Let’s Keep an Important Thing In Mind About the Price of Crude Oil
Energy usage per unit of production
By blackhedd Posted in Economy | Oil Prices — Comments (37) / Email this page » / Leave a comment »
As I write this morning, the price of crude oil is below $137/barrel, down from its historic, near-10% surge on Friday to an intraday high over $139. And South Korea is the latest government to announce policy measures to contain the impact of high crude prices on its local economy.
China has been slowly increasing its controlled prices for key fuels like diesel. (In China, the large oil companies are mostly state-owned, and the government has been forcing them to eat the difference between the high crude price and what the people would prefer to pay for fuel. It’s Maxine Waters' fondest dream.)
Other countries have announced that they would abandon price controls. (Reminds me of when the Bank of England, under sustained attack from George Soros and other currency speculators about 15 years ago, threw in the towel and announced that they would no longer defend the pound sterling.)
Keep Reading...
The European Central Bank’s governor, Jean-Claude Trichet, hinted broadly last Thursday that policy euro interest rates were more likely to rise than to fall, setting off a huge spike of dollar selling and crude-oil buying. (The dollar is a bit lower against the euro this morning.)
And South Korea’s news was a big spike of fiscal spending, designed to stimulate (through inflation) the country’s economy, which is showing signs of distress in part because high oil prices mean less spending on everything else.
You may recall that a few weeks ago, I predicted in this space that crude oil could spike to between $150 and $180 a barrel this year before falling back significantly. I’m often asked where the price increases are coming from. Many people feel sure there must be a simple reason why, but there isn’t. It’s a combination of pressures, some upward (supply constraints, financial speculation, increased demand from Asia) and some downward (softening of demand in the developed countries).
Policy-makers around the world have begun to take seriously the possibility that high crude-oil prices could lead to a global slowdown or even a recession. And of course, as our politicians are very well aware, there’s a strong expectation that ”government needs to do something about the problem!”
But because the causes are large, complex, and global, there’s essentially nothing that the government can do to “solve the problem” (which, to most people, means reducing the price they pay for gasoline). Nothing, that is, that wouldn’t have powerful negative effects elsewhere. The price of crude oil is simply what it is, and it will be what it will be, and that means that everything made with crude oil will be more expensive.
And people and businesses will adjust their behavior accordingly. This will happen rapidly and more or less smoothly.
But, and this is why I’m writing to you this morning, the effects of these adjustments will not be symmetrical across different countries, especially as it relates to recessionary pressure.
Many people will tell you that the US is the most profligate user of energy on the planet, and if only we stopped using so darn much of it, the grass would get greener, the girls would get prettier, and life would just be all-around better.
If you compare simple energy-intensity (the amount of energy used per unit of GDP), the large economies are bunched together fairly close. The US isn’t the most or the least energy-intensive.
But that’s if you look at total energy use by the whole society. If you look at industrial production only, the US is considerably more energy-efficient than other large economies. We use less energy to produce a unit of economic output than other countries do.
What’s the difference? We drive much longer distances in our cars than people in other countries. In fact, per-capita consumption of motor transport by Americans and Canadians is perhaps two or more times as high as in other large countries.
And in the US, petroleum is used primarily for motor transport.
The US economy is led by consumer spending. Almost every other large economy is driven more by industrial production for export and less by consumer demand than ours is.
To put it crudely, that means that the pain from higher crude oil prices is felt by Americans as pressure to drive less. But in countries like South Korea and Japan, it’s also felt as pressure to produce less.
Therefore, the US will feel less of a recessionary influence from expensive crude oil than other countries will. Jobs are less at risk here than elsewhere.
And if expensive gasoline turns out to be a permanent reality (I’m not among the people who take this on faith), we’ll make the adjustments, with or without interference from Washington.
It will just mean that we’ll drive fewer miles, in lighter vehicles, and this is an adjustment people will make readily. (They’ll grumble, of course.) But none of the other predicted effects (including alternative fuels, hybrid engines, nuclear-powered electric cars, or increased use of public transport) will happen anytime soon. And to the extent that they happen at all, government can only hinder them, not help them along.
