Oil prices and the U.S. economy

Here’s why I believe that the current high price of oil is not enough to derail the U.S. economic recovery.



New Jersey Historical Gas Price Charts Provided by GasBuddy.com

Although the prices of oil and gasoline have risen significantly from their values in October, they are still not back to the levels we saw last spring or in the summer of 2008. There is a good deal of statistical evidence (for example, [1],[2]) that an oil price increase that does no more than reverse an earlier decline has a much more limited effect on the economy than if the price of oil surges to a new all-time high.

One reason for this is that much of the impact on the economy of an increase in oil prices comes from abrupt changes in the patterns of consumer spending. For example, one thing we often observe when oil prices spike up is that U.S. consumers suddenly stop buying the less fuel-efficient vehicles that tend to be manufactured in North America. That drop in income for the domestic auto sector is one factor aggravating the overall economic consequences. But if consumers have recently seen even higher prices than they’re paying at the moment, their spending plans and firms’ production plans are likely already to have incorporated that reality.

For example, take a look at February sales of domestic light trucks, which includes SUVs. These were up a bit from last year, but are still 28% below February 2007. Since the original spike in gas prices in 2007-2008, Americans have never gone back to buying the larger vehicles in the numbers we used to.



Data source: Webstract.
dom_trucks_mar_12.gif

By contrast, here’s a plot of sales of domestically manufactured cars. Sales for February 2012 set an all-time high for this category. Again, historically when oil prices make an all-time high, what we often see is American consumers spending their money on more fuel-efficient imports rather than the domestic vehicles. But this time, Detroit was already in position with the kind of cars people want when the price of gasoline is higher.



Data source: Webstract.
dom_cars_mar_12.gif

Of course, there are other channels by which higher oil prices exert a drag on the U.S. economy besides the domestic auto sector. Another series I pay close attention to is the share of total consumer spending that is eaten up by the cost of energy. But the remarkable thing here is that nominal consumer spending on energy goods and services actually declined on a seasonally adjusted basis between September and January, even as the price of gasoline was going up considerably. This represents a combination of an unusually mild winter, very low natural gas prices, and consumers finding ways to reduce their energy consumption and thereby insulate their budgets from some of the damage of higher gasoline prices.



Energy expenditures as a percentage of consumer spending, 1959:M1 to 2012:M1. Calculated as 100 times nominal monthly consumption expenditures on energy goods and services divided by total personal consumption expenditures. Data source: BEA Table 2.4.5U. Blue line is drawn at 6.0%.
en_share_mar_12.gif

If tensions with Iran were to escalate, then I would start to worry a good deal more. But based on what has happened to oil prices so far, I find myself in the unusual position of being less concerned about the impact of oil prices on the U.S. economy than many other analysts.

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51 thoughts on “Oil prices and the U.S. economy

  1. Curt Doolittle

    James,
    Nice argument. But if there is a conflict in the middle east, how are we NOT going to see a series of increasing record oil prices? You’re right that volatility within existing bounds isn’t materially impactful. But a series of highs appear to be.

  2. Ironman

    I would agree overall – by themselves, they won’t derail the economy, but I will observe that they can shift the trajectory of the economy – at least if their apparent effect on the pace of layoffs in the U.S. last year is any indication.
    Speaking of tensions with Iran and their potential effect upon oil prices, well, there’s an app for that!

  3. Bruce Hall

    This chart shows average miles drive as the price of gasoline varies:
    http://www.nytimes.com/imagepages/2010/05/02/business/02metrics.html?pagewanted=all
    The individual consumer changes driving habits during abrupt price changes but, like the frog in a lukewarm pot of water that is gradually brought to a boil, doesn’t react quickly to gradual price changes.
    It’s interesting to note that vehicle manufacturer are now coming up with a new “flex fuel” engine not based on E-85, but natural gas.
    http://abcnews.go.com/Business/wireStory/chrysler-sell-natural-gas-powered-truck-15857516#.T1aRBM1SSfo
    If the government steps out of the way, the market generally reacts when conditions are favorable… or unfavorable depending on your viewpoint.

  4. David L. Hagen

    At about 6%, current energy expenditures are still 1% point above the ~ 5% for energy expenditures during 1995-2005. Isn’t that increase reflected in the elevated unemployment rate?
    More importantly, conventional global crude oil production appears to have hit a “plateau” or “ceiling” in 2005, after 20 years of ~ 1 million bbl/day growth each year.
    See: Oil’s tipping point has passed
    “The economic pain of a flattening supply will trump the environment as a reason to curb the use of fossil fuels, say James Murray and David King.”
    http://www.ocean.washington.edu/people/faculty/jmurray/MurrayKing2012.pdf
    Doesn’t this expose the economies of oil importing countries to far more serious prospects of shortages of transport fuels with serious harm to their economies. e.g. the US Department of Defense and Lloyds of London among others are warning of impending fuel shortages in the 2012-2015 time frame.
    e.g., See Lloyds 360 – Sustainable Energy Security Strategic Risks and Opportunities for Business.
    Jeff Brown and Sam Foucher (2011) warn that the Available Net Exports (after China & India) have already declined 13% since 2005. Current trends project Available Net Exports declining to in 19 years.
    See post by Jeffrey Brown
    Westexas post February 24, 2012 – 7:32pm TOD

  5. 2slugbaits

    If tensions with Iran were to escalate, then I would start to worry a good deal more.
    So does this imply that the markets are not expecting things to escalate with Iran? Because if the markets had already priced in the likelihood of some kind of (yet another!)conflict in the Gulf, then wouldn’t we expect a relaxation of tensions to bring prices down?
    Also, any thoughts about how the Franco-German war on Europe’s periphery might dampen demand for oil?

