The President’s new initiative on increasing energy independence inspired much commentary on how much it was aspirational, rather than realistic; see for instance this extensive NYT article. In this post, I want to consider whether reduced dependence on imported energy is a worthwhile objective.
Oil Price Shocks: How Important in the Past?
What are the macroeconomic consequences of oil shocks. Jim has covered this extensively recent article by Prakash Loungani recounts Jim’s take on the impact of oil price hikes in the lead up to the recession.
Chart 3: from Loungani (2011).
Loungani notes Olivier Blanchard’s recent work with Marianne Riggi asserting a smaller impact on GDP in recent decades due to decreasing real wage rigidity and enhanced monetary policy credibility [VoxEU] paper based upon estimates derived from structural VARs.
Chapter 3 of the IMF’s World Economic Outlook, just released today, has an extensive discussion of the role of oil in macroeconomic performance. One interesting table highlights the differences in views regarding the impact of an oil shock.
Table 3.3.1. from IMF WEO April 2011, Chapter 3.
Clearly, energy — and oil — are important. But it might be useful to think about why they are important. And here, the change over time in the structure of the economy seems to be key.
Energy Intensity versus Oil Imports
First, it’s clear that energy intensity is decreasing. Figure 1 depicts log quads of primary energy consumption versus log real GDP. Holding all else, one might think that reduced energy intensity would result in lower sensitivity to energy price shocks. Unfortunately, as Jim Hamilton points, out, there’s no clear relationship between intensity and output sensitivity to energy shocks (on a sectoral basis).
Figure 1: Log energy consumption, in quads (blue), seasonally adjusted using X-12, and log GDP in Ch.2005$ (red), normalized to 1990Q1=0. NBER defined recession dates shaded gray. Source: Energy Information Administration, BEA, NBER, and author’s calculations.
So, we might not want to take too much comfort from the fact that energy intensity has decreased over time, at least from the production side.
Second, the quantity of oil imports (in real units) is decreasing, as shown in Figure 2. This is probably a short term phenomenon; with resurgent growth, the volume of oil imports should increase. Nonetheless, for now, the volume of oil imports is down.
Figure 2: Petroleum imports, in bn.$ (blue), and in bn Ch.05$ (red), both SAAR. NBER defined recession dates shaded gray. Source: BEA, 2010Q4 3rd release.
Do either of these trends work to mitigate worries about rising oil prices, and what do they imply for policy?
At this juncture, I think it is of interest to consider the different effects emanating from an oil price increase. First, consider the demand side. When the relative price of oil rises, then spending is diverted to abroad. In other words, with higher oil prices, a transfer is effected thereby reducing aggregate demand.
If preferences were such that even as relative prices changed, expenditure shares remained constant (e.g., Cobb-Douglas utility function), then the transfer effect would be minimal. But I think the presumption is that when oil prices rise, spending on oil related products also rise squeezing expenditures on other goods. Hence when the nominal value of oil imports rise, there are essentially two impacts on the demand side: the transfer to rest-of-the-world, and decrease in spending on non-oil goods and services. These effects are in addition to the supply side impact.
On the supply, side, the increase in oil prices feeds into the cost of production. If wages relative to other input prices do not fall, then the overall price level rises. Whether the change in oil prices feeds into either a relative factor price change or a general price level increase depends critically on monetary policy, and how price level changes influence expected price levels.
The Blanchard-Riggi results speak most to these supply side effects (although I admit I’ve not figured out all the details of the model). But the demand side effects are arguably of comparable importance.
This is where I think the President’s proposals to reduce oil import dependence by increased domestic production do not directly address minimizing the supply side impact. Increased domestic production wouldn’t really help, except to reduce the size of transfer to the rest of the world (which is not necessarily a bad thing).
However, increasing the substitutability between energy and other consumption goods, and reducing the amount of oil use would mitigate the negative consequences of oil price shocks. That is why the development of effective green technologies, might be a more efficacious route than “drill, baby, drill”.  
Addendum: Prakash Loungani also has an interesting working paper on energy security, including a discussion on the geographical sourcing of supplies.
You might take a look at slide 13 of my first presentation to Congress here: http://ourfiniteworld.com/2011/03/03/steven-kopits-oil-the-economy-and-policy/
From an oil perspective, what was the purpose of the 2008 oil shock? To move 5 mbpd of consumption from the OECD countries to the non-OECD countries. When did the OECD countries cede that quantity? Essentially from the first month of the recession to the last month of the recession.
It’s not a gradual transfer. It’s abrupt and traumatic. That’s the implication of ‘inelastic demand’ for oil during times of economic expansion–that demand is only really elastic during a recession.