-Francis Cianfrocca (“blackhedd”)
« Rethinking the Goals of a National Mortgage Bailout — Comments (45) | Free Trade: A Hero, Not A Villain — Comments (6) »
Let’s Keep an Important Thing In Mind About the Price of Crude Oil 37 Comments (0 topical, 37 editorial, 0 hidden) Post a comment »
Interesting piece, as always.
I agree that the US is relatively well-positioned to survive higher oil prices. However, I do worry more about the recessionary effect, since it is added to the non-related downturns in financial services. If the economic boat hits enough of these waves, it could capsize.
The travel & leisure industries are being hit pretty hard, ditto restaurants. It will be interesting to see where else consumers cut back to pay their energy bills. My hunch is that it will be on gadgets and household items, which will be bad for Japanese/Chinese imports. Just a hunch, though.
No argument with your main point. The market will allocate resources efficiently in response to higher energy prices. The only thing the government can do is make things worse. We should be ready to award our government an A for effort in this area!
...so I'm always up really early ;-)
I think part of your point is that we are still facing a global credit crisis and ongoing disorders in the housing markets, which combine into a powerful recessionary force, regardless of what crude oil does.
I couldn't agree more.
I think there is a lot of slack in consumer fuel use that will continue to be realized. The silver lining of rising oil prices has been that Americans will finally be forced to conserve. Gas was so cheap for so long that a lot of consumer behaviors sprouted and took root: insanely long commutes, SUVs, soccer mom taxi services, single car commuters, etc.
We're going to see people, over time, revisit these assumptions and adjust accordingly. As a knowledge worker for example, I have the option of working from home. I have been doing more of that lately! I suspect others have modified their behaviors a little. And it doesn't take much. What if consumers reduced their demand 5%? What would happen to oil prices?
This is like government spending: you ask them to cut back to meet budget and they insist they need every penny. But if you take away money anyway, they will kvetch but they'll be forced to make a hard decision. Americans are being asked to do the same. Thank the heavens that the free market is doing this and not some Carteresque rationing scheme.
---------------------------------
Oil: Drill here. Drill now. Pay less.
Interesting piece, as always.
I agree that the US is relatively well-positioned to survive higher oil prices. However, I do worry more about the recessionary effect, since it is added to the non-related downturns in financial services. If the economic boat hits enough of these waves, it could capsize.
The travel & leisure industries are being hit pretty hard, ditto restaurants. It will be interesting to see where else consumers cut back to pay their energy bills. My hunch is that it will be on gadgets and household items, which will be bad for Japanese/Chinese imports. Just a hunch, though.
No argument with your main point. The market will allocate resources efficiently in response to higher energy prices. The only thing the government can do is make things worse. We should be ready to award our government an A for effort in this area!
Admittedly my hopes aren't very high, but government may do a few things that might actually help, namely by clearing up part of the mess they created.
Especially when it comes to the nuclear industry, a few well-designed laws could help a lot, think of limiting litigation and finally sorting Yucca mountain for waste disposal. If high oil prices would cause Congress to cut down on environmental nonsense it would have at least some upside.
Interesting write-up with some points the media mostly forgets; compliments to Blackhedd, as always.
Now one thing I've some trouble with to disentangle, and as you're closer to the markets than I, maybe you could give your 2 cents on it:
To what extent and why is oil moving along with the dollar these days, in your opinion? I get the distinct feeling (though I can't back it up with numbers till I find some time to get the data) the correlation between oilprices and the euro/dollar rate has risen sharply, perhaps even to the extent the market is effectively pricing oil in euros rather than dollars. (no, it doesnt explain every movement, but it may account for a big chunk of it)
Now I can see two possible explanations for such a situation:
- self-reinforcing effects from people who want to hedge against a falling dollar (but there are easier and less risky ways to do that, unless you believe that whatever happens, oil can only go up)
- Our 'friends' in whatever hole the dear Lord put crude oil in prefer to get their revenue in euros (most likely they spend more and more in euros anyway) and manipulate the markets, which doesnt take much given the current jittery state of it. But that only makes sense if the dollar is moving first.
Neither explanation givers much reason to be cheerful, assuming a weak dollar is here to stay for a while - which is something I'd be willing to bet on.
