Q&A on oil prices

I recently did an interview with OilPrice.com on a range of issues related to oil prices. Here are some excerpts.

Oilprice.com: Oil prices have shot up in the last month. What range do you see oil prices trading in over the next 12 months?

James Hamilton: Oil prices have always been very volatile. If you look at 12-month logarithmic changes in WTI going back to 1947, you come up with a standard deviation of 0.27. In other words, 25% moves up or down within a year are fairly common, and 50% moves or greater have also been seen on a number of occasions.

If you look at options prices at the moment, they imply the same level of uncertainty looking forward. For example, somebody today is willing to pay $2.90/barrel for a NYMEX option to buy oil in September 2013 at $120/barrel, consistent with a standard deviation of annual log changes of 0.26. The market is saying that prices that high or higher are not that remote a possibility.

And if you look at current fundamentals, it’s not hard to imagine big moves in either direction coming fairly quickly. The price of oil would surely collapse if we saw a significant economic downturn in China (something nobody can rule out) or if Iraq succeeds in producing even half of its ambitious production targets (though I personally consider the latter unlikely). On the other hand, a military confrontation with Iran could produce a pretty spectacular price spike. If the Strait of Hormuz were to close, for example, it would represent a shock to world production that in percentage terms would be 3 times as big as the 1973-74 OPEC embargo.

Because the demand for oil is so insensitive to the price over the short run, and because there is little excess capacity in the world at the moment, even small disruptions or additions could produce big price changes. For this reason, I do not have a lot of confidence in anybody’s near-term oil-price forecasts.

On the other hand, I think we understand pretty clearly the main factors behind the overall increase in oil prices since 2005. Demand for oil, particularly from the emerging economies, has grown significantly, and we have had a hard time increasing global production. The single most likely outcome is that both conditions will continue to be with us. The most likely scenario is that the next decade will look something like the last, with oil prices volatile but exhibiting an upward trend.

Oilprice.com: For the past century or so, economies have generally been built upon energy. The economies with access to plentiful, cheap energy have developed the most. With the stagnation of oil production growth, how do you suggest economies could continue to grow from here? Should we stop expecting to see constant economic growth as the norm?

James Hamilton: I think this has put a significant burden on the oil-consuming countries. These economic problems have been compounded by the fact that some of the key manufacturing that once came out of countries like the United States and Japan has now been taken over by the emerging Asian economies.

But there is still a strategy for trying to take advantage of the resources we do have. The United States has had astonishing success in producing natural gas. This could be the basis for a renewed manufacturing advantage, a new source of U.S. exports, or an alternative transportation fuel. We should be looking for regulatory reform and infrastructure investment to encourage consumers and entrepreneurs to adopt alternatives to conventional gasoline-powered vehicles.

Oilprice.com: Apart from the Iran and Syria situations– are there any other geopolitical risks that could lead to increased volatility in the energy markets?

James Hamilton: The list of oil-producing countries is almost a Who’s Who of world trouble spots. There is ongoing unrest in Sudan and Nigeria, and it wouldn’t take much to see a major turn of events in Venezuela and Kazakhstan. Iraq, a key hope for future increases in production, has been a place of conflict for most of the last three decades. The same forces that disrupted production in Egypt and Libya last year could easily return. And the key worry about Syria and Iran is the possibility that instability there could spill over into other nations of the region.

We discussed a number of other topics as well, including peak oil, the shale revolution, and the Romney energy plan. For the complete interview visit OilPrice.com.

33 thoughts on “Q&A on oil prices

  1. MarcV

    Two more questions (if I was Oilprice.com guy):
    – Could the oil stored out in the ocean (supertankers) be enough of a hedge to avert a big price spike if the situation in Iran causes oil shipments to come to a trickle?
    – Is there any economic justification for tapping the SPR, or should it only be used in times of true national emergencies?

