: Asian Phoenix (high growth; global economic shift toward Asia ); Break Point; and Global Fissures (poorer economic performance, protectionism, and backlash against globalization).

Our Dawn of New Age study laid the groundwork for CERA’s new Global Energy Forum, which is a strategically focused advisory research service that integrates the thought leadership from across CERA’s regional and energy sector practices to provide a broad view of the global landscape in tandem with our deep knowledge of the energy industry. The Global Energy Forum draws upon the Dawn of a New Age analytical framework and the scenario methodology, extending and enriching the discourse begun by the study through a series of interactive, highlevel meetings and ongoing research and analysis. The innaugural Global Energy Summit will be held on May 19-20, 2008 , in Cambridge, Massachusetts.

For more information on Dawn of a New Age and the Global Energy Forum, contact Richard Morris at +1 617 866 5121 or rmorris@cera.com .

DANIEL YERGIN is a highly respected authority on international politics and economics and on energy. Dr.Yergin is a Pulitzer Prize winner and recipient of the United States Energy Award for “lifelong achievements in energy and the promotion of international understanding.” He is Chairman of Cambridge Energy Research

Associates (CERA) and Executive Vice President, IHS. Dr. Yergin received the Pulitzer Prize for his work The Prize: The Epic Quest for Oil, Money and Power. His most recent book Commanding Heights: The Battle for the World Economy has been translated into 13 languages. He was Chairman of both CERA’s Dawn of a New Age: Global Energy Scenarios for Strategic Decision Making—The Energy Future to 2030 Multiclient Study and CERA’s recent Crossing the Divide Multiclient Study on clean energy. He was Vice Chairman of the US National Petroleum Council (NPC) committee that provided recommendations on US oil and gas policy to the US Secretary of Energy in the 2007 NPC report Facing the Hard Truths About Energy.

JAMES BURKHARD, Managing Director of CERA’s Global Oil Group, leads the team of CERA experts that analyze and assess upstream and downstream business conditions and strategies. His team also develops and maintains detailed short- and long-term outlooks for global crude oil and refined products markets. Mr. Burkhard was the project director of Dawn of a New Age: Global Energy Scenarios for Strategic Decision Making—The Energy Future to 2030, the most  omprehensive study that CERA has ever undertaken, encompassing the oil, gas, and electricity sectors. He is also the coauthor of CERA’s respected World Oil Watch, which  analyzes short- to medium-term developments in the oil market. In addition to leading CERA’s oil research, Mr. Burkhard served on the US National Petroleum Council (NPC) committee that provided recommendations on US oil and gas policy to the US Secretary of Energy. He led the team that developed demand-oriented  recommendations that were published in the 2007 NPC report Facing the Hard Truths About Energy.