THE LONG DECLINE

7 comments

Posted on 14th April 2013 by Administrator in Economy |Politics |Social Issues

,

Gail Tverberg http://ourfiniteworld.com/ with another thoughtful piece that reveals those in the MSM and on Wall Street to be liars and frauds when it comes to our true energy situation. Even with the entire world in recession, the price of oil is above $90 per barrel. The energy consumption per capita in the US/Japan/EU peaked in 1973. We continue to use less oil, but only due a collapse in commercial activity. This continued energy usage decline reveals the storyline of economic recovery to be false. The rest of the world continues to increase their energy usage and will continue to do so. When the current recession deepens further, prices will decline further, but the Canadian tar sands and the Bakkan shale oil require prices above $80 for them to be profitable. This puts a floor on how low prices can go. The government and MSM have an agenda to keep the public ignorant of the true long-term energy situation. No matter how you cut it, there is no easy way out.

Peak Oil Demand is Already a Huge Problem

We in the United States, the Euro-zone, and Japan are already past peak oil demand. Oil demand has to do with how much oil we can afford. Many of the developed nations are not able to outbid the developing nations when it comes to the world’s limited oil supply. A chart of oil consumption shows that oil consumption peaked for the combination of the United States, EU-27, and Japan in 2005 (Figure 1).

Figure 1. Oil consumption by part of the world, based on EIA data. 2012 world consumption data estimated based on world "all liquids" production amounts.

Figure 1. Oil consumption by part of the world, based on EIA data. 2012 world consumption data estimated based on world “all liquids” production amounts.

We can see an even more pronounced version of this pattern if we look at the oil consumption of the five countries known as the PIIGS in Europe: Portugal, Italy, Ireland, Greece, and Spain. All of these countries have had serious declines in oil consumption in recent years, as high oil prices have impeded their economies.

Figure 2. Oil consumption for Portugal, Italy, Ireland, Greece, and Spain, based on EIA data.

Figure 2. Oil consumption for Portugal, Italy, Ireland, Greece, and Spain, based on EIA data.

Oil consumption for the PIIGS in total hit its highest level in 2004, before the decline began. Peak oil consumption by country varied a bit: Portugal, 2002; Italy, declining since 1995; Ireland, peak in 2007; Spain, peak in 2007; Greece, peak in 2006.

Peak demand is very much related to jobs. Peak oil demand occurs when a country is not competitive in the world market-place, and because of this, loses industry and jobs. One reason this happens is because the country’s energy cost structure is not competitive in the world market-place. With the run-up in oil prices starting about 2003, oil is by far the most expensive of the traditional energy sources we have available today. Countries that use a large percentage of oil in their energy mix can be expected to have a hard time competing, because of oil’s higher cost.

Figure 3. Oil consumption as percentage of energy consumption for selected countries, based on BP's 2012 Statistical Review of World Energy.

Figure 3. Oil consumption as percentage of energy consumption for selected countries, based on BP’s 2012 Statistical Review of World Energy.

Anything else that is done which raises costs for businesses will also have an impact. This would include “carbon taxes,” if competitors do not have them, and if there is no tariff on imported goods to reflect carbon inputs.

High-cost renewables can also have an adverse impact, regardless of whether the cost is borne by businesses, consumers or the government.

  • If the cost is borne by businesses, those businesses must raise their prices to keep the same profit margins, and because of this become less competitive.
  • If the cost is borne by consumers, those consumers will cut back on discretionary expenditures, in order to balance their budgets. This is likely to mean  a cutback in demand for discretionary goods by local consumers.
  • If the government bears the cost, it still must pass the cost back to businesses or consumers, and thus reduce competitiveness because of higher tax costs.

This importance of competitiveness holds, no matter how worthy a given approach is. If costs were “externalized” before, and are now borne by the local system, it makes the local system less competitive. For example, putting in proper pollution controls will make local industry less competitive, if the competition is Chinese industry, acting without such  controls.

One issue in competitiveness is wage levels. Wages in turn are related to standards of living. In a global economy, countries with higher wage levels for workers, and higher benefit levels for workers (such as health insurance and pensions) will be at a competitive disadvantage. Countries that use coal as their prime source of energy will be at an advantage, because workers’ wages will tend to “go farther” in heating their homes and buying electricity.

Countries that are warm in the winter will be at a competitive advantage, because homes don’t have to be built as sturdily, and don’t have to be heated in winter. Workers can commute by bicycle even in the coldest weather.

Energy usage (all types combined, not just oil) is far higher in cold countries than it is in warm wet countries. Countries that extract oil also tend to be high users of energy.

Figure 4. Per capita energy consumption for selected countries for the year 2010, based on EIA data.

Figure 4. Per capita energy consumption for selected countries for the year 2010, based on EIA data.

The difference in per capita energy usage among the various countries is truly astounding. For example, Bangladesh’s per capita energy consumption is slightly less than 2% of US energy consumption. This difference in energy consumption means that salaries can be much lower, and thus products made in Bangladesh can be much cheaper, than those made in the United States. This is part of our competitiveness problem, even apart from the energy mix problem mentioned earlier.

In my view, globalization brought on many of our current problems. Perhaps globalization could not be avoided, but we should have foreseen the problems. We could have put tariffs in place to make a more level playing field.  See my post, Twelve Reasons Why Globalization is a Huge Problem.

Inadequate world oil supply isn’t exactly the problem. The issue is far more that the price of oil extraction is rising.  The price of oil extraction is rising for a variety of reasons, an important one being that we extracted the easy to extract oil first, and what is left is more expensive to extract. Another issue is that oil exporters now have large populations that need to be kept fed and clothed, so they don’t revolt. This is a separate issue, that raises costs, even above the direct cost of extraction. There is no reason to believe that these costs will level off or fall, no matter how much oil the US produces using high-priced methods, such as fracking.

When oil prices rise, wages don’t rise at the same time. In fact, in the US there is evidence  that wages stagnate when oil prices are high, partly because fewer are employed, and partly because the wages of those employed flatten.

Figure 5. High oil prices are associated with depressed wages. Oil price through 2011 from BP’s 2012 Statistical Review of World Energy, updated to 2012 using EIA data and CPI-Urban from BLS. Average wages calculated by dividing Private Industry wages from US BEA Table 2.1 by US population, and bringing to 2012 cost level using CPI-Urban.

Figure 5. High oil prices are associated with depressed wages. Oil price through 2011 from BP’s 2012 Statistical Review of World Energy, updated to 2012 using EIA data and CPI-Urban from BLS. Average wages calculated by dividing Private Industry wages from US BEA Table 2.1 by US population, and bringing to 2012 cost level using CPI-Urban.

The countries that are most affected by rising oil prices are the countries that use oil to the greatest extent in their mix of energy products. In Figure 3, that would be the PIIGS. The rest of the US, EU-27, and Japan would be next in line.

When oil prices rise, consumers need to balance their budgets. The price of oil products and food rises, so they cut back on discretionary items.  Their smaller purchases of discretionary goods and services means that workers in discretionary sectors get laid off.

Businesses find that the price of oil used in manufacturing and shipping their products has risen. If they raise the sales price of the goods to reflect their higher costs, it means that fewer people can afford their products. This too, leads to cutbacks in sales, and layoffs of workers. Sometimes businesses decide to outsource production to a cheaper country, or use more automation, as a way of mitigating the cost increases that higher oil prices add, but automation or outsourcing also tends to reduce US wages.

The net effect of all of these changes is that there are fewer workers with jobs in the countries with high oil usage. This reduces the demand for oil in the high oil usage countries, both from business owners making goods and from the consumers who might use gasoline to drive their cars. This price mechanism is part of what leads to the oil consumption shift we see in Figure 1.

We are dealing with is close to a zero-sum game, when it comes to oil supply. The amount of oil that is extracted from the ground is almost constant (very slightly increasing for the world in total). If prices stayed at the low level they were in the past (say $20 barrel), there would not be enough to go around. Instead, higher prices redistribute oil to countries that can use it manufacture goods at low overall cost. Workers in factories making these goods are then able to afford to buy goods that use oil, such as a motor scooter.

Citigroup recently released a report titled, “Global Oil Demand Growth, – the End is Nigh.” Its subtitle says,

The substitution of natural gas for oil combined with increasing fuel economy means oil demand is approaching a tipping point.

