Oil and gas prices in 2008 saw some of their biggest swings in history. In July they were at their highest levels ever in nominal terms. By year end they were at their lowest in five years (though still above their 25-year nominal average). The sudden and severe economic downturn explains the sharp drop. Lower levels of economic activity mean less energy is used. However, it is the rise in prices in the past five years, and the big price swings, that matter more for the long term. Energy prices are likely to remain more volatile, and, on average, higher than they have been in the past.

This is mainly because of our second hard truth: that energy supplies will struggle to keep up with growing demand. That struggle is new. In the past, a number of countries had extra capacity in reserve. They could quickly bring it into production to respond to unexpected jumps in oil demand, even at points when economic growth was strongest. This moderated volatility and demand-driven price rises. However, that reserve capacity got used up over the last decade. It was needed to meet rapid growth in demand and to make up for a faster than expected decline in production from mature fields. At the moment, there is some extra capacity again because of the recession. However, the buffer is depleted so that when growth returns to the global economy even minor changes in demand will move prices.

Nor is there much chance of building up a new buffer of reserve capacity. As the International Energy Agency has shown, even before the recession investment activity industry-wide was struggling just to keep up with the long-term growth in demand. A doubling of production costs across the industry in the last five years has added to the challenge. The current lower oil prices are reducing investment across the industry at a time when it needs to be rising to prepare for the return of economic growth.

Shell, with 2% of the world’s oil and 3% of its natural gas production, cannot influence global energy prices. Like everyone else, we are preparing for a world of more volatile and on average higher prices.