The math suggests we don’t get back the oil that we ceded during the recession. Imports don’t recover, at least not materially. And the pressure’s on again. We’re on track for a summer oil shock, barring some real production push from the Saudis.
First, it’s useful to look at some recent trends in oil consumption. The following chart shows normalized oil consumption by the US and four developing countries from 1998 to 2009, with 1998 consumption = 100 (EIA):
Note that while US consumption in 2009 was below our 1998 consumption level, all four developing countries, especially China & India (“Chindia”) showed large increases in consumption. Note that annual oil prices rose at an average rate of 20%/year from 1998 to 2008, and at 14%/year from 1998 to 2009.
Second, here is a chart that shows the ratios of US consumption to production (C/P) for oil, natural gas and coal (EIA):
A 100% line on a C/P chart is the dividing line between net exporter and net importer status. The US is of course the world’s largest net oil importer, and we are a large net natural gas importer. Somewhat surprisingly, we are just barely self-sufficient in coal, on a tonnage basis.
If we extrapolate the 2005 to 2009 decline in the US C/P oil ratio, the US would approach zero net oil imports around 2024.
Note that if we extrapolate the the rate of increase in Chindia’s combined net oil imports, as a percentage of global net oil exports, they would approach 100% around 2025, when they would consume all global net oil exports (they went from 11% in 2005 to 17% in 2009).
So, these two extrapolations, while troubling for the US and other developed countries, are not inconsistent, but as they say, Somethings gotta give.
We explore some scenarios in this article:
In summary, our work suggests that the US is well on its way to “freedom” from our dependence on foreign sources of oil, just not in the way that most people anticipated. It would appear that we are being outbid by the developing countries for declining volumes of global net oil exports.
Incidentally, regarding the “vast” Canadian tar sands resources, it’s useful to put the very slow rate of increase in Canadian net oil exports in perspective. This chart shows several years of net oil exports from Canada and Venezuela, plus their combined net oil exports:
These kinds of graphs are easier to make, but harder to interpret for the fact that they ignore the energy content of non-energy import/export. Virtually all products have some energy content, and surely part of the lower energy-intensity of the US economy is due to the outsourcing of highly energy-intensive manufacturing, replacing it with less demanding things like services. That does not mean the energy-dependency of the economy as a whole changes, just that it is hidden in the imported products.
Probably too hard to get numbers for?
Actually, Japan nuke incident moving into category 7 is bullish for oil/gas/coal prices as nuclear glamor goes into dustbin and fossils remain the only real replacement.
Short summary with data and table why Fukushima moved into 7 and how 10% of Chernobyl has been calculated. Actually, Cs-137 with 30 years half life is has been already leaked at amounts =20% of Chernobyl total. And its reactor 2 which has been and still is responsible.
I hope this is relevant, as higher oil prices means more efforts by the USA to secure energy independence, including military options as domestic development may take many years.
Here’s a thought on oil. We have not pursued our own oil aggressively because we cannot affect prices. However, every barrel we produce contributes to GDP twice. First by the price of the barrel produced, and again by the price of the barrel not imported. This makes our inability to affect prices a very good thing. And this is before any multiplier effects.
You also forgot the increased demand for savings when consumables prices rise and wages don’t.
If we extrapolate the 2005 to 2009 decline in the US C/P oil ratio, the US would approach zero net oil imports around 2024.
In the context of:
– the worst recession since the 1930s (steepest fall in industrial production and GDP)
– a doubling more or less of oil prices from trough to peak (following a 7 fold rise in the 1998-2005 period)
What your projections show is that the US is well on the way to oil independence, if oil prices keep doubling every 5 years from here?
Also of course as oil consumption falls we get closer to the completely inelastic part of the demand curve.
Roughly 15% of US electricity at the start of the 1970s was generated by oil. That’s less than 2% now.
Similarly the easy money is mostly made in CAFE: Getting average car MPG to 16 to 24 mpg and truck and light vehicle to over 20mpg (if it happens, when it happens).
It will take an increase to 36mpg to have the same effect again *if* VMT does not increase (and of course it will– USians are not going to go back to living and shopping downtown in a hurry, and the electric streetcar networks no longer exist in most cities).
It’s a brave man who would forecast $960 per barrel oil in 2030. Which is what you are implying.
The impact of the gulf spill has proved to be rather minute. The main cost were politically generated.
The main ecological threat I expected was from dispersants. This proved not to be the case, the natural bacteria that break-down oil work more optimally below the surface at cooler temps and higher pressures. While waters in the arctic may be cooler than that bacteria works at, the arctic no doubt has its own natural seepage and bacteria suited for its waters. Otherwise there’d be large amounts of oil trapped just below the ice.