  6. spencer

    Very, Very good.
    thanks
    Remember, in November, December and January real
    personal consumption expenditures did not grow–
    which makes the drop in energy’s share all that much more impressive.
    Actually, from Oct to Jan. energy expenditures actually fell over 10%.

  7. Ellis

    When economists speak about markets, who are they talking about it? Are markets just some kind of abstraction? Or are they something real, like a few big banks and oil companies? Also, there is a lot of talk about speculation driving up prices. Any comment on that? Or are we dealing in computer models only?

  8. Jeffrey J. Brown

    The crack spread is the gross profit per barrel between what a refinery pays for a barrel of crude oil and what they get from selling the refined products.
    Gasoline prices on the East & West Coasts are traditionally more expensive than in the center of the country, e.g., the gap between West Coast and Midwest gasoline prices in early March, 2008 (31¢) was similar to early March, 2012 (45¢).
    Note that the average WTI crude oil price in March, 2008 was $105, and the average Brent crude oil price in March, 2008 was almost identical, $104.
    On March 4, 2008, the closing WTI crack spread was $10, and the closing Brent crack spread was $12.
    The current price spread between Brent and WTI crude oils is about $17.
    Here are the Bloomberg charts for WTI and Brent crack spreads. If you click on the five year option, you get an idea of historical trends:
    WTI crack spread (currently about $30):
    http://www.bloomberg.com/quote/CRK321M1:IND/chart/
    Brent crack spread (currently about $13):
    http://www.bloomberg.com/quote/ACK321A:IND/chart/
    Note that the difference between the two crack spreads is also about $17.
    In other words, Mid-continent refiners are paying WTI crude oil prices, but basically charging Brent based prices for refined product, and it appears that the only real overall winners from the current spread between WTI and global crude oil prices are the Mid-continent refiners, who are doing quite well.
    Therefore, what the Bloomberg data show is that US consumers are generally paying refined product prices that are based on global crude oil prices, and thus American consumers are almost fully exposed to global crude prices, which makes the daily MSM reports on WTI prices almost irrelevant, from a consumers point of view.
    With that as a background, the average annual rate of increase in annual Brent crude oil prices from 2005 to 2011 was 12%/year, or about one percent per month, although prices have of course fluctuated above and below this trend line.
    As noted above, rising oil prices were necessary in order to balance demand against a declining supply of Global Net Exports of oil (GNE), with developing countries like the Chindia region consuming an increasing share of a declining volume of GNE.

  9. Binky the Bear

    At what point does the federal government seize the oil industry’s plants, assets and reserves and begin a process of rationing gas, fuel oil, lube oil and grease like WWII? Odd/Even day or green window stickers?

  10. JBH

    To be science, it requires prediction. Otherwise it’s just talk. In this case the prediction must answer the question implicit in the initial sentence of this posting: To what price does crude have to go to “derail the US economic recovery”? I presume “derail” means take the economy off the tracks and tumble it into recession. A range or threshold would be adequate. So, Dr. Hamilton, what does the model in your head or on paper say (other than risky territory is $147 per barrel?

  11. aaron

    I’m a bit less optimistic.
    Energy costs aren’t a new high, but they were already too high before the increase in gas prices regardless of what the peak was.
    The main reasons for seasonally low energy costs are cheap natural gas and the fantastically mild winter. As the heating season fades, the impact of natural gas prices will diminish and the seasonal energy cost will jump.
    I think unadjusted is what we should be looking given the NA weather anomaly.

  12. aaron

    I’ve been meaning to look at expenditures by income and wealth level (and also default and foreclosures), but I haven’t had the time or energy. I’m confident that will paint a much bleaker picture.
    How will investors justify the high stock values we have when there isn’t the discretionary income to sustain the high consumer prices people are paying?

  13. jonathan

    Two questions:
    1. Do you have a way of incorporating the current level of corporate profits in your thinking? They’re high so they can shrink. That suggests less cost push inflation pressure. Not so good, of course, for small business.
    2. Not exactly on point, but in Boston we’ve been reading about the impact on our gas prices of refinery closings. I gather 3 more are closing in the near future – assuming they can’t be sold. I don’t understand the economics of this part of the production cycle. I gather they’re not making enough money. One question is how these closings fit in the larger scheme of rising gas prices.