This is out-and-out baloney, for a number of reasons:

1. There are way too many of “them” compared to the number of “us,” for energy efficiency to make even a dent in our problem.

2. When we look at past oil consumption, changes in vehicle energy efficiency did not make a big difference.

3. Substituting natural gas for oil still leaves cost levels for the US, Europe, and Japan very high, compared to those for the rest of the world, where little energy is used.

4. There are really separate markets in many parts of the globe. Our market is collapsing because of high price. Perhaps increased efficiency and natural gas substitution will help low-cost producers until they reach a different limit of some sort.

Let’s look at these issues separately.

There are way too many of “them” relative to us, for energy efficiency to even make a dent in our problem.

If we look at world population, this is what we see:

Figure 6. World population split between US, EU-27, and Japan, and the Rest of the World.

Figure 6. World population split between US, EU-27, and Japan, and the Rest of the World.

Using a ruler, we could probably make fairly reasonable projections of future population for each of these groups.

If we look at per capita oil consumption for the two groups separately, there is a huge disparity:

Figure 7. Per capita oil consumption separately for the group US, EU-27, plus Japan, and for the rest of the world, based on BP's 2102 Statistical Review of World Energy, and population statistics from EIA (since 1980) and Angus Maddison data. (earlier dates).

Figure 7. Per capita oil consumption separately for the group US, EU-27, plus Japan, and for the rest of the world, based on BP’s 2102 Statistical Review of World Energy, and population statistics from EIA (since 1980) and Angus Maddison data. (earlier dates).

Per capita oil consumption for the EU, US, and Japan group peaked in 1973–a very long time ago. In recent years, it has been drifting down fairly rapidly, just to keep up with a slight per capita rise in oil consumption of the Rest of the World. Even with recent changes, per capita oil consumption of the EU, US and Japan group is more than 4.5 times that of the rest of the world.

If cars were made more efficient, more people could afford them. The market for cars is unbelievably huge, compared to today’s market, if costs could be brought down. Furthermore, gasoline accounts for less than half of US oil consumption. Even if efficiency were improved to allow cars to use half as much fuel, it would save a little less than one-fourth of current oil consumption. How far would this oil go in satisfying the needs of 6 billion other people–and growing every year?

When we look at past oil consumption, changes in vehicle energy efficiency did not make a big difference.

If we look at per capita oil consumption in the US, split between gasoline and other oil products, we see that the big drop in oil consumption came from the drop in other oil products–that is the commercial and industrial part of US oil consumption.

Figure 8. US per capita consumption of oil products, split between gasoline and other. Total consumption from BP's 2012 Statistical Review of World Energy. Gasoline consumption from EIA. (Amounts include biofuels.)

Figure 8. US per capita consumption of oil products, split between gasoline and other. Total consumption from BP’s 2012 Statistical Review of World Energy. Gasoline consumption from EIA. (Amounts include biofuels.) Difference by subtraction.

The amount of fuel used for gasoline has stayed in the 10 to 12 barrels a year per capita band, since 1970, in spite of huge improvements in vehicle efficiency.

I recently wrote a post called Why is US Oil Consumption Lower? Better Gasoline Mileage? In it, I looked at the decrease in US oil consumption between 2005 and 2012. I concluded that the majority of the decrease in consumption was due to a drop in commercial use. Only 7% was due to an improvement in miles per gallon for gasoline powered vehicles.

Substituting natural gas for oil still leaves the US (as well as Europe and Japan) very high priced, compared to the rest of the world, that doesn’t use much energy.

Living in the US, Europe or Japan, it is  hard to get an idea of the cost structure of the rest of the world. We are so far above the cost structure of the rest of the world that substituting natural gas for oil would do little to fix the situation.

Figure 9. Photo I took of an auto-rickshaw while visiting India in October 2012. A total of 10 of us (including driver) traveled for several miles in a three-seated version of one of these. Those of us on the edges held on tightly to the frame, because there was not room for all of us.

Figure 9. Photo of an auto-rickshaw I took while visiting India in October 2012. A total of 10 of us (including driver) traveled for several miles in a three-seated version of one of these. Those of us on the edges held on tightly to the frame, because there was not room for all of us.

We can also debate how much substitution of natural gas will actually do, and in what timeframe. In the US, natural gas is temporarily very cheap. But it costs more to extract shale gas than the market currently pays, in many areas. Also, a recently University of Texas study showed that Barnett Shale was past peak production, if prices do not rise.

There are really separate markets in many parts of the globe. Our market is collapsing because of high price. Perhaps increased efficiency and natural gas substitution will help low-cost producers, until they reach a different limit of some sort.

When a country is not competitive, it is not just oil consumption that drops, but consumption of other energy products as well.  If we look at the per capita energy consumption of the US, EU-27, and Japan combined, we see that non-oil energy consumption per capita reached its peak in 2004, and is now declining (Figure 10, below).  If consumers are too poor to buy oil products, they are also too poor to buy products made with other types of energy.

Figure 10. Per capita consumption for the sum of the EU-27, US, and Japan, based on BP's 2012 Statistical Review of World Energy.

Figure 10. Per capita consumption for the sum of the EU-27, US, and Japan, based on BP’s 2012 Statistical Review of World Energy.

The Rest of the World followed a very different pattern of energy consumption. Non-oil consumption soared, on a per capita basis. Oil consumption also increased on a per capita basis.

Figure 11. Per capita energy consumption for the Rest of the World, based on BP's 2012 Statistical Review of World Energy.

Figure 11. Per capita energy consumption for the Rest of the World, based on BP’s 2012 Statistical Review of World Energy.

More detailed data shows that the big increase in non-oil consumption was a huge rise in coal consumption, after China was admitted to the World Trade Organization in December 2001.

How does peak oil demand work out in the end?

I would argue that lack of competitiveness in world markets is a limit that the US, EU-27 and Japan are hitting right now, but at slightly different rates. EU-27 now seems to be ahead in the race to the bottom, partly because its combined currency. I wrote a post in March 2012 called Why High Oil Prices Are Now Affecting Europe More Than the US, explaining the situation.

It seems to me, though, that a big piece of the problem with lack of competitiveness gets transferred to the governments of the affected countries. This happens because collection of tax revenue lags, because not enough people are working, and those who are working are earning lower wages. At the same time increased payouts are needed to stimulate the economy, and to provide benefits to the many without jobs.

Governments increase their debt to meet the revenue shortfall. They reduce interest rates to record-low levels, to stimulate the economy.  They also use Quantitative Easing, or “printing money” to try to lower long-term interest rates, and to try to make their exports more competitive. Unfortunately, these actions do not solve the basic structural problem of high and rising world oil prices, and the fact that these rising prices make their economies increasingly less competitive in the world marketplace.

One possible way I see of the current situation working out is that the total energy consumption (including all types of energy products, not just oil) of the EU, US and Japan will continue to fall, as high-priced oil continues to erode our competitive position in the world marketplace.

Figure 12. One view of future energy consumption for the EU-27, US, and Japan. Historical is based on BP's 2012 Statistical Review of World Energy.

Figure 12. One view of future energy consumption for the EU-27, US, and Japan. Historical is based on BP’s 2012 Statistical Review of World Energy.

The slope of the decline is based on the type of decline experienced by the Former Soviet Union, in the years immediately following its collapse. This pattern might reflect a combination of different patterns for different countries. Greece and Spain, for example might continue to fall quite quickly. The US might lag the EU in the speed at which problems take place. The likely path seems downward, because any action taken to fix the government gap between income and expense can be expected to have a recessionary impact, and thus have an adverse impact on energy consumption.

The Rest of the World is now growing rapidly, but at some point they will start reaching limits. One of these limits will be lack of an export market. Another will be lack of spare parts, because businesses in the US, Europe and Japan are failing for financial reasons. Some of these limits will relate to pollution and lack of fresh water. The effect of these limits will also be to raise costs. For example, a shortage of water can be worked around through desalination, but this raises costs. Lack of spare parts can be worked around by building a new plant to make the spare part. Pollution problems can be mitigated by pollution controls, but these add costs. These higher costs, when passed on to consumers will also lead to a cutback in demand for discretionary goods, and the same kinds of problems experienced in oil exporting nations. Thus, these countries will also have “Peak Demand” problems, because of rising prices, related to limits they are reaching.