Also, there are fantastic amounts of gas to be pursued there.
Here were my comments on the ASPO-USA website, when several of us were asked for predictions at the end of 2010:
“No matter what specific years that one picks as the starting and ending points, the period from the late Nineties to the end of this decade was characterized by a double-digit average long-term rate of increase in average annual oil prices. For example, from 1998 to 2008 the average rate of increase in US spot crude oil prices was about 20 percent per year. However, what I find interesting is the progression in three year-over-year annual price declines in the 1997 to 2009 time period: down to $14 in 1998, down to $26 in 2001 and down to $62 in 2009. Note that each successive year-over-year price decline was to a level that was about twice the level reached during the prior decline. If this pattern holds, the next year-over-year price decline would bring us down to an average annual oil price of about $120, in the context of a long-term average double-digit rate of increase in annual oil prices, which is what we are seeing in 2010, versus 2009.”
Regarding the Thirties, note that monthly crude oil prices hit their low in the Summer of 1931, and then rose at about 11%/year from the Summer of 1931 to the Summer of 1937, when they fell again. Also, it appears that global oil demand only fell one year, in 1930, with following years showing increasing consumption. And there were reportedly three million more cars on the road in 1937 in the US, versus 1929.
So, the Thirties were broadly characterized by rising oil prices and rising demand.
China and India, et al are to our current predicament as the US was to the Thirties, with the key difference being of course now that hundreds of millions of people in developing countries want to buy their first car.
endorendil, good points! Thanks.
Jeffrey, good chart information. Thanks.
The energy intensity of the domestic US economy has fallen primarily because we have undergone a 25- to 30-year period of deindustrialization and financialization of the US economy while substituting value-add goods production and returns to US labor with debt-money increasing per capita at a rate 3-4 times that of per capita production in order for the bottom 80-90% of US households to take on debt to purchase unreal estate durable goods via cheap imports.
So-called multi-factor productivity gains went overwhelmingly to “uneconomic” rents via returns to capital; that is, principally “financial” capital from falling nominal interest rates since the Long Wave Peak in the early ’80s.
Yet, e-CON-omists for three decades have lauded the process of deindustrialization and financialization as a “virtuous cycle” and a period during which central bank monetary policy reduced business cycle volatility, etc. What infantile nonsense!!!
We have increased debt-money supply and its implied net interest costs in perpetuity at a level five times the level of per capita capital stock of value-add productive capacity, including domestic oil production per capita.
[edited for length – mdc]
How can any e-CON-omist claim to be informed and relevant who ignores the obvious?
Without recognizing that the US economy has been in demonstrable decline for 35-40 years, and that the capitalist system (or any known system today that promotes growth) is not sustainable on a finite, spherical planet, any analysis and policy prescriptions are worse than worthless.
“Aspirational, not realistic” – that says it all for the Obama administration. Many seem to be disillusioned; I am not. Was it hard to see that he was not qualified to be a mayor of a small town, say Wasilla AK, let alone president? Much damage has been done, but Obama seems to be stymied. Next comes removal.
Rich Berger: I would like to confirm that you are stating the following: Sarah Palin would have done a better job at managing the capital injections into the banks, handling the GM bankruptcy, increasing the pace of job creation, getting BP to pay for costs of the oil spill, and the impending raising of the debt limit (given that she has stated, as far as I can tell unequivocally, that it should not be raised).
I would like to have this stated explicitly, so I can refer to the statement in the future. Thank you.
Perhaps the moderator would please allow the above links to remain. Thanks.
Yes to all of the above, although it’s pretty hard to imagine how you might refer to that statement in the future, unless you believe SP will be elected President.
Do you think Obama has done a good job? I think he is (a) lazy (b) over his head and (c) more interested in the perks of office than actually performing.
BTW, I think he is going to get shredded in the presidential debates (that’s a real prediction that you can hold me to).
Menzie Chinn: admit it, you like your far right leaning followers – easy and fun targets. Nice post, btw.
Menzie Interesting topic. For a long time there was an ongoing debate whether capital and labor were complements or substitutes. Back in the late 1990s the Center for Economic Analysis within the Dept of Commerce did a BIG study that used detailed data across over 11,000 manufacturing plants. Aside from the sheer ambition and scope of the project the study was also unique (at the time) in that it used KLEM (translog) production functions rather than cost functions. The study concluded that energy and capital were substitutes rather than complements. The cross-price elasticities showed a weak substitution effect (1% increase in energy prices results in a 0.02% increase in capital demand), but the Morishima elasticities showed a more robust relationship, with a 1% increase in energy prices leading to a 3.59 increase in the capital/energy ratio. The study also concluded that over time those elasticities were trending more towards substitutes rather than complements. As I said, the study has some moss on it, but if those parameter estimates are still valid, there might be a little bit of good news with higher energy prices. Higher energy prices coupled with a ZIRP monetary policy might justify capital expansion even in the face of weak aggregate demand.