The euro isn't. The primary factor that drives the foreign exchange value of the dollar is short-term interest rates. The correlation between the dollar and the crude-oil price has been strong since the Federal Reserve started cutting interest rates late last summer. Some calculations I've seen put the correlation at nearly -0.9.
The dollar stopped falling a few weeks ago, when the Fed started hinting that it was done cutting interest rates, and that was also when oil started falling from the then-record high of $135. Now Trichet says that euro rates will start to rise (mostly because the Germans are petrified of inflation), so that set off the current move in both the dollar and the euro.
Easier and less risky ways to hedge against a falling dollar: in a time when financial assets are shunned by many investors as we muddle our way through the continuing credit crisis, oil is actually a pretty attractive hedge. There's an awful lot of it out there, and as long as demand remains strong, there's a floor under its price. You can't say the same for gold or debt instruments.
would be a much purer hedge, though perhaps people don't like the quotes they're getting for that. Still, oil can go down due to a dozen other factors. It would be too risky a play for my taste.
Anyway, the -.9 correlation you cite is even higher than I thought. And it doesn't matter much if the US or euro interest rates cause it (it's the differential that counts anyway); it seems that analyzing oil markets has become quite a bit more complicated if they respond that sharply to the exchange rate.
question remains: why is that relation so strong now, and will it persist?
...when volatility is high. Which nearly by definition is when you most want to buy them. Combine today's historically-high volatility (although it's less than a couple of months ago) with ongoing severe disorders in money markets, and you get derivatives pricing that's just out of this world.
Just try buying a plain-vanilla interest-rate swap. The bid-ask spread on those is now two or three times as high as a year ago. Mostly because the London interbank money market is still broken.
("though perhaps people don't like the quotes they're getting for that")
Which would in turn mean that it's even more important to get that market working properly again.
Blackhedd, I asked for your opinion, and I got it. Many thanks for your time ;)
From what I've read, our current $4/gal price is based on oil trading at $90/barrel, not the current $130+.
Is the price per barrel a good predictor of coming gas prices?
There are active spot markets in both crude and the refined products (gasoline, heating oil, jet fuel). They should all be in sync around the current crude spot price (or prices, since there are various types of crude).
There are active futures markets in both crude and crack spreads (difference between crude and the prices of the refined products). While these give an indication of future prices, they are by no means infallible.
The crude oil (upstream) market follows different dynamics than the refined products (downstream) market. Each has different supply/demand fundamentals. Crude oil has risen nearly 300% in 18 months, while gasoline has risen only about 50%.
If you want to know where the difference went, look at the stock prices of companies that buy crude oil and turn it into gasoline. Valero Energy (VLO) is one.
Thanks to both streetwise and blackhedd.
If supply/demand is any predictor, is demand falling with these high prices?
hope for the best. He may do the same, but I bet his prayers are more efficacious than mine. :>)
seriously, I have no idea about short term price trends. However, given the press accounts of drivers cutting back, if the high prices last long enough, driving habits will change, depressing demand over the longer term.
I don't really follow the gasoline markets. I do follow the heating oil and jet markets more. Crack spreads there have risen from the $2-$5 per bbl range in the early part of this decade to $25-$30 now. My imprssion is that the same trend holds true for gas. Not surprising, as we have not really added to our refining capacity in 30 years.
...much less in relative terms than diesel fuel. That suggests to me that demand for gasoline is more elastic. People have some flexibility to drive fewer miles in their gasoline-powered cars. I've seen statistics indicating that gasoline demand is one percent or more lower than a year ago.
But diesel fuel is a production factor. You can't use less of it unless you're planning to stop shipping your products (including food) to market. And in the Northeast where I live, a lot of people use heating oil (which is diesel fuel dyed a different color to indicate the lower federal tax on it). You can't use less heating oil unless you're willing to be cold in the winter.
Streetwise may have some insight on the other major distillate, which is jet fuel.
Not to butt in, but I may offer some insight on the JP Fuel prices. The people who buy most of the JP fuel sold, buy it for entire fleets. They buy at EOQs far beyond what is required to fuel just one air frame, a la Enviromullah Al Gore.
If JP prices lag the normalized mark up for other types of fuels, it's because the end users thereof are getting price breaks for buying large quantity orders. At least that's RMJ's humble theory of the morning.