I don’t know exactly how soon the Rest of the World will hit limits, but given the interconnectedness of the world system, it would seem to be within the next few years. Figure 13 shows one estimate of how this may occur.

Figure 13. One view of energy consumption for the Rest of the World. Historical data is based on BP's 2012 Statistical Review of World Energy.

Figure 13. One view of energy consumption for the Rest of the World. Historical data are based on BP’s 2012 Statistical Review of World Energy.

Here again, individual countries may do better than others. Countries with little connectedness to the world system (for example, countries in central Africa) may have fewer problems than others. Of course, their energy consumption (of the type measured by the EIA or BP) is very low now. They may use cow dung and fallen branches for fuel, but these are not counted in international data.

Figure 14, below, shows the sum of the amounts from Figures 12 and 13. Thus, it gives one estimate of  future world energy consumption based on Peak Demand considerations.

Figure 14. One view of future energy consumption for the world as a whole. History is based on BP's 2012 Statistical Review of World Energy.

Figure 14. One view of future energy consumption for the world as a whole. History is based on BP’s 2012 Statistical Review of World Energy.

If there is a silver lining to all of this, it is that world CO2 emissions are likely to start falling quite rapidly, because of Peak Oil Demand. World CO2 emissions could quite possibly drop below 20% of current levels before 2050. In the scenario I show, energy consumption drops faster than forecasts such as those put out by the Energy Watch Group. Such forecasts do not take into account financial considerations, so are likely overstated.

The downside of Peak Oil Demand is that the world we live in will be very much changed. Population levels will likely drop, indirectly because of serious recession, job loss, and cutbacks in government benefits. The financial system will need to be completely revised, because debt financing will make sense much less often than today. In fact, in a shrinking world economy, money can no longer act as a store of value. There no doubt will be some people who survive and prosper, but their lives will likely be very different from what they are today.

DON’T WORRY, BE HAPPY – ENERGY INDEPENDENCE JUST AROUND THE CORNER

56 comments

Posted on 19th January 2013 by Administrator in Economy |Politics |Social Issues

, ,

Another fact based, non-ideological analysis by Gail Tverberg that shoots multiple holes in the bullshit Energy Independence storyline being perpetuated by the MSM and politicians in both parties. As you’ve seen in recent posts, we are using significantly less oil today than we were in 2006 because we’ve been in an ongoing recession. And still the price of oil is over $95 per barrel and rising. This is happening despite the “miracle” of shale oil in North Dakota. Americans are so myopic and self centered, they don’t grasp that our oil usage has become meaningless in the pricing of oil. India, China and the rest of the developing world are driving the ship with their huge demand increase.

Oil is a fungible product and will be sold to the highest bidder. Accessing the remaining oil grows more expensive by the day. Our progressing recession may provide a brief respite in gasoline price increases, but there is absolutely no doubt that prices will exceed $5 per gallon in the next few years. When you understand the implications of Gail’s article you will understand why we keep getting our military involved in Iraq, Libya, Algeria and the rest of the Middle East. Visit her site on a regular basis to understand our true energy situation:

http://ourfiniteworld.com/

 

Ten Reasons Why High Oil Prices are a Problem

QuantcastA person might think from looking at news reports that our oil problems are gone, but oil prices are still high.Figure 1. US crude oil prices (based on average prices paid by US refiners for all grades of oil based on EIA data) converted to 2012$ using CPI-Urban data from the US Bureau of Labor Statistics. Figure 1. US crude oil prices (based on average prices paid by US refiners for all grades of oil based on EIA data) converted to 2012$ using CPI-Urban data from the US Bureau of Labor Statistics.

In fact, the new “tight oil” sources of oil which are supposed to grow in supply are still expensive to extract. If we expect to have more tight oil and more oil from other unconventional sources, we need to expect to continue to have high oil prices. The new oil may help supply somewhat, but the high cost of extraction is not likely to go away.

Why are high oil prices a problem?

1. It is not just oil prices that rise. The cost of food rises as well, partly because oil is used in many ways in growing and transporting food and partly because of the competition from biofuels for land, sending land prices up. The cost of shipping goods of all types rises, since oil is used in nearly all methods of transports. The cost of materials that are made from oil, such as asphalt and chemical products, also rises.

If the cost of oil rises, it tends to raise the cost of other fossil fuels. The cost of natural gas extraction tends to rises, since oil is used in natural gas drilling and in transporting water for fracking. Because of an over-supply of natural gas in the US, its sales price is temporarily less than the cost of production. This is not a sustainable situation. Higher oil costs also tend to raise the cost of transporting coal to the destination where it is used.

US Energy Prices as % of Wages and as of GDP. Ratio to GDP provided by EIA Short Term Economic Outlook - Figure 27, converted to Wage Base by author, using same wages as described for Figure 3.

Figure 2. US Energy Prices as % of Wages and as of GDP. Ratio to GDP provided by EIA Short Term Economic Outlook – Figure 27, converted to Wage Base by author, using same wages as described for Figure 3.

Figure 2 shows total energy costs as a percentage of two different bases: GDP and Wages.1 These costs are still near their high point in 2008, relative to these bases. Because oil is the largest source of energy, and the highest priced, it represents the majority of energy costs. GDP is the usual base of comparison, but I have chosen to show a comparison to wages as well. I do this because even if an increase in costs takes place in the government or business sector of the economy, most of the higher costs will eventually have to be paid for by individuals, through higher taxes or higher prices on goods or services.

2. High oil prices don’t go away, except in recession.

We extracted the easiest (and cheapest) to extract oil first. Even oil company executives say, “The easy oil is gone.” The oil that is available now tends to be expensive to extract because it is deep under the sea, or near the North Pole, or needs to be “fracked,” or is thick like paste, and needs to be melted. We haven’t discovered cheaper substitutes, either, even though we have been looking for years.

In fact, there is good reason to believe that the cost of oil extraction will continue to rise faster than the rate of inflation, because we are hitting a situation of “diminishing returns”. There is evidence that world oil production costs are increasing at about 9% per year (7% after backing about the effect of inflation). Oil prices paid by consumers will need to keep pace, if we expect increased extraction to take place.  There is even evidence that sweet sports are extracted first in Bakken tight oil, causing the cost of this extraction to rise as well.

3. Salaries don’t increase to offset rising oil prices.

Most of us know from personal experience that salaries don’t rise with rising oil prices.

In fact, as oil prices have risen since 2000, wage growth has increasingly lagged GDP growth. Figure 3 shows the ratio of  wages (using the same definition as in Figure 2) to GDP.

Figure 3. Wage Base (defined as sum of "Wage and Salary Disbursements" plus "Employer Contributions for Social Insurance" plus "Proprietors' Income" from Table 2.1. Personal Income and its Distribution) as Percentage of GDP, based on US Bureau of Economic Analysis data. *2012 amounts estimated based on part-year data.

Figure 3. Wage Base (defined as sum of “Wage and Salary Disbursements” plus “Employer Contributions for Social Insurance” plus “Proprietors’ Income” from Table 2.1. Personal Income and its Distribution) as Percentage of GDP, based on US Bureau of Economic Analysis data. *2012 amounts estimated based on part-year data.

If salaries don’t rise, and prices of many types of goods and services do, something has to “give”. This disparity seems to be  the reason for the continuing economic discomfort experienced in the past several years. For many consumers, the only solution is a long-term cut back in discretionary spending.

4. Spikes in oil prices tend to be associated with recessions.

Economist James Hamilton has shown that 10 out of the last 11 US recessions were associated with oil price spikes.

When oil prices rise, consumers tend to cut back on discretionary spending, so as to have enough money for basics, such as food and gasoline for commuting. These cut-backs in spending  lead to lay-offs in discretionary sectors of the economy, such as vacation travel and visits to  restaurants. The lay-offs in these sectors lead to more cutbacks in spending, and to more debt defaults.

5. High oil prices don’t “recycle” well through the economy.

Theoretically, high oil prices might lead to more employment in the oil sector, and more purchases by these employees. In practice, this provides only a very partial offset to higher price. The oil sector is not a big employer, although with rising oil extraction costs and more US drilling, it is getting to be a larger employer.  Oil importing countries find that much of their expenditures must go abroad. Even if these expenditures are recycled back as more US debt, this is not the same as more US salaries. Also, the United States government is reaching debt limits.