  2. David

    I thought you made a mistake with this comment:
    “I do not think the expression “peak oil” is the most helpful way to frame the question. Too many people have a knee-jerk reaction as soon as they hear the phrase. I can’t tell you how many times I’ve seen people assume that it means that we’re “running out of oil”, which straw man they then try to debunk. I would instead call attention to the basic fact that the annual production flow from any given field shows an initial period of increase followed by subsequent decline. Anyone who tries to deny that has a serious lack of grip on reality.”
    To which I agree.
    But you just gave him the very definition of peak oil. So why avoid the term? Because people who, in your words, have a ‘serious lack of grip on reality’ complain? So why try to appease them?
    From 1965 to 2005, 40 straight years, oil production increased over 2% per year.
    From 2005 to today, oil production has increased a measly 0.4 % per year.
    Peak Oil is a fact of life. The only question is: when? Demand destruction, tight oil, as well as increased production from Iraq, Brazil and Canada will offset the conventional declines but it’s far from certain that they will increase supply.
    There’s a longer mathematical argument that can be made here, but we’ve been on a pleteau for over 7 years. A very mildly upwards tilting plateau.
    Maugeri’s report can be dismissed. He doesn’t even know the difference between decline rate and depletion. His assumed decline rate is 1.5-2%. That’s about three times as less as the IEA’s assumed decline rate(6.7 %).
    And he also makes lunatic forecasts. Maugeri, like Yergin, has done these lunatic forecasts before:
    Needless to say he was dead wrong then and he is dead wrong now.
    Remember, even if you took Maugeri’s assumed 110 mb/d in new oil production and used IEA’s decline rates, you’d end up with only 92 mb/d by 2020, not 110 which he predicts.
    And again, that’s assuming that all those countries get to the production levels he thinks they will. He envisions tight oil to get to almost 5 mb/d, while the EIA says about 1.3 mb/d.
    So if Maugeri’s production estimates are off by a lot(just like they were back in 2006 when he wrote that for forbes), together with the benchmark IEA decline rates, we’re very likely to see a peak this decade.
    Tight oil/Brazil/Iraq/Canada might push that date to the latter half but anyone who does the basic math, sees that you need extreme amounts of oil just to keep even the whole decade out.
    Sadad Al-Husseini noted this too, the former VP of enginerring at Saudi Aramco.
    Your cowardice regarding the term peak oil – while embracing the exact definition of it – is not helping. You’re not going to make people understand where we are energy-wise if you’re refusing to make the case for the concept, which you embrace in principle.
    You might not yet take a position on when the peak will come, understandably, but it’s obvious that you’re not a cornucopian and you know Maugeri’s report was a joke, just like Yergin’s constant pronouncements which have been proved wrong time and again.
    Again, Peak Oil isn’t a theory. It’s only a question of time. You don’t have to take a position on what date it will come, and you can still plainly talk about it.
    By running away from the term you’re being a coward.

  3. JDH

    David: As soon as you utter the expression “peak oil”, there is a class of people who dismiss everything else you have to say. They do so because the expression in their minds connotes (mistakenly, you could reasonably argue) a set of straw man beliefs. To some it connotes the Hubbert linearization, which I regard as unsound. To others it connotes the claim of imminent Armageddon, which I likewise do not preach.

    If one wants to communicate with others, as is most certainly my goal, it is important not to use expressions that mean something different to the listener than it might mean to the speaker.

    This is the reason, not cowardice, that I personally prefer not to use the expression “peak oil”, but instead to lay out from scratch exactly the doctrine I am seeking to have others evaluate fairly and with an open mind.