  14. Jeffrey J. Brown

    In order to help me understand the mathematics behind net oil export declines, I proposed a simple model of an oil exporting country called Export Land, which was consuming 50% of production at a final production peak of 2 mbpd:
    “Export Land Model” (ELM)
    Production Declines at 5%/year, Consumption Increases at 2.5%/year, and therefore Net Exports show an accelerating rate of decline
    CNE = Post-peak Cumulative Net Exports = 1,382 mb
    ELM assuming a production peak in 2000:
    http://i1095.photobucket.com/albums/i475/westexas/Slide1-17.jpg
    Note that one can do “Cowboy Integration” by calculating the area under a triangle, and get a pretty good approximation for post-peak CNE (Cumulative Net Exports) by multiplying 365 mb/year X 9 Years X 0.5, (less 365 mb), which is 1,260 mb, versus actual post-peak CNE of 1,382 mb.
    However, if we want to estimate high, we can just multiply the peak net export rate times the number of years to zero, times 0.5, resulting in an estimate of 1643 mb (or 1,600 mb, rounded off to nearest 100 mb), versus the actual value of 1,382 mb.
    Also, if we extrapolate the 2000 to 2003 rate of increase in the Consumption to Production ratio (C/P) for the ELM (50% to 64%), it suggests that ELM would approach a 100% C/P ratio in 8.5 years, when it actually took 9 years. The rate of increase in the C/P ratio was 8.2%/year from 2000 to 2003, so we just take the natural log of (100/50) divided by 0.082, which gives you 8.5 years. This suggests (post-peak) CNE of 1,600 mb, if we round up to 9 years (as shown above), and round to the nearest 100 mb.
    Key Point: In some cases, we can extrapolate the initial rate of increase in the C/P ratio to determine approximately when the net exports might approach zero (as the C/P ratio approaches 100%), and thus we can integrate the area under what tends to be a triangular shaped area to get a reasonable ballpark estimate for CNE.
    Also, a rough rule of thumb is that about one-half of post-peak CNE are shipped one-third of the way into a net export decline period, e.g., ELM, Egypt, UK, Indonesia:
    http://i1095.photobucket.com/albums/i475/westexas/Slide1-8.jpg
    Some Applications:
    Saudi Arabia Post-2005 CNE Estimate
    I estimate that 2011 annual Saudi net exports (total petroleum liquids) will be 1.0 to 1.6 mbpd below their 2005 annual rate of 9.1 mbpd, as we are seeing a small change in the slope of the projected and ongoing net export decline. If we take a net export rate of 7.8 mbpd as a middle case estimate, then Saudi Arabia would approach zero net oil exports some time around 2028 (projecting the 2005 to 2011 estimated Consumption to Production ratios, total petroleum liquids, which increased from 18% in 2005 to an estimated 28% in 2011). The 2028 estimate is consistent with Sam Foucher’s projections.
    Using the same approach that we used for “Export Land,” post-2005 Saudi CNE would approximately be: 3.3 Gb/year X 23 years X 0.5, which would be approximately 38 Gb. Post-2005 Saudi CNE are about 17.5 Gb through 2011, so based on this ballpark estimate, post-2005 Saudi CNE would already be about 46% depleted.
    You can see how this estimate of about 21 billion barrels in remaining cumulative Saudi net oil exports differs “slightly” from conventional wisdom.
    Global Net Export (GNE) Post-2005 CNE estimate
    Our data table shows the C/P ratio for the top 33 net oil exporters in 2005 (GNE) increasing from 26.9% in 2005 to 31.1% in 2010, a 2.9%/year rate of increase. This suggests that GNE would approach zero in 45 years from 2005, or around 2050, suggesting post-2005 Global CNE of about 374 Gb, and it suggest that Global CNE will be about 50% depleted around 2020.
    CANE (Cumulative Available Net Exports*)
    The ratio of Chindia’s combined net oil imports to GNE increased from 11.2% in 2005 to 17.6% in 2010. This suggests that ANE might approach zero in 24 years after 2005, or around 2029, suggesting post-2005 CANE of about 175 Gb, and it suggests that CANE would be about 50% depleted by the end of next year, 2013.
    *Available Net Exports (ANE) = GNE less Chindia’s net import

  15. ppcm

    This post is consistent with previous supported statement,as long as oil prices are just merely retracing towards their previous tops, no risk of recession is to be feared
    J. Hamilton Econbrowser ‘Fundamentals,speculation, and oil prices”
    “My judgment is that, contrary to my 2003 model, there will be some contractionary consequences of recent developments, but, consistent with that model and many others, they will not be as severe as what we experienced in 2008”
    Unsettling may be the other macro components, a consumption subtracting on savings.Even though markets are supplied with good capital gains in the stocks markets and the bonds markets, the Pigou effect is factoring only the real cash balance effect.Something will have to give in, the real cash balance or the markets prices.
    As of February 2012, the IMF was not finding the savings to be commensurate with a level of equilibrium,neither did the same report found the oil prices to be nonthreatening (IMF Meeting of the G20, Mexico city, Global economic prospect and policy changes)
    Since the oil prices is a speculation with no culprits,rolling the futures position can be costly if no capital gains are recorded on the financial instruments only,the same for the other markets.
    As for the potential conflict with Iran,when stretched to the brinkmanship the straight of Ormuz is a conveyor of almost 20% of the world oil production (Iran and neighbouring countries) When applied to Ironman interesting calculation device 20% of 89,346,535 bl/d represent 17869307 bl/d that may not come to any far away shores but may drive the oil price to ~ 184,48 usd (not factoring the overheated mood within context).It should not take too many sunken tankers to fill up a straight of ~ 50 kms widh.That compares with the canal de suez 1956 episode, when the oil output loss was of 10% only.
    As for the alleged Franco German war with the geographical periphery,it is more of a source of inspiration for the anemic thoughts of the press,or vindicative mood of speculators than a reality.Through several comments included in Econbrowser posts, illustration has been given as to the prices to be paid when leaving the euro zone.The Maastrich treaty in its great wisdom has provided for a clause where a member could on its free will, take a vacancy from the eurozone,so far no clamors towards this clause, have been heard from the concerned parties. .
    The punitive financial markets will be happy to raise domestic rates and depreciate ad vi tam eternal the exchange rates.Sympathy has be given to the 1,717279 trillion usd (source FDIC report country exposure lending survey March 31st 2011)including derivatives cross borders claims that are queuing for repayments,queuing for counter parties reality check if and when unwound.More pity than sympathy has to be addressed, to the proponents of the stand still when dealing with the derivatives.