Even within oil exporting countries, high oil prices don’t necessarily recycle to other citizens well. A recent study shows that 2011 food price spikes helped trigger the Arab Spring. Since higher food prices are closely related to higher oil prices (and occurred at the same time), this is an example of poor recycling. As populations rise, the need to keep big populations properly fed and otherwise cared for gets to be more of an issue. Countries with high populations relative to exports, such as Iran, Nigeria, Russia, Sudan, and Venezuela would seem to have the most difficulty in providing needed goods to citizens.

6. Housing prices are adversely affected by high oil prices.

If a person is  required to pay more for oil, food, and delivered goods of all sorts, less will be left over for discretionary spending. Buying a new home is one such type of discretionary expenditure.

US housing prices started to drop in mid 2006, according to data of the S&P Case Shiller home price index. This timing fits in well with when oil prices began to rise, based on Figure 1.

7. Business profitability is adversely affected by high oil prices.

Some businesses in discretionary sectors may close their doors completely. Others may lay off workers to get supply and demand back into balance.

8. The impact of high oil prices doesn’t “go away”.

Citizens’ discretionary income is permanently lower. Businesses that close when oil prices rise generally don’t re-open. In some cases, businesses that close may be replaced by companies in China or India, with lower operating costs. These lower operating costs indirectly reflect the fact that the companies use less oil, and the fact that their workers can be paid less, because the workers use less oil. This is a part of the reason why US employment levels remain low, and why we don’t see a big bounce-back in growth after the Great Recession. Figure 4 below shows the big shifts in oil consumption that have taken place.

Figure 4. Percentage growth in oil consumption between 2006 and 2011, based on BP's 2012 Statistical Review of World Energy.

Figure 4. Percentage growth in oil consumption between 2006 and 2011, based on BP’s 2012 Statistical Review of World Energy.

A major part of the “fix” for high oil prices that does takes place is provided by the government. This takes the place in the form of unemployment benefits, stimulus programs, and artificially low interest rates.

Efficiency changes may provide some mitigation, as older less fuel-efficient cars are replaced with more fuel-efficient cars. Of course, if the more fuel-efficient cars are more expensive, part of the savings to consumers will be lost because of higher monthly payments for the replacement vehicles.

9. Government finances are especially affected by high oil prices.

With higher unemployment rates, governments are faced with paying more unemployment benefits and making more stimulus payments. If there have been many debt defaults (because of more unemployment or because of falling home prices), the government may also need to bail out banks. At the same time, taxes collected from citizens are lower, because of lower employment. A major reason (but not the only reason) for today’s debt problems of the governments of large oil importers, such as US, Japan, and much of Europe, is high oil prices.

Governments are also affected by the high cost of replacing infrastructure that was built when oil prices were much lower. For example, the cost of replacing asphalt roads is much higher. So is the cost of replacing bridges and buried underground pipelines. The only way these costs can be reduced is by doing less–going back to gravel roads, for example.

10. Higher oil prices reflect a need to focus a disproportionate share of investment and resource use inside the oil sector. This makes it increasingly difficult maintain growth within the oil sector, and acts to reduce growth rates outside the oil sector.

There is a close tie between energy consumption and economic activity because nearly all economic activity requires the use of some type of energy besides human labor.  Oil is the single largest source of energy, and the most expensive. When we look at GDP growth for the world, it is closely aligned with growth in oil consumption and growth in energy consumption in general. In fact, changes in oil and energy growth seem to precede GDP growth, as might be expected if oil and energy use are a cause of world economic growth.

Figure 5. Growth in World GDP, energy consumption, and oil consumption. GDP growth is based on USDA International Macroeconomic Data. Oil consumption and energy consumption growth are based on BP's 2012 Statistical Review of World Energy.

Figure 5. Growth in World GDP, energy consumption, and oil consumption. GDP growth is based on USDA International Macroeconomic Data. Oil consumption and energy consumption growth are based on BP’s 2012 Statistical Review of World Energy.

The current situation of needing increasing amounts of resources to extract oil is sometimes referred to one of declining Energy Return on Energy Invested (EROEI). Multiple problems are associated with declining EROEI, when cost levels are already high:

(a) It becomes increasingly difficult to keep scaling up oil industry investment because of limits on debt availability, when heavy investment is made up front, and returns are many years away. As an example, Petrobas in Brazil is running into this limit. Some US oil and gas producers are reaching debt limits as well.

(b) Greater use of oil within the industry leaves less for other sectors of the economy. Oil production has not been rising very quickly in recent years (Figure 6 below), so even a small increase by the industry can reduce net availability of oil to society.  Some of this additional oil use is difficult to avoid. For example, if oil is located in a remote area, employees frequently need to live at great distance from the site and commute using oil-based means of transport.

Figure 6. World crude oil production (including condensate) based primarily on US Energy Information Administration data, with trend lines fitted by the author.

Figure 6. World crude oil production (including condensate) based primarily on US Energy Information Administration data, with trend lines fitted by the author.

(c) Declining EROEI puts pressure on other limited resources as well. For example, there can be water limits, when fracking is used, leading to conflicts with other use, such as agricultural use of water. Pollution can become an increasingly large problem as well.

(d) High oil investment cost can be expected to slow down new investment, and keep oil supply from rising as fast world demand rises. To the extent that oil is necessary for economic growth, this slowdown will tend to constrain growth in other economic sectors.

Airline Industry as an Example of Impacts on Discretionary Industries

High oil prices can be expected to cause discretionary sectors to shrink back in size. In many respects, the airline industry is the “canary in the coal mine,” showing how discretionary sectors can be forced to shrink.

In the case of commercial air lines, when oil prices are high, consumers have less money to spend on vacation travel, so demand for airline tickets falls. At the same time, the price of fuel to operate airplanes rises, making the cost of operating airplanes higher. Business travel is less affected, but still is affected to some extent, because some long-distance business travel is discretionary.

Airlines respond by consolidating and cutting back in whatever ways they can. Salaries of pilots and stewardesses are reduced. Pension plans are scaled back. New more fuel-efficient aircraft are purchased, and less fuel-efficient aircraft are phased out. Less profitable routes are closed. The industry still experiences bankruptcy after bankruptcy, and merger after merger. If oil prices stabilize for a while, this process stabilizes a bit, but doesn’t really stop. Eventually, the commercial airline industry may shrink to such an extent that necessary business flights become difficult.

There are many discretionary sectors besides the airline industry waiting in the wings to shrink.  While oil prices have been high for several years, their effects have not yet been fully incorporated into discretionary sectors. This is the case because governments have been able to use deficit spending and artificially low interest rates to shield consumers from the “real” impacts of high-priced oil.

Governments are now finding that debt cannot be ramped up indefinitely. As taxes need to be raised and benefits decreased, and as interest rates are forced higher, consumers will again see discretionary income squeezed. New cutbacks are likely to hit additional discretionary sectors, such as restaurants, the “arts,” higher education, and medicine for the elderly.

It would be very helpful if new unconventional oil developments would fix the problem of high-cost oil, but it is difficult to see how they will. They are high-cost to develop and slow to ramp up. Governments are in such poor financial condition that they need taxes from wherever they can get them–revenue of oil and gas operators is a likely target. To the extent that unconventional oil and gas production does ramp up, my expectation is that it will be too little, too late, and too high-priced.

Note:

[1] Wages include private and government wages, proprietors’ income, and taxes paid by employers on behalf of employees. They do not include transfer payments, such as Social Security.

QE = HIGHER OIL PRICES = RECESSION = MORE QE………

19 comments

Posted on 3rd October 2012 by Administrator in Economy |Politics |Social Issues

, ,

You will see more shills, paid mouthpieces, Keynesian economists and central banker puppets writing articles about $4 a gallon gas not having a negative impact on the economy. They need to do this because QE to infinity will raise the price of oil, food, and everything associated with these two minor expenses. They will provide false storylines about cars being more fuel efficient. An article in my paper claimed the strong vehicle sales in September were due to people buying small fuel efficient cars. It’s complete bullshit. The strong vehicle sales are due to subprime 7 year 0% loans being shelled out by Ally Financial and the rest of the Wall Street scum banks. And Americans are buying SUVs and pickups, not hybrids and Chevy Volts. Gail Tverberg clearly destroys this storyline and accurately points out that stimulus has not solved anything, while driving oil prices higher. When oil prices are driven higher by QE, the people who spend the money in this economy are hurt and the economy goes back into the dumper.   