  4. Steven Kopits

    This was a very nice interview, and I agree with just about all of it.
    “For the past century or so, economies have generally been built upon energy. The economies with access to plentiful, cheap energy have developed the most. With the stagnation of oil production growth, how do you suggest economies could continue to grow from here? Should we stop expecting to see constant economic growth as the norm?”
    Here’s how I would have answered:
    If the petroleum liquids supply is unable to increase by, say, 2.4 mbpd/year, then the oil supply will be rationed, such that the emerging economies will be bidding away the consumption of the advanced economies–the pattern we have seen since 2005.
    In such a case, the price of oil will be above the so-called carrying capacity of the OECD economies. And we have a good idea of what that number is, about $95 Brent. So at $115 Brent, we can conclude that the oil supply is constrained and that the OECD economies will be forced to reduce consumption.
    Now, the question is whether this matters. Whether it does depends on how fast an economy can adapt to reduced oil consumption. If it can adapt quickly, then oil consumption will not be a binding constraint. If an economy can only adapt slowly, then oil is likely a binding constraint and will have an effect on GDP growth.
    What do the numbers tell us? In normal times, oil efficiency in GDP increases by about 1.2% per year. So producing a 100 units of GDP next year will only require 98.8% of the oil consumed this year.
    If we put the economy under stress, then the efficiency gain looks able to increase by 2% per year. So this would appear the sustainable “forced march” pace of efficiency improvement.
    At times, efficieny growth has been much greater. For example, from mid-1980 to mid-1981, GDP growth was greater than 3% and oil consumption was falling. There was a similar situation last year after the April Arab Spring and associated oil shock. But it’s not clear that the global economy can maintain such a pace. In mid-1981, the US fell back into recession; and in late 2011, Europe also fell back into recession. So it’s not been demonstrated that efficiency gains above 2% can be sustained indefinitely.
    We also have a pretty good idea of the rate at which US oil consumption must decline to make room for China and other emerging economies, assuming growth in the oil supply similar to what we’ve seen in the last few years. In such a scenario, US consumption has to decline by 1.5% per annum–and indeed, we’re right on that trajectory from 2005.
    Now, we have to add increased US oil production into the mix. Obviously, high oil prices are good for oil producers, so if the US produces more oil, then that should help GDP. In the past year, US oil production increased by an astounding 1 mbpd–the US just blew away every other promising producer, including Iraq and Brazil. Now what’s that worth? The oil itself is worth perhaps $40 bn. If we allow a multiplier of 2-3 for that production, then increased US oil production might be worth on the order of 0.6-0.8% of GDP. Add shale gas to that, and you’re probably in the 1.0-1.2% range–although I’d add that no one has really worked through the numbers properly, to the best of my knowledge.
    Add those numbers together–0.5% net efficiency gain of reduced consumption + 1.2% for the impact of increased oil and gas consumption–and you have 1.7%, which is the US growth rate. Take out the oil production (and then some, because UK production is plummetting), and then you have EU GDP growth.
    Put another way, if 3% GDP growth requires 1% more oil and oil consumption is declining by 1.5% per year, then a constrained oil supply could be knocking as much as 2.5% off the growth rate. It’s probably not quite that bad, but one could argue that a constrained oil supply is reducing potential US and OECD growth by 1.0-1.7%. In other words, it’s just killing the economy, because we need to be above 2% growth to reduce unemployment meaningfully. High oil prices thus equal malaise and stagnation.
    So do high oil prices impact GDP? The numbers suggest they do. But what I find odd about all this is the utter lack of discussion and analysis by mainstream economists. Of course, few of them understand oil markets. Even fewer understand why US oil consumption is in secular decline. But high oil prices have often been associated with recessions. And if voters are complaining about high oil prices to their Congressmen, then it would seem likely that these prices are really hurting. And it’s clear there is no lack of aggregate demand for oil. The swath from Texas to Alberta, with way stations in the Bakken, are just booming. All the price signals are telling us that oil is, in fact, the constrained commodity.
    And I’d add that estimating the carrying capacity of the US is a trivial exercise. The data’s all right there in the EIA STEO and other documents–and all in spreadsheet form. It’s not a big deal to pull out the numbers.
    So do a count. Count all the papers and analysis on QE1, 2 and 3, on NGDP targetting, and a full range of other proposed monetary solutions to our ills. There must be thousands of them. And then count the number of papers on the impact of oil on the economy. There are maybe half a dozen or so, from three or four analysts. It makes you wonder.

  5. JDH

    Steven Kopits: Last week I gave some lectures in Berkeley surveying about 40 different academic studies of the impact of oil on the economy. You can find the reading list and lecture slides here.

  6. Jeffrey J. Brown

    Professor Hamilton has previously highlighted the work by Michael Kumhof, et al, with the IMF, regarding their hybrid model for global crude oil production. Following is a link that has an embedded link to a video of a presentation by Michael Kumhof that is very good:
    Incidentally, we have Michael Kumhof, with the IMF, and Mark Lewis, with Deutsche Bank, signed up to speak at the upcoming ASPO-USA conference in Austin, Texas, on November 30, 2012.

  7. Steven Kopits

    Jim –
    Thanks for the slides.
    I would caution, however, that the issue at question is not a supply shock, as the oil supply has not actually fallen.
    Rather, we see a divergent demand shock where the emerging economies are bidding away the incumbent economies’ oil consumption. It is the impact of this phenomenon which is the central issue today.
    I would add that price rises are unnecessary for emerging economies to reduce OECD consumption; indeed, the non-OECD can bid away OECD consumption at prices $10 less than currently prevail. The issue is volumes, not prices. The prices are just the mechanism to achieve the proper allocation of volumes between the OECD and non-OECD.
    Also, I think it critical that we distinguish acute events–an oil price shock–from chronic issues, the grind down in OECD oil consumption.
    On this issue, I still don’t think I’ve read much beyond Gail Tverberg–and even Gail is well off the leading edge of the argument–which is precisely the rate at which an economy can adjust to reduced oil consumption.
    And I would highlight that, OK, you and Lutz write on this as well, as a number of lesser known economists, some of whom count as Dabblers. (The litmus test: How long would they last in a debate over data sources and quality with Jeffrey Brown?) And many of the papers are old. (By the way, the date on the Blanchard paper is Aug. 2007).
    In your response to Oil Price, you use the phrase “significant burden on the oil-consuming countries.” If so, then should we not be discussing the magnitude of this “significant burden”? Where’s the follow-up question? Where are Mankiw, Summers, Krugman, DeLong, Cowen, Sumner, Feldstein and other talking heads in the blogosphere? Want to find posts on what the Fed should do on monetary policy? I wouldn’t be surprized if Krugman alone had more than a hundred posts on the topic. But if your analysis suggests that oil could be trimming, say, 1.2 percentage points off GDP growth and that this alone is enough to materially prevent a reduction in unemployment, well, this is a lonely thought. It’s not even worth discussing, it seems!
    So, I think the body of work on oil and the economy remains thin. Much of it is dated and not exactly relevant to the current situation. At the same time, the issue is potentially decisive and should be a central subject of debate in the blogosphere–at least as much as is the choice of dining establishments for economists. But it’s not, and that’s worrisome.