  16. dwb

    as always, nice analysis.
    the “other analysts” that i worry about of course are those at the Fed that last year at this time failed to see that in the face of 9% UE, inflation was transient – and worried about permanently higher inflation. Supply side inflation – which is what this is – should not be a concern to the Fed. It’s demand side inflation (specifically, wage inflation) that should concern the Fed and so far nonexistent. {The reason supply side inflation should not concern the Fed is that the SRAS is pretty inelastic in the short term but over a year or two flattens out as new supplies come online).
    the question is: will the Fed overreact to the news as they have done before???

  17. Buzzcut

    Gasoline prices on the East & West Coasts are traditionally more expensive than in the center of the country, e.g., the gap between West Coast and Midwest gasoline prices in early March, 2008 (31¢) was similar to early March, 2012 (45¢).
    Actually, 14 cents per gallon is a huge spread to a refiner. There is a relatively big spread in retail prices due to the WTI/ Brent dislocation. Just not as much as you think it should be.

  18. Pedro

    Professor, implied gas demand & AAA prices suggest the gas&energy ratio of PCE will jump up to a little under 6.0% in February from a little over 5.5% registered in January…
    (Not to dispute any of the analysis, just to offer a new data point in the series.)

  19. aaron

    The rest of the world is having a cold, harsh winter. Is gasoline, diesel, and other energy consumption up abroad?

  20. Jeffrey J. Brown

    Re: Buzzcut
    As noted above, the key data are the crack spreads. They were quite similar in March, 2008, with the WTI crack spread currently at $30, and with the Brent crack spread currently at about $13.
    Midwest consumers are seeing some slight benefit from lower WTI prices, but in my opinion–given the crack spreads–it seems self evident that the actual benefit is fairly negligible. But I’m sure some refinery executives are getting very nice bonuses.

  21. Jeffrey J. Brown

    More “Net Export Math”
    Note that Export Land’s production at Peak + 9 years was only down by 35%, but of course net exports had gone to zero, so despite the fact that the hypothetical exporting country would continue to produce oil, from the point of view of the export market, they had ceased to exist, and in fact they went from increasing the global supply of net oil exports, to decreasing the global supply, as the country became a net importer. Incidentally, I estimate that only 10% of Export Land’s post-peak production would be (net) exported; about 90% would be consumed domestically.
    Note that net export declines are really a progression in the increase in the ratio of domestic consumption to production (C/P).
    However, given increasing production on the upslope, the C/P ratio tends to decline, unless the rate of increase in consumption exceeds the rate of increase in production, which is why the rate of increase in net exports, on the upslope, tends to exceed the rate of increase in production.
    On the production downslope, it all flips.
    Unless consumption falls at the same rate as the production decline rate, or at a faster rate, the C/P ratio will increase, causing the net export decline rate to exceed the production decline rate, and causing the net export decline rate to to accelerate with time.
    Also, if consumption is increasing faster than production, an exporting country can become a net importer, even before their production peaks, e.g., the US and China.
    So, let’s review the case histories and current data:
    The ELM and Three Case Histories:
    Export Land went from a 50% C/P ratio to 100% in 9 years, a 7.7%/year rate of increase.
    Indonesia went from a 53% C/P ratio to 100% in 9 years, a 7.1%/year rate of increase.
    The UK went from a 59% C/P ratio to 100% in 6 years, an 8.8%/year rate of increase.
    Egypt went from a 51% C/P ratio to 100% in 15 years, a 4.5%/year rate of increase.
    GNE, Saudi Arabia and ANE:
    The Top 33 Net Exporters’ C/P ratio went from 26.9% in 2005 to 31.1% in 2010, a 2.9%/year rate of increase.
    (Note that the Top 33 C/P ratio declined from 30% in 2002 to 26.9% in 2005.)
    I estimate that the Saudi C/P ratio went from 18% in 2005 to 28% in 2011, a 7.4%/year rate of increase.
    The ANE to GNE ratio went from 11.2% in 2005 to 17.6% in 2010, a 9%/year rate of increase.
    This relatively basic exercise in math has profound implications for the global economy, but how many people worldwide understand what is going on?
    Given the progression in the ANE to GNE ratio, I find it endlessly ironic that OECD countries are borrowing against future revenue in order to maintain, or increase, current consumption.
    Following is my “Thelma & Louise” metaphor, (originally written in 2010, updated with latest Chindia numbers):
    The OECD “Thelma & Louise” Race to the Edge of the Cliff
    “Thelma and Louise” is an American movie that ends with the two main characters committing suicide by driving off the edge of a cliff. I’ve often thought that this cinematic moment is an appropriate symbol for the actions of many developed OECD countries that are in effect borrowing money to maintain or increase current consumption. The central problem with this approach is that as my frequent co-author, Samuel Foucher, and I have repeatedly discussed, the supply of global net oil exports has been flat to declining since 2005, with “Chindia” so far consuming an ever greater share of what is (net) exported globally. Chindia’s combined net oil imports, as a percentage of global net exports, rose from 11.2% in 2005 to 17.6% in 2010.
    At precisely the point in time that developed countries should be taking steps to discourage consumption, many OECD countries, especially the US, are doing the exact opposite, by effectively encouraging consumption. Therefore, the actions by many OECD countries aimed at encouraging consumption in the face of declining available global net oil exports can be seen as the OECD “Thelma & Louise” Race to the Edge of the Cliff. I suppose that the “winner” could be viewed as the first country that can no longer borrow enough money, at affordable rates, to maintain their current lifestyle. So, based on this metric, Greece would appear to be currently in the lead, with many other countries not far behind them.