I some times ask general audiences if they can point out the successful Obama policies? What metric do they use to measure that success.
I am serious about this question. Any answers?
Rich Berger Are you a graduate of Glenn Beck University?
For a long time there was an ongoing debate whether capital and labor were complements or substitutes. Ugh! Doh! Meant to say “capital and energy were complementsor substitutes.”
CoRev There are degrees of success and we have to keep in mind that Obama has had to deal with a pretty crazy loyal opposition. Given that we all too frequently end up with the worst of all possible worlds, I count myself lucky if we get away with the next-to-worst of all possible outcomes. That said, the auto bailout was clearly a success. The Treasury made rather tidy profit on TARP, so that seems to have worked out pretty well despite Tea Party hysterics. The withdrawal from Iraq has been going surprisingly well and at a somewhat quicker pace than I thought possible given the logistical complexities. The healthcare reform was a big success even though there’s still plenty of reworking that needs to be done. The banking system didn’t collapse, which is more than we can say had John McCain been elected. McCain was simply a confused doddering old fool who didn’t understand a lick of it and frankly wasn’t the least bit interested in economic issues. And now that we’ve witnessed McCain’s craven cowardice with his last re-election, I shudder to think what would have happened if McCain had won. Obama has also had his share of half-way successes, oftentimes due to his own half-hearted efforts and bizarre negotiating tactics. The stimulus worked pretty much as predicted by the math, but the math also said it should have been almost twice as large as it was. Still, the stimulus was better than the GOP alternative. Same with the financial reform bill. Could have been better, but it easily could have been a lot worse. Obama also renominated Bernanke, which I count as a success. And he nominated a couple of good Supreme Court justices. And Obama would clean Rich Berger’s clock in a debate.
I would like to confirm that you are stating the following: Sarah Palin would have done a better job at managing the capital injections into the banks, handling the GM bankruptcy [etc., etc.] … I would like to have this stated explicitly, so I can refer to the statement in the future.
Wasn’t the alternative John McCain?
Why the jump over the shark to Palin? What’s with all the fixation so many people have on Palin?
All those kinds of things are handled much more by the senior party people and appointees than by Presidents personally. But if we want to play this game, OK.
If we assume that experience in high position under the intense politital pressure of DC matters for a President personally, then I say explicitly and on the record, that considering McCain’s four terms as a US Senator prior to 2008, serving in a long list of senior positions … versus Obama’s four years as a US Senator, following seven years as a nondescript state senator in Illinois (“the land of good government”) … it is entirely plausible to believe that McCain was better equipped personally to manage those issues.
Anyone can feel free to refer to this statement in the future.
Bottom line is, if you want to elect an “outsider” to change the political establishment, and your candidate wins, then you get an “outsider” trying to deal with the poltical establishment.
What is the economic cost of the US dependency on imported oil driving up military spending to exceed the next 20 largest nations in the world combined?
Brazil was hit hard by global oil prices, harder than the US at the time, but Brazil didn’t have Reagan, so Brazil actually met its goal of energy independence. And it made it a requirement that any energy production in Brazil benefit Brazilians more than anyone outside Brazil – Brazil’s oil production is done by Brazilians to a much greater degree than Saudi production being done by Saudis.
Result, Saudi dictators needed to control Saudi unemployed vs Brazilian democracy responding politically and Saudi present a terrorist threat to the US. But as US needs stable oil prices, unrest in Persian Gulf brings US into Persian Gulf thanks to Carter Doctrine.
Now Reagan and conservatives slam Carter at every turn, but the one thing I wish they would have laughed at and rejected was the Carter Doctrine. If only Reagan had said “the US does not depend on anyone’s friggen oil because we’re exceptional, so we don’t give a damn about their oil and they can just burn it in hell.”
I guess conservatives think Carter was a genius in terms of Persian Gulf politics and military strategy….
“The region which is now threatened by Soviet troops in Afghanistan is of great strategic importance: It contains more than two-thirds of the world’s exportable oil. The Soviet effort to dominate Afghanistan has brought Soviet military forces to within 300 miles of the Indian Ocean and close to the Straits of Hormuz, a waterway through which most of the world’s oil must flow. The Soviet Union is now attempting to consolidate a strategic position, therefore, that poses a grave threat to the free movement of Middle East oil.