  8. Jeffrey J. Brown

    In my opinion, you were the best overall speaker at the NYC symposium, and I think that you have done some excellent demand side analysis.
    A question I have been recently asking is what percentage of already weak GDP growth in net oil importing OECD countries in recent years has been attributable to deficit spending?
    Following is an excerpt from the draft of a paper I am working on:
    Available Net Exports of oil (ANE)
    ANE are defined as GNE (Global Net Exports) less Chindia’s combined net oil imports. Our data base shows that ANE fell from 40 mbpd in 2005 to 35 mbpd in 2011. The following graph shows the ratio of GNE to Chindia’s Net Imports (CNI):
    In 2002, there were 11 barrels of GNE for every barrel that Chindia net imported.
    In 2005, there were 8.9 barrels of GNE for every barrel that Chindia net imported.
    In 2011, there were 5.3 barrels of GNE for every barrel that Chindia net imported.
    The 2008 to 2011 decline in the GNE/CNI ratio (8.7%/year) was faster than what the 2005 to 2008 rate of decline (7.7%/year) predicted we would see.
    Based on the six year (2005 to 2011) rate of decline in the GNE/CNI ratio, estimated post-2005 Available CNE (Cumulative Net Exports) are about 168 Gb (billion barrels). Cumulative ANE for 2006 to 2011 inclusive were about 81 Gb, putting estimated post-2005 Available CNE about 48% depleted, a 2005 to 2011 estimated post-2005 Available CNE depletion rate of about 11%/year.
    The following graph shows the GNE/CNI ratio versus estimated remaining post-2005 Available CNE by year:
    The 2005 to 2011 rate of decline in the GNE/CNI ratio, if extrapolated, suggests that China and India would be consuming 100% of Global Net Exports of oil in the year 2030, which is 18 years from now. Of course, I don’t think that will actually happen, but that is the trend line, and the rate of decline in the GNE/CNI ratio accelerated from 2008 to 2011, versus 2005 to 2008.
    GNE/CNI Vs. Total Global Public Debt
    In my opinion, oil importing OECD countries are trying desperately to maintain their “Wants” based economies, when a more likely scenario in my opinion is that we will be lucky to maintain a “Needs” based economy. Note that from 2002 to 2011, the absolute value of the rate of increase in Total Global Public Debt (8.5%/year) is about the same as absolute value of the rate of decline in the GNE/CNI ratio (8.1%/year).
    If the GNE to CNI ratio were to hit 1.0, China & India would theoretically consume 100% of Global Net Exports of oil.
    The decline in the GNE/CNI ratio, which is an indication of the percentage of GNE that will be available to importers other than China & India, will of course make it increasingly difficult, and probably impossible, to repay, at least with currencies of close to current values, the debts incurred trying to keep some semblance of Business As Usual going in oil importing OECD countries.
    Following is a graph of the GNE/CNI ratio versus total global public debt:
    GNE = Global Net Oil Exports*
    CNI = Chindia’s Combined Net Oil Imports
    *Top 33 net oil exporters in 2005, total petroleum liquids, BP Data + Minor EIA data
    Debt Data:

  9. Steven Kopits

    Jeffrey –
    A case could be made linking oil to deficits via oil’s effect on GDP. You need a certain volume of oil at any given time to produce a given amount of GDP. This seems reasonable. Now, if you reduce the amount of oil available, and the economy cannot adapt quickly, it stands to reason that GDP should also decline. You can either adjust consumption immediately or try to maintain consumption by borrowing. If we wanted to adjust to reality today, we’d have to reduce GDP by about 5%. As it is, the country is running a deficit in the hope–from the oil perspective–that either the oil supply will grow more quickly or that the economy will be able to pick up the pace of adjustment.
    This is then a supply-side story, not a lack of aggregate demand. It gives a quite different take on the economic outlook. The Obama budget, for example, sees government revenues rising by 7% of GDP by 2015 compared to 2012. If the problem is cyclical and a lack of aggregate demand, such a recovery in tax revenues could happen. If the problem is an economy constrained by a lack of oil, the revenues will not fully materialize and large deficits will persist.
    So that’s the link to deficits. If you believe in a constrained oil supply, and you believe that oil matters to GDP, then the government is vainly trying to maintain consumption rather than adjusting to reality. In this world, the Estonians have it right and Krugman has it wrong.
    Interestingly, during the 70s oil shocks, the Fed provided an equivalent response using easy money in the hopes of stimulating the economy. Of course, this proved impossible, because the fundamental issue was a lack of oil. You can’t stimulate your way out of a supply-constained hole. The result was instead high inflation, which was eventually crushed by Volcker’s recession, leading to 4 mbpd fall in US oil consumption (versus 2 mbpd fall since the start of the Great Recession). The period ended was the supply-constrained model argued it would: with materially lower US oil consumption, achieved ultimately through two back-to-back recessions and a period of stagnation for the economy.
    It is interesting to contemplate why monetary policy was invoked in the 1970s and fiscal policy today (perhaps because monetary policy has proved ineffective). In addition, the effect of the financial meltdown must be factored in, something which the oil-based analysis doesn’t really account for.

  10. Steven Kopits

    Bruce gets to the heart of the matter. If oil matters, then seeking economical, alternative fuels is a high priority. Jim makes this case directly: “We should be looking for regulatory reform and infrastructure investment to encourage consumers and entrepreneurs to adopt alternatives to conventional gasoline-powered vehicles.” That’s very clear.
    Now, you have probably been following the Republican Convention this week. Who has made the statement Jim has? Because if you believe my arguments above, then oil is not a peripheral issue, it is literally the defining issue of the election.
    But no one has done the heavy lifting to make the case for the impact of oil on the economy within the framework I have described above (ie, divergent demand shocks). I would parenthetically note that Jim appears to be getting ready to lift something, based on the reference list he posted above. Jim is critical to the matter, but he is not enough. This is not a nice, specialist topic. If one accepts my line of reasoning, the issue of affordable transportation fuel is entirely central to the prosperity and future of the advanced economies, at a minimum.
    In any event, oil is not central to the Republican Party platform. It is a nice-to-have, rather than a must-have issue. There is no causal explanation for weakness in the economy and no direct prescription for a remedy. No one’s covering the big picture, at least as I see it, because academics in large numbers haven’t seized the topic, on the one hand, and the oil industry has sought to downplay the whole issue, on the other.

  11. Jeffrey J. Brown

    Paraphrasing Mitt Romney:
    “Since President Roosevelt, every president (at the end of their first term) has been able to say to Americans that they are better off than four year earlier, except for Jimmy Carter (elected in 1976) and Barack Obama (elected in 2008).”
    If true, there is not much mystery as to why:
    Imagine, if you will, that the Seventies never ended.

  12. Jeffrey J. Brown

    I suspect that we may be seeing “Revolving Door” politics, as voters turn against the power in party on two year and four year cycles, as politicians (and voters) continue to refuse to recognize the reality of resource limits.

  13. Steven Kopits

    Jeffrey –
    I made the same point to Senate Republican staffers last year. I stated that CBO GDP estimates were likely overstated (which proved true); that there was a risk of a recession (which proved true for Europe), and that Democrats would have to be pro-oil and gas or risk their seats, which also proved true.
    I also stated that I felt the numbers suggested that the 113th Congress–to be elected this November–would prove the most important for oil and gas legislation since the approval of the Trans Alaska Pipeline system back in the 1970s.
    I urged both attending staffers (as I have the oil industry itself) to prepare and prioritize for the coming session, as time would be short. It will be short because i) oil and gas will not be the most important item on what may be a very active legislative agenda; ii) and the Republicans will surely screw up something by next summer, by which time their mandate will have tarnished and the Democrats will have regrouped.
    Finally, pressures on oil prices and OECD consumption should remain chronic issues for the next several years. Thus, the reversion of the House and possibly Senate to the Democrats in 2014 must be seriously considered. My working assumption is that the future will prove a revolving door, as you suggest.