Can an Economy Learn to Live with Increasingly High Oil Prices?

Posted on October 2, 2012

Quantcast

Prof. James Hamilton of University of California recently wrote a post called Thresholds in the economic effects of oil prices. In it, he concludes

As U.S. retail gasoline prices once again near $4.00 a gallon, does this pose a threat to the economy and President Obama’s prospects for re-election? My answer is no.

He looks at a variety of data to come to this conclusion: Fuel economy of cars sold in since October 2007; longer term vehicle miles traveled; monthly car and light truck sales since 2006; and consumer sentiment by month.

I don’t agree with Hamilton’s analysis. As I see it, increasingly high oil prices weaken an economy because they reduce discretionary spending and indirectly cause people to be laid-off from work. They have many other adverse effects as well–they tend to raise food prices, with similar effect. The laid-off workers require unemployment compensation payments, and the same time they are contributing less tax revenue. All of this creates a huge imbalance between revenue collected by governments and expenditures paid out. If oil prices rise again, it will tend to make the imbalance worse.

An economy such as the United States can cover up the problems caused by high oil prices with variety of financial techniques. In my view, high consumer confidence measures the success of those cover-ups, more than it measures the actual underlying situation. One way the US government has managed to cover up how badly the economy is being hurt by high oil prices is by spending far more than the government takes in as revenue. This has happened continuously since late 2008, with outgo exceeding income by more than 50% each year, even though the country is supposedly not in recession.

Figure 1. US Government Income and Outlay, based on historical tables from the White House Office of Management and Budget (Table 1.1). Amounts include off-budget spending, such as Social Security and Medicare, in addition to on-budget spending. *2012 is estimated. http://www.whitehouse.gov/omb/budget/Historicals

 

The amount consumers have available to spend on cars and gasoline is very much affected by deficit spending. With deficit spending, government employment can remain high and transfer payments can continue, without anyone really “paying” for these costs, putting more money into the economy to spend on oil and cars.

There are other government programs as well. Interest rates on homes and new cars are being kept at record lows, leaving consumers with more money to spend on cars and gasoline. Low interest rates and low taxes also stimulate employers to hire more employees. Quantitative easing helps contribute to higher stock market prices, and makes it easier for the federal government to keep adding large amount of debt.

To me, the fact that the economy is not currently completely “in the tank” speaks more to the success of stimulus programs than having anything to do with adaptation to higher price levels. Countries such as Greece, Spain and Italy do not have the luxury of being able to hide the impacts of their high cost of oil. They are doing less well financially, but were not included in Hamilton’s analysis.

Easy to Overestimate Impact of Recent Changes in Vehicles

With vehicles, we are dealing with a mixture of vehicles of all ages. The average age of automobiles is now estimated to be 10.8 years. The average age of trucks is no doubt greater. The EIA provides a summary of average fuel economy by type of vehicle based on US Federal Highway Administration Data, summarized in Figure 2.

Figure 2. US Motor Vehicle Average Fuel Economy based on US Federal Highway Administration Data (Based on EIA Annual Energy Review, Table 2.8) SW = Short Wheelbase; LW = Long Wheelbase

 

This data is only through 2010. While it shows some improvement in efficiency of light duty short wheelbase vehicles, it shows little improvement in efficiency overall. The big increases in efficiency were in the period between 1973 and 1991.

The mix of cars by type is concerning.

Figure 3. Automobiles as percentage of total registered vehicles, based on data of the Federal Highway Administration.

 

The percentage of automobiles has been dropping, as the number of SUV and trucks has been rising. The change between 2008 and 2010 reflects the fact that the number of “automobile” registrations dropped by 4.5% in that time-period, while the number of other (larger) vehicles rose slightly. Thus, the long-term trend to relatively more of the larger vehicles continued. Obviously, this data doesn’t show carpooling and other adaptations, but it is difficult to see any recent big trend toward efficiency.

Can the Economy Weather another Rise to $4.00 Gasoline?

The question of whether the economy can weather $4.00 gasoline, to me, depends on the issue of whether the US government can keep coming up with more manipulations to hide its financial problems.

The US economy started to run into severe headwinds about the year 2001. This is when the percentage of Americans with jobs started falling.

Figure 4. US Number Employed / Population, where US Number Employed is Total Non-Farm Workers from Current Employment Statistics of the Bureau of Labor Statistics and Population is US Resident Population from the US Census. (This includes children and others not usually in the labor force.) 2012 is a partial year estimate.

 

While economists don’t seem to attribute past economic growth to increasing employment percentages, it seems logical to believe they played a role in the long-term growth in the 1960 to 2000 period. The economic growth came not just from the work these employees did themselves, but from the fossil fuels they used on the job. The wages the employees obtained for doing the work allowed the workers to buy products others had made. The long-term growth in non-farm employment between 1960 and 2000 was enabled by increased productivity in the agricultural sector, which was also fueled by increasing use of fossil fuels.

The percentage of the US population with jobs started falling starting in 2001. This is very close to the time when the US started importing far more goods from China, India, and the rest of Asia. If we look at energy consumption for China, we see a sharp increase in energy consumption about 2002:

Figure 5. China’s energy consumption by source, based on BP’s Statistical Review of World Energy data.

 

We can also look at broader groupings of energy consumption, and see a similar pattern:

Figure 6. Energy Consumption Divided among three parts of the world: (1) The combination of the European Union-27, USA, and Japan, (2) The Former Soviet Union, and (3) The Rest of the World, based on data from BP’s 2012 Statistical Review of World Energy.

 

The cost of goods produced in Asia is cheaper for two reasons: (1) They tend to use a lot of coal in their energy mix, keeping energy costs down. (2) Wages are far lower. One reason wages can be lower is because of the warmer climate.

It seems to be an article of faith of economists today that the US economy and the European economies will return to growth. Then the stimulus can be removed, and everyone can live happily ever after. But is this really something we should be expecting? We really have two kinds of headwinds: (1) higher oil prices, and (2) cheaper competition for jobs from Asia and other developing countries.

As far back as 2001, we read about Greenspan stimulating the economy by lowering interest rates. Various other approaches were used as well, including encouraging more home ownership through subprime loans in the 2002 to 2006 period. The greater demand for homes helped create jobs in the construction industry and helped raise home prices. By refinancing their homes, consumers were able to have funds for purchases they could not otherwise afford. In recent years, we have added a whole list of new stimulus approaches.

I would ask: Aren’t we kidding ourselves if we think a small increase in miles per gallons on new cars is going to fix the problem of another upward bounce in oil prices? Aren’t there some much more basic issues “out there” that need to be fixed as well? Aren’t we fighting two kinds of downside risks to the economy with increasing stimulus, and only marginal success? If oil prices rise some more, aren’t we likely to need “more stimulus”? Where would it possibly come from?

PREPARING FOR THE INEVITABLE

12 comments

Posted on 11th August 2012 by Administrator in Economy |Politics |Social Issues

,

More level headed advice from Gail Tverberg. When a new financial crisis is sure to hit within a two year time frame, preparing now is essential.

Reaching financial limits–What kinds of solutions are available?

We live in a finite world. At this point, we seem to be reaching limits in several different areas:
  • Cheap oil. Our economy runs on cheap oil, but there is a limit to the amount of cheap oil that can be pulled out of the ground. There is still a lot of expensive-to-produce oil left, but this is not a substitute for cheap oil.
  • Fresh water. Fresh water is used for drinking, for growing food, for producing oil and gas, and for creating electricity, among other things. In many parts of the world, we are using fresh water faster than aquifers can replenish.
  • Climate Change. Our agricultural system depends on relatively constant climate. Changes to climate, whether caused by humans or not, are a problem. It is possible that this year’s hot summer is caused by climate change.
  • Soil fertility. Soil fertility depends on adequate depth of top soil, adequate humus content, suitable bacteria in the soil, and proper mineral balance. We have been able to hide soil fertility problems through greater use fertilizers, pesticides, and irrigation, but these are not permanent “fixes”.
  • Pollution. There are many types of pollution that are problems, from excessive carbon dioxide, to mercury in food sources, to endocrine disruptors, to algal blooms.
  • Human population. The number of humans on earth is out of balance with world ecosystems and keeps growing, year after year.
  • Financial system. Our financial system depends on growth, but growth in a finite world system cannot continue forever. High oil prices tend to lead to recession, and reduced economic growth–hence the need for cheap oil, rather than expensive oil.