  22. Jeffrey J. Brown

    Saudi Oil Minister, Then & Now:
    http://archive.arabnews.com/?page=6&section=0&article=44011&d=29&m=4&y=2004
    Saudi Oil Minister in April, 2004: Saudi Oil Is Secure and Plentiful, Say Officials
    Excerpt:
    “Saudi Arabia now has 1.2 trillion barrels of estimated reserve. This estimate is very conservative. Our analysis gives us reason to be very optimistic. We are continuing to discover new resources, and we are using new technologies to extract even more oil from existing reserves,” the minister said.
    Naimi said Saudi Arabia is committed to sustaining the average price of $25 per barrel set by the Organization of the Petroleum Exporting Countries. He said prices should never increase to more than $28 or drop under $22. “This is a fair price to consumers and producers. But, really, Saudi Arabia and OPEC has limited control on world markets,” said Al-Naimi. “Prices are driven by other factors: Instability in key oil producing countries; industry struggles to produce specialized gasoline; and the resulting strains on refineries to meet local demand.”
    “Saudi Arabia’s vast oil reserves are certainly there,” Naimi added. “None of these reserves requires advanced recovery techniques. We have more than sufficient reserves to increase output. If required, we can increase output from 10.5 million barrels a day to 12-15 million barrels a day. And we can sustain this increased output for 50 years or more. There will be no shortage of oil for the next 50 years. Perhaps much longer.”
    Annual Saudi net oil exports (BP, estimated for 2011) from 2002 to 2011, versus annual Brent crude oil prices:
    http://i1095.photobucket.com/albums/i475/westexas/Slide1-21.jpg
    http://www.brecorder.com/fuel-a-energy/193/1162364/
    Saudi Oil Minister in April, 2012: Saudi Arabia must diversify oil industry
    Excerpt:
    Top oil exporter Saudi Arabia must reduce its reliance on crude sales revenues and develop its downstream industry to shield its economy from international market volatility, the kingdom’s oil minister said on Tuesday . . .
    “In light of such unpredictable fluctuations, it is not appropriate to depend on the production and export of oil as a basis for national income and sustainable economic development,” he said.

  23. Ricardo

    Good analysis professor.
    I would suggest that the cost of gasoline as a percentage of the average person’s budget would be a better guage of the impact of gasoline prices on the economy than simply a snapshot of a price or even a price trend. Of course thta is a more difficult analysis than simply looking at price and price trends.

  24. Jeffrey J. Brown

    Minor correction:
    Saudi Oil Minister in March, 2012: Saudi Arabia must diversify oil industry

  25. hrsaccount

    If American auto-makers will just make
    more fuel efficient cars, our economy
    will benefit from consumers ditching
    their gas guzzlers, however recent
    they may be. My ‘recent model’ gets
    25/30 mpg, so should I swap it out
    for one that gets 30/40, or wait
    til 40/60 comes along?
    (Conventional wisdom would, of course
    be to go for the 30/40 model now, and
    then buy the 40/60 car once it’s in the
    showroom.)

  26. Buzz

    Midwest consumers are seeing some slight benefit from lower WTI prices, but in my opinion–given the crack spreads–it seems self evident that the actual benefit is fairly negligible.
    It seems to me that you have a difference in crude prices of about 9%, resulting in a 3% discount for consumers of gasoline in the midwest. I agree that the cost difference is not being completely transferred to consumers, but I don’t agree that this is “negligible”.
    I don’t see many anti-Keystone XL arguments in these terms. For what it is worth, Keystone XL will raise gasoline prices in the midwest.

  27. Jeffrey J. Brown

    Buzz,
    As noted above, the difference in Brent/WTI prices is about $17, and the difference in Brent/WTI crack spreads is also about $17.
    So, on average, refiners currently get a gross profit per barrel of about $13 from refining a barrel of Brent and they currently get a gross profit per barrel of about $30 from refining a barrel of WTI.
    Regarding Keystone, I am all in favor of it. I think that a real threat to the US economy is that the lower WTI price is going to cause the Canadians go forward with plans to ship crude west and/or east, instead of south. In effect, Midwest refiners are providing a billion dollar per month incentive to the Canadians to take their oil elsewhere.
    And regarding Midwest prices, versus the East & West Coasts, you also have to consider differences in state taxes and regional requirements for specific gasoline blends.

  28. Jeff

    The first paper seems to refer to a new 3 year high being important. Isn’t oil making a new three year high right now?
    Did you run the same analysis with what happens when oil makes a 5 year high and find similar non-linear effects? Or is it that there would be basically no difference between the “three year high” and “five year high” time series until now?

  29. Steven Kopits

    Nice post.
    My take: http://www.foreignpolicy.com/articles/2012/03/05/the_petrostates_of_america?page=0,2
    In essence, the US economy is reacting very flexibly to higher prices.
    As regards the innoculation theory:
    – Reduced sensitivity is posited a function of expectations, as I understand it. It would seem to matter then whether price changes are viewed as permanent or transient by the consumer.
    – There is also a budget constraint or a fixed cost constraint. Even if I expect higher prices, if I have a long commute or an inefficient car, I may not be able change those in the short term. So timing matters. The longer the lag between a previous oil price high believed to be permanent and the next high, the greater the adjustment of the economy. Which in fact is consistent with what we see today.
    If the US can continue to increase its oil efficiency gains at the pace achieved in H2 2011, it can meet both GDP growth goals (say, 3%) and reduce consumption at the required pace (cc 1.5% per annum).