  14. Steven Kopits

    Meant to be “I urged both staffers and the industry itself…” There were in fact about a dozen staffers in attendence!

  15. Mike_in_FL

    Let’s keep things simple on oil prices, and forget the economic theory for a minute. Today, Bernanke hinted at his willingness to do more QE. What happened? Gold prices shot up. Oil prices shot up. Silver prices shot up. Heating oil prices shot up. Gasoline prices shot up. And so on.
    Bernanke likes to take credit for “good” asset inflation — “Look, Wall Street! I helped puff up the Russell 2000!” But he completely washes his hands of the “bad” asset inflation that comes right along with it — namely, in commodities. “Oh that? It’s Libya/Iran/supply/demand/Martians stealing or oil, etc., etc.”
    Do you want to know why oil prices are going up? Becuase the Fed is promising to ease, that’s why! That is ultimately bad for the economy, bad for disposable income, bad for investment, and more. But Bernanke refuses to take ownership of the problem he is creating. Disgraceful!

  16. Jeffrey J. Brown

    In the alternative, it could be because we have seen a material decline in Global Net Exports of oil (GNE*), with the Chindia region–so far at least–consuming an increasing share of a declining volume of GNE.
    The volume of GNE available to importers other than China & India fell from 40 mbpd in 2005 to 35 mbpd in 2011.
    However, this does of course conflict with the prevailing opinion that there is no problem with an indefinite rate of increase in our consumption of a finite fossil fuel resource base.
    Incidentally, just out of curiosity, why has Fed easing driven down natural gas prices, but but driven up oil prices?
    *Top 33 net exporters in 2005, countries with net exports of 100,000 bpd or more in 2005, BP + Minor EIA data

  17. Second Look

    I’m a bit skeptical of the notion that we are entering a “revolving door” situation regarding what party controls Congress and Presidency.

    History strongly suggest that there is in American politics a form of Newton’s First Law: Parties in power tend to stay in power.

    Even in the most politically contentious era of our history – from 1834 to 1858, The Democratic party held control of the House in 10 out of 13 elections, the Senate 9 out of 13, and the Presidency 5 of 7.

    The structural advantages of incumbency, long lasting social social and demographic trends, gives such major advantages to one party in a particular era, are almost insurmountable.

    If any thing, the trend now seems to favor the Republican party: Since 1996 they have controlled the House 7 out the last 9 elections, the Senate 5 out the last 8. Only solid hold of the Presidency has been out either parties grasp. For better or worse (in my opinion worse for reasons I’ll foot note below), we do seem to be in an era of Republican ascendency; which will likely last for a few more decades.

    * Why I said for worse, in a nutshell:

    1. Their social policy is in control of religious conservatives and nativist populists.

    2. The foreign policy is still under the influence of the neo-conservative movement.

    3. Their economic policy leaves me, paraphrasing that song in Pal Joey: Befuddled, bothered and bewildered am I…

  18. Steven Kopits

    Second –
    You are making a case based on historical patterns. Jeffrey and I are arguing a fundamentals-based case that alack of oil will contribute to a weak economy. This lack is structural, not cyclical. But voters will interpret this weakness as political incompetence and tend to vote out incumbents. The models for us (I may be a bit presumptuous to speak for Jeffrey) are Greece and France. The French didn’t vote for Hollande because they’re all socialists, but because the economy there is weak. Americans didn’t vote out Bush because they wanted socialized health care, but because Bush cratered the economy. They won’t vote out Obama because they’ve become libertarian, but because Obama has been unable to fix the problem.
    But there’s no guarantee that incoming Republicans will do much better if the transportation fuels supply remains constrained. In this enviroment, you can’t assume that people elected you because they prefered you; it’s that they wanted to get rid of the other guy. Next time around, you’ll be the “other guy”.

  19. Second Look

    Sorry, but I have to disagree. American politics is strongly personality based, unlike European politics which is more party oriented.
    “All congressmen are bums, but my guy is okay” – Classic American folklore that poll after poll confirms as a belief.
    Even when party does matter, between endemic gerrymandering making 90% of House seats “safe” for one party or the other, and, increasing rise of “rotten borough” states – the ten smallest states have 2.67% of the US population and have 20% of the Senate, ensures a stability that takes a powerful secular change in trend to alter.
    I do agree that Peak Oil (not abashed about using that term), is clearly one of those massive secular political trend changers. However, the fundamentals of American society, the structure of our political institutions, make it unlikely that we’ll see the kind of rapid representative switching you all seem to believe is going to happen.
    If anything Peak Oil is going to add to the Republican ascendancy for some decades. The “drill baby, drill” mantra has enormous appeal to a public that has no real grasp of the macro issues. It’s a huge paradigm shift, and as we know, those take 20 years or more – whether it’s in the sciences, or in social attitudes.
    You all see anger at those in power, I see anger focused at the other guy, the other party.