The question then becomes, “What can we do?”  Are there any solutions available, even if they are only partial solutions, as high oil prices and other limits squeeze the economy?

Many of us sense that we likely are not too far away from a contraction imposed by nature–something that looks like a severe recession that will help bring the world back into balance. While we probably cannot completely “fix” the situation, there seem to  be several things we can do, in the way of mitigation.

1. Manage your finances to try to avoid the impact of a possible crash. My crystal ball is not as good as it should be, but it is hard to believe that the stock market will continue to rise, as we get closer to the limits nature is imposing. Recession will hit, and the result will likely be both lower oil prices and lower stock market prices. Default rates on bonds are also likely to rise.

I am not sure there are any entirely safe investments, but actual goods and land you own would seem more likely to hold value. Cash would seem to be safer than stocks or bonds. Things like tools you expect to need in the future would seem to be especially good investments.

2. Plan your own family size with world limits in mind. Most people will still want to have children, but stopping at two would seem to be a good choice. It would be even better if families would choose to stop at one.

3. Get family planning back on the world agenda.  When Paul Ehrlich wrote the book Population Bomb back in 1968, he got the need for family planning on the world’s agenda at that time. Now, it is off the world’s agenda, as richer nations feel that the situation will fix itself, as education of women rises.  I am not sure how to get the issue back on the agenda, but free “rhythm method” classes for women around the world would seem to be a start.

Figure 1. World Population by Area based on data of the US Energy Information Administration. FSU is Former Soviet Union.

4. As layoffs hit, depend more on family and friends. Even before layoffs hit, it would be in our best interests to strengthen ties with family and friends. Then, if misfortune hits, there is a better chance of being able to move in together, if the need arises.

5. Plant trees and bushes with edible fruit or nuts. In terms of protecting the soil, perennials seem to be much better than annual plants. Complementary plants and animals will be needed as well, if long-term fertility is to be maintained. There are other things that can be done to upgrade the soil, but these generally require time and money.

6. Look for simpler and cheaper ways of doing things. The usual pattern is to move toward more complex and more expensive solutions, with ever-better technology and more bells and whistles. We need to be going the other way though–toward simpler solutions that are easier to maintain with local materials, and cheaper. LEED certified homes sound great, but what we really need is homes that are closer in size to what we usually think of as  storage sheds, and that can be put up quickly with local materials. It would be great to have state of the art commuter trains, but we need to be planning based on what communities can really afford, and that may be bicycle paths.

7. Appreciate what you have. We are very privileged now–we enjoy a wide selection of food, generally seasonable weather, and nations that are mostly at peace with one another. Every day, think about the good things that are part of your life–the squirrel on your lawn; the ability to zip around in a car or on a bicycle; the job you have that allows you to pay bills; the time you spend with family members. Even if things go downhill, there are likely still to be many good things. We need to keep looking for these every day.

8. Don’t focus too much on bad things that might happen. We really don’t know what exactly will happen. About all we can do is be flexible and continue living our lives as best we can. If we take care of our bodies by exercising and by eating well, that will be to our benefit, regardless of what happens.  Learning skills that might be helpful for the long term, especially if they are enjoyable now might be good as well (playing a musical instrument; doing crafts; studying how we coped without fossil fuels before, as through Low-Tech Magazine).

9. Be prepared for minor outages. If things go downhill, there will be more chance of outages of various kinds. The most likely of these is that you will lose your job and not be able to pay your bills. There is also the possibility that food or water or fuel for your vehicle will become unavailable. It seems worthwhile to do at least some planning for emergencies. I personally am not an advocate of hoarding, but it does make sense to keep some inventory on hand.

Energy Observations

I might note that I am doubtful that energy solutions will come quickly enough to fix our many interrelated limits problems before a financial crunch hits.

Clearly, if we have an adequate supply of cheap oil substitutes, we can continue to hide many of our other “limits” problems. For example, if there is enough cheap oil substitutes, countries like Saudi Arabia can get water from desalination, so fresh water ceases to be as much of an issue an issue. Soil problems are also less of an issue, if we can continue to use fossil fuels for fertilizer and irrigation.

There are some renewable energy sources that may be helpful for individual families, but don’t really fix our problem with a lack of cheap oil.  For example, solar can be used by families for heating hot water, and a reflective solar cooker can be used for cooking. Neither of these directly substitutes for cheap oil, though. Wind and solar PV can both be used to generate intermittent electricity, but again, this is not really a substitute for oil, certainly not in the time frame to prevent a financial crash in the next year or two.

The closest substitutes for oil are biofuels, but these are in direct competition in the use of soil for food. The next closest would seem to be natural gas, since existing vehicles can be converted to use natural gas. Even this takes time and money, so I am not convinced that natural gas, if available, could prevent a contraction in the next 12 to 24 months. So in the end, we find ourselves thinking about what other solutions to a potential financial crash are available, besides oil substitutes.



LIMITS TO GROWTH

11 comments

Posted on 21st July 2012 by Administrator in Economy |Politics |Social Issues

, , , , ,

Gail Tverberg with another factual, reality based, non ideological assessment of our energy and economic dilemma. The main point is that the tremendous world GDP growth that has occurred over the last century and a half has been driven by cheap, plentiful oil. Without cheap plentiful oil, GDP will stagnate and eventually decline. Despite the propaganda spouted by politicians and paid hacks for the energy industry, oil is becoming harder to access and more expensive to extract. The peak oil deniers attempt to frame the debate by declaring we are not running out of oil. The North Dakota shale oil formation is touted as having centuries of oil which will make the U.S. energy independent. There is plenty of oil left in the crust of the earth. The question is how much energy will it take to extract and at what price.

All of the cheap easy to access sweet crude has been tapped. All that is left is sour, deep water, oil sands, and shale oil. There is plenty of oil left, but as it becomes more expensive to acquire the GDP of oil consuming countries will decline. We have seen the impact in the last few years. The U.S. economy was pushed into recession by $145 oil in 2008. This year we were pushed into recession by $110 oil. As our debt saturated economy weakens further, $90 oil will constrain our economy. There really is no solution to the inevitable decline in available oil supply. We will be forced to adapt to a world with less energy. Too bad our leaders choose to mislead us and bury their heads in the sand. Electric cars and ethanol will not come to the rescue. Our entire society and infrastructure is cheap oil dependent. Time to read Kunstler’s books.

I was reading the comment stream on The Oil Drum and was amazed at the intelligence and civility of the commentors. It was similar to the comment stream on TBP, except for the civility part. One comment from the author Gail grabbed my attention as she is a middle aged woman trained as an actuary and not prone to hyperbole. Here is her comment:

“My view is that the money for retirement that is available to you today is likely not to be available to you tomorrow. Thus, the money in bank accounts is likely to either lose value or will disappear for some reason–the electrical supply to the bank is no longer working; the government puts a cap on how much that can be removed in a given week at $50; or there is some other huge change, such as substitution of local currencies for national currencies, that changes the nature of the “ball game’ greatly.  

Pensions have their own particular issues. They have been making investments, assuming annual returns in the 8% to 10% range. These haven’t been happening. The US government guarantees these up to some extent, but at some point in time the number of government guarantees would seem to be overwhelming. If pensions have problems, there is a good change banks will have problems as well.

Social security (and most other government programs) are more of a pay as you go plan, with funding today for today’s recipients. These may continue to some extent, but if the country is poorer, the relative benefits are likely to decline.”

There are big problems on the horizon. Pretending they don’t exist or will somehow fix themselves is delusional thinking. Sober, reasonable, critical thinking people can see what is coming. The government restricting your access to your own money could happen at any moment. The ruling oligarchs are desperate and they will do anything to retain their wealth, power and control, including stealing your money. The time to prepare is now. Get your money out of Wall Street banks.

 

Evidence that Oil Limits are Leading to Limits to GDP Growth

Posted by Gail the Actuary on July 19, 2012 – 4:09am

The usual assumption that economists, financial planners, and actuaries make is that future real GDP growth can be expected to be fairly similar to the average past growth rate for some historical time period. This assumption can take a number of forms–how much a portfolio can be expected to yield in a future period, or how high real (that is, net of inflation considerations) interest rates can be expected to be in the future, or what percentage of GDP the government of a country can safely borrow.