  30. Joseph

    Jeffrey J. Brown: I think that a real threat to the US economy is that the lower WTI price is going to cause the Canadians go forward with plans to ship crude west and/or east, instead of south.
    Does it matter if the U.S. has to import a barrel of oil from Mexico instead of from Canada? Imported oil is imported oil. If Canada ships oil to China, that is less oil that China will import from Mexico, for example.

  31. aaron

    Joseph, Yes. Mexico has peaked, and it the most dangerous country in the world (last I heard). Canada has growing reserves and would be a secure supply line.
    The key to dealing with risk is excess capacity. It is likely why it took WWII to boost the economy. We tried building one lane roads to parks, when we built large freeways for security is when people found practical uses for them.
    And see James’s post on the inefficiencies in getting oil to refineries in the US.

  32. Jeffrey J. Brown

    Jospeh: “Does it matter if the U.S. has to import a barrel of oil from Mexico instead of from Canada? Imported oil is imported oil. If Canada ships oil to China, that is less oil that China will import from Mexico, for example.”
    I think that the US will be better positioned to bid for Canadian oil, with the Keystone pipeline, than without it, and it’s important to remember that there were only two net oil exporters in the entire Western Hemisphere that showed increasing net oil exports from 2005 to 2010, Canada & Colombia (Brazil is a net importer of petroleum liquids, with a recent history of increasing net petroleum imports).
    The BP data base shows combined net oil exports (total petroleum liquids) from the seven major net oil exporters* in the Americas and the Caribbean declining from 6.2 mbpd in 2004 to 4.8 mbpd in 2010, a 23% decline in six years. Excluding Canada, the combined net oil exports from the other six countries fell from 5.4 mbpd in 2004 to 3.7 mbpd in 2010, a decline of 31% in five years.
    The dominant trend that we continue to see is that developed oil importing countries like the US are gradually being shut out of the global market for exported oil as developing countries, like the Chindia region, consume an increasing share of a declining volume of Global Net Exports of oil (GNE).
    *Net oil exporters with 2004 net exports of 100,000 bpd or more: Venezuela, Canada, Colombia, Mexico, Argentina, Ecuador, Trinidad & Tobago

  33. Ricardo

    Jeffery,
    Excellent observation and comments about the US being shut out of the global market in exported oil.

  34. Jeffrey J. Brown

    Ricardo,
    The declines in regional net exports (Americas and the Caribbean), in Global Net Exports of oil (GNE) and in Available Net Exports (ANE) are all far in excess of the slow rate of increase in US crude oil production. So, at least until we see a sizable overall decline in global demand, it looks like American consumers will see rising oil prices, despite the slow rate of increase in US crude oil production.
    Recent US crude oil production, in the context of declining net exports:
    Average annual increase in US crude oil production per year, 2009-2011: About 125,000 bpd per year
    Average annual decline in regional net oil exports* from major exporters in the Americas 2005 to 2010: 240,000 bpd per year
    Average annual decline in Global Net Exports of oil (GNE) 2005-2010: 600,000 bpd per year
    Average annual decline in Available Net Exports (GNE less Chindia’s net imports) 2005 to 2010: 1,000,000 bpd per year**
    Despite the slow rate of increase in US crude oil production, the dominant trend is that developed oil importing countries like the US are gradually be priced out of the global market for exported oil, as developing countries like the Chindia region consume an increasing share of a declining volume of GNE.
    *Major net oil exporters in 2005 in the Americas and Caribbean: Venezuela; Mexico; Canada; Colombia; Argentina and Trinidad & Tobago (Total Petroleum Liquids, BP)
    **I estimate that the volumetric annual ANE decline rate will increase to between 1,400,00 bpd and 2,000,000 bpd per year between 2010 and 2020.

  35. Joseph

    The dominant trend that we continue to see is that developed oil importing countries like the US are gradually being shut out of the global market for exported oil as developing countries, like the Chindia region, consume an increasing share of a declining volume of Global Net Exports of oil (GNE).
    Shut out of the global market? What the heck does that even mean? Is there a global market or isn’t there? Do consumers compete on price or not? Is China or India’s money worth more than U.S. money? Does oil flow to the entity who pays the highest price or doesn’t it? Is there a free market in oil or not?
    This just seems to me to be incoherent jingoistic justification for a Canadian pipeline. Just one more in the long series of invented justifications — “it will reduce gas prices”, “it will improve our security”, “we won’t be giving money to terrorists”, “jobs by the millions”, “billions more GDP” etc.

  36. aaron

    You hear what you want.
    China and India are willing to pay more. We are buying less and they are buying more. Other producers are choosing to use their oil instead of sell it at the price we are willing to pay. We are getting squeezed out.

  37. Jeffrey J. Brown

    Joseph,
    I think that as have previously discussed, the data are pretty clear. As global oil prices doubled from 2005 to 2011, the US has reduced its oil consumption, but many developing countries, especially China & India, have increased their consumption.
    As noted above, if we extrapolate the 2005 to 2010 data, in only 19 years China and India alone would consume 100% of Global Net Exports of oil.