  20. David

    Steven Kopits, I thought your comments were very, very intelligent and reasoned.
    Nonetheless, there are a few quibbles I’d make:
    “What do the numbers tell us? In normal times, oil efficiency in GDP increases by about 1.2% per year. So producing a 100 units of GDP next year will only require 98.8% of the oil consumed this year. ”
    The amount of GDP each year is increasing – presuming there is GDP growth – so even if there is a 1,2-2,0 oil efficiency, it’s taken out from the current economy and then subtracted from the economy of next year. Therefore, oil efficiency does not always decrease oil consumption unless there is a very high pressure or a lack of growth – or both.
    Both of us agree that U.S. oil consumption is in secular decline, but the low-hanging fruit has already been picked.
    Indeed, the EIA forecasts a stable 18.5 mb/d in consumption. I think it will go lower, I think the decline will continue, but it will slow considerably. The first few years from 2005 were the easy years, then came the recession on top of that.
    Now you’re seeing the slowing rates, even if they are helping.
    Second, I think you’re overestimating the impact of prices and/or efficiency on the oil canvas.
    Just to maintain supply – forget increasing it – we need to add more than 3.5 mb/d.
    And again, I’m using a lower decline rate here(about 5 %) since I’m taking fields which are not just post-peak but also on a plateau and in development. Almost 5 years ago, when IEA & CERA ordered the IHS study – the largest to date – the decline rate was about 4.5 % for all fields(6.7 % for post-peak only).
    Decline rates increase 0.1 to 0.2% per year. Let’s take a generous 0.1 %.
    That means that we’re at about 5 % this year, again, including fields which are not yet post-peak.
    That means that just to stay even, we need Maugeri’s astronomical production forecasts.
    So even if the U.S. continues it’s secular oil decline, it won’t do much more than allow China to take it’s place in a zero-sum world.
    And again, there are floors to how far oil consumption can drop so rapidly.
    If one uses a more optimistic-realistic scenario, the world will get to about 87 mb/d in 2020. That’s lower than it is today. And I didn’t even account for increasing decline rates, just because I want to prove my point here by bending over backwards.
    U.S. declining oil consumption cannot simply decrease fast enough to make way for China. If it’s oil consumption rates were to grow as they did the last few years, it would reach 18 mb/d in 2020. Unless the U.S., which is now plateauing at 18~ mb/d in consumption, is willing to go down to 10 mb/d during the same time, it’s an impossible equation.
    And as I stated before, this ignores the fact that decline rates are increasing all the time. And it ignores India, Saudi and the rest.
    And the actual realistic production estimate for 2020 is far lower than Maugeri assumes. This is true for tight oil, Brazil, Iraq and other examples. Also, note that he mixes NGL with oil and his starting point is 78 mb/d, not the current 76 mb/d in crude oil production. So his increases has to be lowered to reach the actual base, and the NGL increase has to be adjusted on a net energy basis equivalent with oil.
    I’m not saying you defend Maugeri, but I am using his report as an example to show that even if someone accepts your basic position, the basic math gets up to you much earlier.
    The U.S. is not going to go to 10 mb/d in oil consumption in 8 years without facing an extreme depression unlike anything seen before, including the 1930s. And that will never happen because China will slow down as the OECD slows down; due to lack of oil growth.
    What we face is a prolonged malaise, as you correctly pointed out, but prices and economics have no effect on ever-increasing decline rates, and the effect on increased production is much smaller, since the increase of new production the past few years have been abysmal despite a quadrupal increase in prices.
    So my fundamental critique is: the oil efficiency is not always curbing oil consumption, sometimes it’s enough to make it stagnant though in the case of an growing economy(there are signs that this is starting to happen to the U.S.)
    Prices overall have shown to have a specious effect. They prolong the situation, soften it, but they do not alter it fundamentally or change the direction.
    And America isn’t going to drop 8 mb/d(almost half it’s oil consumption) in 7 short years towards 2020(starting next year) to give way to China. It isn’t economically possible, and China’s growth is going to subdue.
    And someone might think, aha! Great! So we’ll see less oil growth.
    Well, indeed, we will. Much less. But as I’ve pointed out, the challenge this decade is merely staying even, forget about oil growth. Just keeping in place will require miracles(yes that’s the word) in terms of production.
    Economics can stretch and ameliorate – it cannot fundamentally change.
    And Kumar himself noted that according to his model, real oil prices would be over $180 in *today’s prices*. This is a joke. That will never happen as the economy will crash long before then, and enter secular decline.