At a rate of 6,000 earmarks per spending bill, Speaker Pelosi is selling America's future to the special intrest groups.
suppliers weeks in advance and volume does affect price.
However, those prices are affected by the the prices in the spot and "nearby" futures contracts, so the price relief has been modest.
Given the recent schedule cutbacks announced by American, United, Continental, etc, one would expect downwards price pressure in a rational market due to decreased demand. If the markets were rational, that is. :>)
Funny timing, too -- just a couple days ago, I happened to look up what other countries' citizens pay for gas lately (not the subsidizing ones, although they will have issues, too - I mean the heavily taxed ones - Western Europe.) It's $9.50/gal in France. Similar in Germany and the UK. Now, sure, they drive less than us; they're geographically much smaller countries. But they have industry, too: plastics, shipping, airlines, and all that stuff.
So I wondered - Will other major economies crack completely while we're busy suffering and grumbling? Remember, nobody knew the Soviet Union was fully bankrupt until the country broke apart. In less words, it may not be the USA that high oil prices brings down. But it may not be nobody, either.
Yes, I realize it's a world economy, and we're all connected. But it often seems to me that a lot of us think we're the only target, and moreover, the weakest and most vulnerable one. There's other countries making bigger mistakes than us - What if we eventually get through it, but OTHER countries fail?
The European economies are rather a mixed bag at the moment, but not so much because of oil prices (which the strong euro insulates them from). France and Germany are ok, although both are export-driven and the strong euro hurts them there. (EADS, which is the parent company of Airbus, is probably worthless at this point.)
But Spain and the UK are in deep trouble, mostly because they each have a housing crisis like ours. Italy is also in trouble, but I think their problems are fiscal in nature.
In Asia, the big problem is still inflation. The underlying high-growth story is still intact there.
To your last point, I think we face a lot of problems of our own making, and government policies that disadvantage business and capital formation make the problem worse. (Unfortunately all of the politics seems to be going in the direction of making this problem worse rather than better.)
The real risk we face isn't recession (a measurable reduction in output that lasts a couple of quarters and then washes out), but rather a multi-year period of low growth. You want to see the economy averaging 3 or 4% growth per year, but we may be in for more like 1-2%. That's caused by the credit crisis, not the oil price.
a problem to have if it was accompanied by a stronger dollar.
My own belief is that we will get weak growth, maybe even a recession, and a continually anemic dollar.
And then get hit with higher taxes. Things are going to get a lot worse before they can get better. Our leaders are stupid and reckless, and our people have forgotten what bad fiscal policies are like.
"Nothing works like freedom, Nothing succeeds like liberty"
Kyle
Trade is only about 10% of the US economy (compared to 16% or so for Germany, much more for China).
I think 2% growth is basically flat when you add in population growth.
No argument whatsoever with your point about the policymakers. It's like Obama specifically asked what is most likely to damage the US economy, and then decided he was for it.
And his wife came right out and said that young people shouldn't go into business.
not crude or other refined products. From a 10 dollar/gal country I can tell you that our chemical industry is not taxed that heavily. Taxes are coming into play when you want to sell the stuff to motorists. If you turn it into paint, plastics and whatnot the price is a fraction of that 10 dollars/gal.
...to us. Because they tax motor fuel so heavily, people buy a lot more cars with diesel engines (which are more efficient than gasoline engines). A barrel of crude oil produces less than half as much diesel fuel as gasoline, so they send their extra gasoline here.
We won't drive less. Maybe a temporary and marginal reduction, but most driving we do is not optional. So, we'll continue to drive our cars and we'll pay what we have to for gas. Net result is that higher gas prices will make us all poorer, which suits the left just fine.
Nothing will make us give up our cars short of general economic collapse or a superior alternative, and by "superior" I mean something consumers prefer, not something government or enviro-nazis try to impose.
Even at $20/gal I'll be driving more or less the same amount. I'll just be poorer for it. God only know how someone working at McDonalds will cope.
Of course it is hard for people to make adjustments over night. But in time, if prices stay high, you will see all of the following.
(1) more carpooling
(2) shorter vacation trips
(3) more sells of small cars and hybrids
(4) more "at home" entertainments like getting the family and neighbors together to watch movies on HD tv instead of driving out to the theater.