But what if this assumption is wrong, and expected growth in real GDP is really declining over time? Then pension funding estimates will prove to be too low, amounts financial planners are telling their clients that invested funds can expect to build to will be too high, and estimates of the amounts that governments of countries can safely borrow will be too high. Other statements may be off as well–such as how much it will cost to mitigate climate change, as a percentage of GDP–since these estimates too depend on GDP growth assumptions.

If we graph historical data, there is significant evidence that growth rates in real GDP are gradually decreasing.  In Europe and the United States, expected GDP growth rates appear to be trending toward expected contraction, rather than growth.  This could be evidence of Limits to Growth, of the type described in the 1972 book by that name, by Meadows et al.

Figure 1. World Real GDP, with fitted exponential trend lines for selected time periods. World Real GDP from USDA Economic Research Service. Fitted periods are 1969-1973, 1975-1979, 1983-1990, 1993-2007, and 2007-2011.

 

Trend lines in Figure 1 were fitted to time periods based on oil supply growth patterns (described later in this post), because limited oil supply seems to be one critical factor in real GDP growth. It is important to note that over time, each fitted trend line shows less growth. For example, the earliest fitted period shows average growth of 4.7% per year, and the most recent fitted period shows 1.3% average growth.

In this post we will examine evidence regarding declining economic growth and discuss additional reasons why such a long-term decline in real GDP might be expected.

Connection of GDP Growth with Oil Supply Growth

It should not be surprising to find that there is a close tie between GDP growth and oil supply growth. Oil is used in many ways, from the manufacture of goods (synthetic cloth, pharmaceuticals, chemicals, asphalt for roads), to transport of goods and people, to food production (plowing, harvesting, weed killers, diesel irrigation), to operating construction equipment, to mining. While it is possible to substitute away from oil in some situations, or to find more efficient ways of using the oil, we have literally trillions of dollars of machinery in the world that uses oil right now. Because of this, the rate of substitution away from oil is necessarily very slow.

James Hamilton has shown that in the United States, 10 out of 11 post-World War II recessions were associated with oil price spikes. He has also published a paper specifically linking the recession of 2007-2008 with stagnating world oil production and the resulting spike in oil prices. I wrote an academic paper, Oil Supply Limits and the Continuing Financial Crisis, explaining some of the connections I see involved.

One connection between oil supply and the economy is the fact that when oil prices rise, indicating short supply, salaries don’t rise at the same time. Fuel for commuting and food (which is grown and transported using oil) are necessities, and their prices tend to rise as oil prices rise. Consumers cut back on buying discretionary goods and services, so as to have enough money for these necessities. This leads to people being laid off from work in “discretionary” industries, and a whole host of other effects we associate with recession.

Figure 2, below, shows world oil supply (broadly defined, including biofuels) with trend lines fitted to periods exhibiting similar growth patterns. It is these same time periods that I fit trend lines to in Figure 1, with one small exception. I had consistent real GDP data going back only to 1969, so stopped at 1969 rather than 1965 with GDP.

Figure 2. World oil supply with exponential trend lines fitted by author. Oil consumption data from BP 2012 Statistical Review of World Energy.

 

What we see in Figure 2 is a pattern of falling growth rates in oil supply rates, similar to the declining pattern we saw for real GDP in Figure 1. In Figure 2, the growth in oil supply falls from 7.8% per year in the first fitted period, to 0.4% per year in the last fitted period. The “gaps” that I didn’t fit lines to were periods of falling oil consumption. A glance up at Figure 1 shows that these periods where no line was fit (that is, the places where the black “actual” data shows through on Figure 1) correspond to relatively flat GDP periods–as a person would expect, if high prices/short supply are associated with recession.

A person wouldn’t expect the two types of growth rates (oil supply and real GDP growth) to be exactly the same. The GDP growth rate would likely be higher than the oil growth rate because the oil growth rate is theoretically depressed for several reasons: continued switching from oil to cheaper fuel (often electricity); improvements in energy efficiency; and a gradual change to more of a service economy. (Services use less energy per unit of GDP than the manufacturing of goods.)

If we compare the two fitted growth rates (world oil consumption and world real GDP), this is what the comparison looks like:

Figure 3. World Oil Supply Growth vs Growth in World GDP, based on exponential trend lines fitted to values for selected groups of years. World GDP based on USDA Economic Research Service data. Earliest time-period uses 1969 to 1973 for both oil and GDP for consistency.

 

Downtrend in Real GDP May Be Understated

The last thing governments want to do is to let their constituents know that the economy is currently doing less well than in the past. There are (at least) two ways that governments can increase real GDP:

1. Understate their inflation estimates. The way “real GDP” is calculated involves first figuring GDP based on how much goods and services increased during the period in question, and then “backing out” the amount of the GDP increase that was due to inflation. There is latitude in figuring out how much inflation to reflect. For example, in the early years, my understanding is that if the price of beef went up, it directly affected the calculation of the inflation rate; now, there is an implicit assumption that they buyer will be willing substitute chicken to some extent instead, keeping the inflation assumption lower and the real GDP increase (as calculated) higher. There are many other things that be manipulated as well–for example, how the cost of housing goes into the calculation. The site Shadowstats gives one view of how changes since 1983 distort reported US real GDP amounts.

2. Encourage lots of additional debt.  Real GDP looks at the amount of goods and services are produced and sold, not how they are paid for. If the government sponsors a program to provide mortgages to people who have no chance of ever paying them back, and this results in the sale of more houses, this will help real GDP–at least until the borrowers start defaulting on their loans. Increases in other types of loans work to increase real GDP too, including auto loans, student loans, and government debt.

Besides increasing real GDP, increasing debt also acts to increase employment, since it takes workers to build the things that people who get the loans can now afford. In other worlds, the higher loan amounts increase employment of  people who build new cars or new houses, or who teach at universities.

The problem with encouraging additional debt is that it at some point the amount of debt becomes too much for holders of the debt to service, and they start cutting back on other purchases. For example, recent graduates with a lot of debt are likely not to be in the market for new homes unless they have very high-paying jobs. So, at some point, additional debt becomes self-defeating, especially when the economy is not growing very quickly. Too much debt seems to be one of the limits, besides oil limits, we are reaching now.

Other Factors Holding Down Real GDP Growth

We live in a finite world, and this fact imposes limits. The amount of land suitable for cultivation is not expanding over time. There is limited fresh water for irrigation and other uses. In many areas, water tables are dropping. Ores are declining in quality because the highest quality ore tends to be extracted first.

Pollution, including carbon dioxide pollution, leads to attempted substitution by higher cost alternatives. It also leads to the addition of devices such as expensive filters. Both of these add costs, without increasing the amount of usable goods and services (in the usual definition) produced. Peoples’ funds for discretionary goods can be expected to drop as a result, (since funding through taxes or other approaches is mandatory) putting downward pressure on real GDP growth.

There is also the issue of how many new entrants are added to the paid labor force. If, for example, in the early years, many homemakers are being added to the paid labor force, their addition will tend to raise GDP growth, because the goods or services the homemaker creates will be added to real GDP, as well as the cost of daycare for her children, if this is purchased. Once homemakers have been pretty well absorbed into the labor force, that positive influence on real GDP will disappear. If the number of people employed starts declining (because of more retirees, or because people can’t find jobs), or fails to rise as quickly, this will tend to slow economic growth.

Oil Importers are Likely to Have Lower Economic Growth than Others

There are a couple of reasons why oil importers can be expected to have lower economic growth than other countries, especially when oil prices are high. First, oil importers have the problem of needing to pay exporters for crude oil or oil products. The revenue that is spent on higher priced crude oil could have been spent on discretionary expenditures. It is unlikely that the oil exporters will reinvest the money in the economy of the buyer of its oil–they are just as likely to reinvest it in their own country.

The second reason is that oil importers tend to be the countries like the United States and Europe that “developed their economies” early on. Since these countries have hired women in large numbers since World War II, most homemakers who want jobs already have them. If birth rates have slowed, these countries may be seeing disproportionate growth in the retiree population and fewer workers in ages where employment usually takes place.