“This situation demands careful thought, steady nerves, and resolute action, not only for this year but for many years to come. It demands collective efforts to meet this new threat to security in the Persian Gulf and in Southwest Asia. It demands the participation of all those who rely on oil from the Middle East and who are concerned with global peace and stability. And it demands consultation and close cooperation with countries in the area which might be threatened.
“Meeting this challenge will take national will, diplomatic and political wisdom, economic sacrifice, and, of course, military capability. We must call on the best that is in us to preserve the security of this crucial region.
“Let our position be absolutely clear: An attempt by any outside force to gain control of the Persian Gulf region will be regarded as an assault on the vital interests of the United States of America, and such an assault will be repelled by any means necessary, including military force.”
2slugs, thanks for the response. Too often no one is willing to answer, and I don’t understand the reticence.
My only comment isn’t TARP a Bush policy? Some Obama derivatives might therefore be questioned, as they would not have been available without TARP.
“Higher energy prices coupled with a ZIRP monetary policy might justify capital expansion even in the face of weak aggregate demand.”
NET ENERGY is now the key with Peak Oil and the onset of the post-Oil Age epoch.
When I read 2sb’s bloviations, I am reminded of the old cartoon character, Foghorn Leghorn. Lots of attitude, little content.
CoRev My only comment isn’t TARP a Bush policy?
Yes, TARP Phase 1 was under Bush’s watch. And at the time I gave him credit for bucking his party and doing the right thing. As I recall, Bush met with his Cabinet, Congressional leaders, candidate Obama and candidate McCain. Obama seemed to be on top of the issue. McCain looked utterly confused.
Rich Berger Lately I feel more like the AFLAC duck.
You flatter yourself. But then you always do.
I read your response to CoRev’s request that you list Obama’s accomplishments. I think it is a real stretch to call Obamacare an “accomplishment”. Yes, it was an accomplishment in the sense that words were put on paper and that the Dems persisted in the face of public opposition (that continues strong even now), through bribery and coercion. But it would be like me writing a science fiction novel that described travel across interstellar distances and saying that I actually made the voyage. Even further, given the many places where the law delegates the details to the Secretary, it would be like I wrote the novel with many blanks, like “insert description of interstellar drive here”, or “assume faster than light travel”. We have seen that the Secretary released over 400 pages of regulations pursuant to six pages of the law. That 70-1 ratio, if it holds, means that the law itself would be about 1.4% of the total description of the system. And given the large number of waivers from the requirements and the repeal of the 1099 requirements, that would be like the pages falling out of my novel and the story becoming unintelligible (let alone the ruling that the law is unconstitutional).
Come to think of it, this “accomplishment” is a fitting symbol of the whole Obama presidency – an illusion.
Rich, wow! Give 2slugs credit for attempting an answer. I’ve asked this question 3 times and this is the first serious attempt to answer.
The political reality is when it comes to 2012, the president will e forced to run on his record, and as 2slugs shows it is thin, and as you show it is inconsequential to the point of being unconstitutional.
Rich Berger And given the large number of waivers from the requirements and the repeal of the 1099 requirements
I see that you’ve fallen for GOP propaganda. The waivers are a necessary, deliberate and sensible aspect of the healthcare reform bill. The reason is that many of the key provisions of the bill are phased in, so in order to bridge the gap until all of the provisions fully kick-in the bill intentionally provided the Secretary of HHS with the authority to grant temporary waivers. Think about the consequences of not granting waivers. It’s a no brainer. And the 1099 provision was something that the Administration recognized early on as being a mistake. The Administration attempted to remove the provision from the bill, but the GOP threatened a filibuster because they wanted to use the issue in November…which they did. Did you get that? The GOP (correctly) argued that the 1099 provision was a mistake, the Administration agreed and tried to remove it, but the GOP insisted that it stay in the bill until after the 2010 elections. And once again you bought the GOP lie. You were duped.
CoRev I would not call passage of healthcare reform that provides near universal coverage a “thin” accomplishment. Look at the other Presidents who tried and failed: Teddy Roosevelt, FDR, Truman, LBJ, Nixon and Clinton. Only Obama actually got it done. And given all of the hell that was breaking loose by the time Obama took the inaugural oath, just keeping the country in one piece was quite an accomplishment. He even had to deal with pirates and swine flu on top of everything else. I’m having a hard time imagining any GOP presidential hopeful accomplishing anything even close to what Obama did. I think Obama blew a lot of opportunities and he could have done a lot better, but calling his record “thin” is a bit of a stretch.
I was supposed to take a spin class early tomorrow morning. I no longer need it.
2slugs, at least put a smiley face on the comment when you’re kidding. ;-))