(5) Eventually people will opt to leave their jobs and take lesser paying jobs closer to their home. If the difference in income is small, you spend less on commuting, and also gain more free time.
"Nothing works like freedom, Nothing succeeds like liberty"
Kyle
If prices remain this high and/or continue to increase, people will adjust their driving patterns and, if possible, buy more fuel efficient vehicles. For some folks, there is a certain amount of driving that is "required" but there is much driving that is done for the sake of convenience.
For my own family, we've already made some minor changes and are planning on even more in the coming months. We are trading in my wife's big SUV for a smaller mid-size one. We would trade in for a sedan but we have little ones still in booster seats and car seats and we would be squished even in a large car. My wife has also become much more conscious of making trips to the grocery store or mall or to the kids' activities. Last summer, she never thought twice of driving 2 miles to the grocery store just to pick up one or two things she had a taste for or to just drive to the mall on a whim just to get out of the house. Now, she limits that type of driving and combines multiple stops in one trip. For the kid's soccer/baseball/golf/dancing/volleyball activities she is partnering with neighbors to carpool.
Honestly, to me, this is amazing. We live in a relatively affluent area and to see these typical suburban folks react to high gas prices in this way was a surprise at first. I can't imagine how families living on $30-50k per year are coping.
Obama is calling for a $50 billion stimulus package.
I sorry but they are happening soon - like now !
"But none of the other predicted effects (including alternative fuels, hybrid engines, nuclear-powered electric cars, or increased use of public transport) will happen anytime soon. And to the extent that they happen at all, government can only hinder them, not help them along."
And US Govt investments and tax credits will also speed the process - not slow it down.
Purchasing $1.7 Billion a day in petroleum products from foreign countries can only hurt this country in the long run.
That number is only rising with the price of oil.
Though I do agree with you about drilling here too.
If American Scientists, Engineers and Techies could develop THE NEXT ENERGY, we'd not only have energy independence but something valuable to export.
The other great technology I'd love to see us develop and export would be next generation water purification. With that, you'll see some real wealth creation.
Our best days are ahead of us---to borrow from Reagan.
We've got to explore for more of the tried and true energy resources but we've also got to be a lot bolder in imagining the future. If Americans can't lead the way, we've lost our way.
like nanotech solar panels which increase efficiency and lower cost, nano-dynamos which can create small amounts of current from random movements. (imagine getting windmill like power from a field of flapping flags)
Also technology which brings down the temperature at which superconductivity operates.
All of these things put together, however will not take the place of fossil fuels or even a healthy nuclear industry.
"Nothing works like freedom, Nothing succeeds like liberty"
Kyle
When gasoline prices exceeded $2.50 (USD) per gallon a year or so back, I consciously made the decision to curb all unnecessary travel and take up bicycling for those local trips which didn't require me to transport perishable items such as frozen groceries and fruit over similar distances within a similar range. I'll miss the road trips to Pennsylvania (although I probably wouldn't be able to do that more than a few times a season anyway), but the tradeoff is a bit more relaxing and likely better for my health in the long run. The only drawback is that these fuel prices will be affecting everything else from the price of the food that I buy at the store to the costs of clothing (many fibers used in clothing are plastics - petroleum byproducts) to how much I may have to pay for whatever planned trips I may take later this summer.
It's all part of my philosophy of "Adapt or Die" coming into play. I need to adapt (shorter work commutes including bus rides if headed towards a common destination, less liesurely travel, etc) in order to get by. So will everyone else I know and work with, no matter how hard they're being pinched.
At the same time, I think it's far past time that we kicked sand in the OPEC gang's face and started developing our own resources. One thing that's standing in our way for now is a Congress and its clients in the environmental extremist movements, OPEC-toady petroleum companies and a host of others that effectively keeps us chained to the unreliable source of our economic power. ("Unreliable" because we've seen how our petrodollars are shoring up a hostile religious philosophy fostered by undemocratic states and petty monarchies whose view of the world is still firmly entrenched in a Hobbesian medieval culture.) Only with the expulsion of those parties and the agencies that use them to foster their neo-feudalistic charade will we be able to move forward.
"Straight Talk Express"? My bum feet! -- Me, on Senator McCain and other "moderates"