In the United States, if we do curve fitting (of the type shown in Figures 1 and 2) to the reported number of non-farm workers employed in the United States (from the Bureau of Labor Statistics), and compare these employment trend rates with the corresponding trend rate in US GDP growth, we find a high correlation:

Figure 4. US growth in number of non-farm workers versus growth in real GDP. US real GDP from US Bureau of Economic Activity; Non-Farm Employment from US Bureau of Labor Statistics. Fitted periods are 1969-1973, 1975-1979, 1983-1990, 1993-2007, and 2007-2011.

 

Note that decreased growth in the number of employees could be taking place for any number of reasons–less growth in illegal immigrants, fewer homemakers going back to work, more people going to college, or more people retiring or taking disability coverage, or just generally discouraged.

It is my observation that the number of workers in the US today seems to depend on the number of jobs available. If jobs in some fields are being increasingly shipped to lower-cost countries–the ones we will see in Figure 7 are now using a disproportionate share of the world’s oil–these jobs will not be available, no matter how many workers might be willing to take them, if they were available.

If we look at the trend in real GDP growth for three major areas (United States, European Union-27, and Remainder = World minus the US and EU-27) , we discover that indeed, all three of the areas show a downward trend in real GDP over time (Figure 4, above). The GDP growth of the EU-27  and the US start from a lower level, and drop off more in the 2007-2011 period, (when the price of oil imports was more of an issue) than the “Remainder” grouping.

Figure 5. Annual growth in world oil supply compared to annual growth in real GDP, both based on exponential trend fits to values for selected years. Oil supply data from BP oil consumption data in 2012 Statistical Review of World Energy; real GDP from USDA Economic Research Service.

 

One reason why the Remainder-GDP may be doing better than the others is that heavy manufacturing, and the jobs that go with heavy manufacturing, are finding their way to lower cost countries. High oil prices may also be discouraging oil importers from purchasing oil. If we look at oil consumption for the three groups, this is what we see:

Figure 6. Comparison of oil consumption by area (United States, European Union -27, and rest of the world), based on BP’s 2012 Statistical Review of World Energy

 

Much of heavy manufacturing has been moved out of the United States and the European Union. Figure 7 below shows that the rest of the world is now using well over half of the world’s oil:

Figure 7. Percentage shares of world oil consumption based on BP’s 2012 Statistical Review of World Energy.

 

Going Forward

We have seen (Figure 5, above) that all three grouping shown (United States, EU-27, and the rest of the world) are showing declining real GDP patterns, similar to the world pattern. GDP growth rates of the United States and EU-27 are both at lower levels than the World and Remainder, for reasons explained.

It is hard to see why current trends wouldn’t continue, with growth in real GDP continuing to decrease for all three groups. Regardless of the hoopla in the United States press about supposed growth in oil supply, the fact remains that growth in world oil supply has been worrisome for many for roughly 40 years, since US oil production started decreasing in 1970. It is hard to believe that the latest “fix” is going to turn things around. The typical pattern in oil supply is for extraction in an area to hit a maximum (or perhaps a plateau) and then decline.

Figure 8. Crude oil production in the US 48 states (excluding Alaska and Federal Offshore), Canada, and Europe, based on data of the US Energy Information Administration.

 

Figure 8 shows (among other things) how steep the US drop in oil production in the contiguous 48 states was starting in 1970. This decline set the stage for the 1973 Arab Oil Embargo, since oil-producing countries now had the upper hand. Production in Alaska and in the Gulf of Mexico eventually helped offset part of the drop, but the Alaska production (not shown) is now declining as well. Change in the balance of power regarding oil production following the decline in US production, and recognition that increased imports would cause balance of payments problems, seem to have influenced the US and Europe’s decision to focus on service industries and on industries with little oil usage, holding their oil usage down (Figure 6).

Figure 8 also shows how new onshore techniques–fracking and other enhanced oil recovery–are affecting US crude oil production. While US-48 states crude oil production has shown a 25% increase since 2006, this production is still only 39% of the 1970 amount, and about equal to 1942 production. Oil production in Canada (which includes the oil sands) is rising, but not very rapidly, from a low base. It is hard for small increases such as those of Canada and the US-48 to make up for major declines in production occurring in Europe and elsewhere. World oil supply would be increasing by more than a fraction of 1% per year if changes frequently noted in the US press were really making an important difference in world supply.

Analysis of Annual Change Percentages for Oil and Real GDP:

It is also possible to look at annual percentage changes, corresponding to the ranges analyzed above. (Some people may be more familiar with this approach.) In this approach, we “lose a year.” For example, the first range is five years, 1969 to 1973. But if we use annual percentage increases, the first percentage increase occurs in 1970, and there are only four percentage changes in total, 1970 to 1973. To calculate some sort of an indication (similar to, but not equivalent, to that above), we calculate the simple average of the four increases. The resulting graphs are as follows:

 

Figure 9. Annual percentage increases in world real GDP with simple averages for the ranges indicated, corresponding to Figure 1.

Note that percentage changes are slightly different, but follow the same pattern as in Figure 1.

 

Figure 10. Annual percentage increases in world oil supply with simple averages for the ranges indicated, corresponding to Figure 2. (except 1966 to 1969 us omitted to correspond to GDP ratios and amounts shown on Figure 3.)  

Here again, we note a very similar pattern. Thus, the analysis on this basis seems to be similar to that using the fitted exponential trend lines.

Tentative Indications for the Future

We can use the relationships between the individual year changes in oil supply and real GDP to build a simple model showing how much of an increase in GDP can be expected to take place for a given increase in oil supply.

If we graph the annual percentage changes in real GDP versus the annual percent changes, what we see is the following:

Figure 11. An “X Y” graph showing the percentage changes in world real GDP that correspond to percentage changes in world oil supply, for the years 1970 to 2011. 
 

It is clear in looking at the data that the pattern in the earliest part of the period is different from that in the later periods. In the very earliest period (1970 to 1973), oil use increased more rapidly than GDP. Once we realized we had a problem, there was a mad dash to try to reduce usage. If we look at only the period since 1983, when there was more of a sustained attempt to transfer to lower priced fuel, this is what the graph looks like.

Figure 12. An “X Y” graph showing the percentage changes in world real GDP that correspond to percentage changes in world oil supply, for the years 1983 to 2011. 
 

Using only the recent data, the R2 is similar (.53 for 1983-2011 data vs. .52 for 1970 to 2011), but the slope of the line is a little steeper. While at R2 of .52 or .53 is not exceptionally high, it does explain a significant portion of the total variance, so let’s look at what the indications of the trend lines are.

If the annual percent change in oil supply is 0.4% (as it seems to be now), the predicted annual increase in world real GDP is 2.5% per year using the 1970-2011 fit, or 2.2% using the 1983-2011 fit. Thus, both fits suggest that with the small increases we are seeing in oil supply currently (about 0.4% per year), we are already at a point where world real GDP can be expected to be much lower than most economists would prefer (2.2% or 2.5% per year).

The Figure 12 fit (using 1983 to 2011 data) would seem to be slightly better for predictive purposes, since it is more representative of the current situation.

If we want world real GDP to grow by 4.0% per year, the fit from Figure 12 (based on the equation y = 0.741 x + 0.0193) would suggest that world oil supply needs to rise by 2.8% per year. If we want world real GDP to grow by 3.0% per year, we need oil supply to grow by 1.4% per year.

We can also look at what theoretically would happen if world oil supply starts declining (but here we are on shakier ground, because of many follow-on effects).  If oil supply declines by 1.0% per year, the regression line in Figure 12 would suggest that world real GDP can be expected still be expected to increase, but by only 1.2% per year. If world oil supply declines by 2.0% per year, the model would suggest world GDP can be expected to increase by only 0.4% per year. If world oil supply declines by 4.0% per year, the model would suggest that world real GDP can be expected to decline by 1.0% per year.

These are very tentative amounts. Clearly, if world oil supply or world real GDP starts decreasing, there will be many follow on effects, including political changes, and these may have effects of their own. Also, if it is clear that we again have a serious oil problem, there will be a mad dash to eliminate unnecessary use, and this may have a favorable impact on real world GDP.

But it is clear from these calculated amounts that we are entering a very challenging period.

This post combines two Our Finite World posts: Evidence that Oil LImits are Leading to Declining Economic Growth and How Much Oil Growth do We Need to Support World GDP Growth?

« Older Entries