  38. Jeffrey J. Brown

    Aaron: “You hear what you want.”
    I think that we are seeing cognitive dissonance on a global scale.
    The numbers regarding Global Net Exports of oil, and Chindia’s increasing net imports, don’t fit most people’s view that we have no oil supply problems, so they reject the numbers.
    I’ve used the the “Sixth Sense” analogy (as in the movie where many ghosts don’t know they are dead and they only see what they want to see). For most Americans, our auto centric suburban way of life is dead, but most of us don’t know it yet, and we only see what we want to see.

  39. aaron

    “The key to dealing with risk is excess capacity. It is likely why it took WWII to boost the economy. We tried building one lane roads to parks, when we built large freeways for security is when people found practical uses for them.”
    In case people haven’t inferred what I expected, creating the production and delivery infastruction is vital to our transportation energy security. Keystone and other pipelines are vital. We need to handle more oil than we use to protect against supply shocks.
    Even if reducing our consumption and increasing our supply doens’t affect global prices (so we sell more petrol products abroad), when there are supply shocks price of delivery will rise considerably, so we need access early on in the supply chain and energy efficiet delivery.

  40. Joseph

    “I think that we are seeing cognitive dissonance on a global scale.”
    You misunderstand. There may be shortages of oil, but you claimed that would close the U.S. out of the global market? The price of oil is the price of oil. It will go to whoever offers the highest price. Surely you don’t believe that the Canadians want to build a pipeline so they can sell oil to Americans at below market prices?

  41. Steven Kopits

    Joseph –
    I think Jeffrey is aware the oil goes to the highest biddger. He’s saying rather than there are every day more Chinese and Indians coming to the bidding table, and taking the incremental share. Without adequate growth of the oil supply, the Indians and Chinese (and let’s not forget the 2.5 bn people in the “other non-OECD” category) are bidding away OECD oil consumption.
    As for the suburban lifestyle, a typical mortgage and real estate taxes in Princeton will run $5,000 / month. A $1 / gallon increment probably runs such a household maybe $250 per month. Thus, $1 / gallon increase would decrease property values in Princeton by, say, 5%. This is a material amount, but hardly the end of the suburbs.
    But Jeffrey is correct in suggesting that incremental growth is more likely to occur in urban or near urban settings, particularly if physical safety improves, as it has in recent years. London, for example, has seen very rapid population growth, despite expectations to the contrary.

  42. Joseph

    Steven: I think Jeffrey is aware the oil goes to the highest bidder.
    Jeffrey said: “countries like the US are gradually being shut out of the global market for exported oil.” Your statement and Jeffrey’s are antithetical.
    And whether Canada chooses to sell oil to the U.S. or China makes no difference. It does not change the global oil supply.

  43. Steve Bean

    “If the US can continue to increase its oil efficiency gains at the pace achieved in H2 2011, it can meet both GDP growth goals (say, 3%) and reduce consumption at the required pace (cc 1.5% per annum).”
    Steven, what was your measure of oil-efficiency growth? I didn’t see it explained in your article aside from that which was related to new vehicle purchases.

  44. Jeffrey J. Brown

    Joseph,
    Are you assuming that we are saying that exporters will refuse to sell to the US?
    The whole point is that the developing countries, e.g., the Chindia region, are outbidding the developed oil importing countries, e.g., the US, for access to a declining supply of Global Net Exports of oil (GNE).
    Annual Brent crude oil prices doubled from $55 in 2005 to $111 in 2011. We have annual production and consumption data, in the BP data base, through 2010.
    In response to rising oil prices, it’s not surprising that US oil consumption fell at 1.7%/year from 2005 to 2010 (BP).
    However, over the same time frame, 2005 to 2010, the Chindia region’s consumption increased at 5.3%/year, and their net imports increased at 7.7%/year.
    Chindia’s combined net oil imports rose from 5.1 mbpd in 2005 to 7.5 mbpd in 2010 (BP). Over this time frame, Global Net Exports of oil (GNE*) fell from 45.5 mbpd to 42.6 mbd.
    Therefore, Chindia’s combined net oil imports, as a percentage of GNE, increased from 11.2% in 2005 to 17.6% in 2010. If we extrapolate this trend, the Chindia region would consume 100% of GNE in only 19 years.
    What the data show are clear. The US is being outbid for access to a declining volume of GNE. What happens from where is an open question, although I think that some kind of continuation of the current trend is likely.
    *Top 33 net oil exporters, BP + Minor EIA data, Total Petroleum Liquids

  45. Jeffrey J. Brown

    Re: The ‘burbs
    A couple of links, a 2011 article and a link to the 2004 video “End of Suburbia.”
    It’s interesting to look back at the video, made eight years ago, and compare their predictions to what has transpired in the intervening years. In my opinion, the only thing that they really got wrong (so far) was natural gas.
    http://realestate.msn.com/article.aspx?cp-documentid=21179977
    Is your suburb the next slum?
    Excerpt:
    “The nation’s suburbs — once the symbol of the American dream — are well on their way to becoming tomorrow’s slums, some experts say.
    The one-two punch of a crippling recession and higher gas prices have quelled demand for many of the nation’s fringe communities from Charlotte, N.C., to Sacramento, Calif., while at the same time demographic trends have begun pushing an aging population back to the nation’s urban cores . . .
    The suburbs, experts say, are actually more costly than people realize, which means they’re not even a good option for most lower-income families looking for a better life.
    As the price of gasoline has risen, commuting to the suburbs has taken a much greater share of take-home pay, says Ed McMahon, the Urban Land Institute’s senior resident fellow on sustainable development — 25% of a household’s income in an auto-dependent suburb, compared with 19% for the average in-city family.
    “In some cases, they are spending close to 30%” if they have a spouse and teenage kids driving on their tab, he says. By contrast, he says, average Europeans spend 9% on transportation because of their access to rail and subways.”
    End of Suburbia: Oil Depletion and the Collapse of the American Dream:
    http://www.youtube.com/watch?v=Q3uvzcY2Xug

  46. Jeffrey J. Brown

    And a topic I touched on up the thread:
    As I have once or twice opined, things look a little different when one looks at Global Net Exports of oil (GNE) and Available Net Exports (ANE, i.e., GNE less Chindia’s net imports)–instead of total liquids.
    Our data table shows that the volumetric ANE decline rate from 2005 to 2010 was 1.0 mbpd per year. I estimate that the volumetric ANE decline rate will accelerate to between 1.4 and 2.0 mbpd per year between 2010 and 2020.
    In some cases, we can extrapolate the initial rate of increase in the Consumption to Production ratio of total petroleum liquids (C/P) to determine approximately when net exports might approach zero (as the C/P ratio approaches 100%), and thus we can integrate the area under what tends to be a triangular shaped curve to get a reasonable ballpark estimate for Cumulative Net Exports (CNE).
    Also, a rough rule of thumb is that about one-half of post-peak CNE are shipped one-third of the way into a net export decline period (e.g., ELM, Egypt, UK, Indonesia).
    Some Applications:
    Saudi Arabia Post-2005 CNE Estimate
    I estimate that 2011 annual Saudi net exports (total petroleum liquids) will be 1.0 to 1.6 mbpd below their 2005 annual rate of 9.1 mbpd, as we are seeing a small change in the slope of the projected and ongoing net export decline. If we take a net export rate of 7.8 mbpd as a middle case estimate, then Saudi Arabia would approach zero net oil exports some time around 2028 (projecting the 2005 to 2011 estimated Consumption to Production ratios, total petroleum liquids, which increased from 18% in 2005 to an estimated 28% in 2011). The 2028 estimate is consistent with Sam Foucher’s projections.
    Post-2005 Saudi CNE would approximately be: 3.3 Gb/year X 23 years X 0.5, which would be approximately 38 Gb. Post-2005 Saudi CNE are about 17.5 Gb through 2011, so based on this ballpark estimate, post-2005 Saudi CNE would already be about 46% depleted.
    You can see how this estimate of about 21 billion barrels in remaining cumulative Saudi net oil exports differs “slightly” from conventional wisdom.
    Global Net Export (GNE) Post-2005 CNE estimate
    Our data table shows the C/P ratio for the top 33 net oil exporters in 2005 (GNE) increasing from 26.9% in 2005 to 31.1% in 2010, a 2.9%/year rate of increase. This suggests that GNE would approach zero in 45 years from 2005, or around 2050, suggesting post-2005 Global CNE of about 374 Gb, and it suggests that post-2005 Global CNE will be about 50% depleted around 2020.
    CANE (Cumulative Available Net Exports)
    The ratio of Chindia’s combined net oil imports to GNE increased from 11.2% in 2005 to 17.6% in 2010. This suggests that ANE might approach zero in 24 years after 2005, or around 2029, suggesting post-2005 CANE of about 175 Gb, and it suggests that CANE would be about 50% depleted by the end of next year, 2013.

  47. valuethinker

    James
    ‘Energy Expenditures as a percent of consumer income’
    Does that mean *including natural gas and electricity*?
    Because natural gas prices are at record lows.
    That may have offset the impact of higher gasoline prices on consumer budgets? (and also the budgets of many manufacturing and commercial companies,that use natural gas for heating or for production).

  48. JDH

    valuethinker: Yes, it includes nat gas and electricity, and that these helped offset gasoline is my point.

  49. JJ

    Wow guys, this thread has turned onto some really fascinating analysis. I tip my hat. There has also been a bit of juvenile name-calling. (Things like “incoherent jingoistic justification” have no place on a bb for adults.)
    I’d like to add a simple bit of data: today it was announced that the retail gasoline price in the US is higher, for this time of year, than ever in history.
    I’m seeing oil analysts predicting numbers hitting the psychological $5/gallon in the high cost states for this Summer.
    Prof. Hamilton mentioned that rising prices that retrace previous highs are less threatening than new highs, it seems logical to conclude that it is likely Summer gas prices _will_ have a noticeable effect on consumer spending.
    Considering the deleterious effect on consumer spending that we saw the first time beyond $4/gallon, I suspect Prof. Hamilton, with all due respect, is being a bit too optimistic about the effects the the first $5/gallon gas will have.
    if we extrapolate the 2005 to 2010 data, in only 19 years China and India alone would consume 100% of Global Net Exports of oil.
    If you think that is probable, I strongly suggest you sell Wal-mart and buy CNOOC.

  50. Matt Savinar

    Either this year or next, we will see $5 a gallon gasoline, there will be an even bigger economic implosion, and then the food shortages will begin and it will be mad max. The depression started later than I predicted, beginning in `08, not `07. It has also lasted longer than I thought by about a year. The collapse is occuring slowly, which is a good thing. Buy gold now, move to the northwest, and learn how to use a gun. We are like six months away from the end of the world.

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