  21. Steven Kopits

    David –
    I agree with much you say.
    My oil supply numbers are net of decline–so we need to increase oil production by 2.4 mbpd / year to meet everyone’s needs.
    I’ve looked at decline rates. To be honest, I understand them no better the price elasticities. Does a decline rate mean there is absolutely no intervention on a well, or does it mean with normal intervention, eg, water flooding, proper maintenance of pumps, etc.? I could make a case for decline rates above 10% onshore, or as low as 3-4% assuming proper well maintenance. So I am never quite sure what we mean by a “decline rate”.
    However, if we assume that 5% is a “normal” decline rate, then we’d need about 4 mbpd of new production to replace existing declines. To that we’d add the 2.4 mbpd needed to meet growing global demands, so figure 6.0-6.5 mbpd in total. That’s quite a bit.
    My 2020 US forecast is 16.4 mbpd for consumption versus 18.5 now. US production (all liquids, allowing for refinery gains)is 13.6 versus 10.5 now. Import dependence falls from 8 mbpd (43%) to 2.8 mbpd (17%).
    This assumes a quite bullish case for US shale production. The smart guys on the topic think the US can assemble another 4 mbpd of shale oil production to 2020. Given that the US was able to increase production by 1 mbpd in the last twelve months, I have taken the bullish view as plausible.

  22. Jeffrey J. Brown

    In my opinion, this chart is my key summary chart, showing the following for 2002 to 2011: Global Net Exports of oil (GNE) divided by Chindia’s Net Imports (CNI) versus Total Global Public debt.
    As discussed up the thread, I think, and I believe that Steven largely concurs, that net oil importing OECD countries are keeping their economies propped up via massive government borrowing, even as the GNE/CNI ratio fell from 8.9 in 2005 to 5.3 in 2011, a decline rate of about 8.6%/year.
    At a GNE/CNI ratio of 1.0, the volume of Global Net Exports of oil that would be available to importers other than China & India would theoretically be zero, and at the 2005 to 2011 rate of decline, the GNE/CNI ratio would be at 1.0 around 2030. We can all agree that won’t happen, and there is already evidence of weakening demand in China & India, but the current trend is pretty worrisome.
    And what the chart shows is that even as total global public debt exploded, especially in net oil importing OECD countries, the volume of oil available to net oil importing countries other than China & India fell.
    I’ve described the situation as the “OECD Thelma & Louise Race to the Edge of the Cliff,” as net oil importing OECD countries keep borrowing–from real creditors and from accommodative central banks–to keep their economies going.
    This works until countries have trouble borrowing money at affordable interest rates, e.g., Greece.

  23. Jeffrey J. Brown

    Incidentally, I think that a lot of people have cause and effect reversed regarding the huge increase in the Federal Reserve balance sheet, versus oil prices:
    I think that global crude oil prices doubled from $55 in 2005 to $111 in 2011, in order to balance a declining supply of Global Net Exports of oil (GNE) against demand, especially the increasing demand from developing countries, led by China.
    I think that constrained oil supplies, and high oil prices, contributed to the increase in central bank balance sheets, as net oil importing countries tried to keep their economies going, via increased government borrowing–from both accommodative central banks and from real creditors.
    While slowly increasing US crude oil production will help, it’s a global market, and as the WTI crack spreads indicate, Americans are fully exposed to global oil prices, as Mid-continent refiners pay WTI based prices for crude oil, but charge Brent based prices for refined product, and pocket the difference as refining profits.
    And in the process, Mid-continent refiners are providing a massive incentive (on the order of about $1.6 billion* per month) for Canadian producers to accelerate plans to ship their crude to their West and East Coasts.
    *Canadian oil exports to US times difference between Brent and WTI crack spreads, currently about $21, per month

  24. 2slugbaits

    This could be the basis for a renewed manufacturing advantage, a new source of U.S. exports, or an alternative transportation fuel. We should be looking for regulatory reform and infrastructure investment to encourage consumers and entrepreneurs to adopt alternatives to conventional gasoline-powered vehicles.
    Why you old socialist central planner! :->
    Some would argue that the market alone, unleashed from government regulation would (somehow) find new solutions and develop alternatives to gasoline-powered vehicles. But how is this possible as long as no one agrees on how much recoverable oil is out there and oil prices seem to follow a random walk? What information can consumers glean from movements in oil prices if they follow a random walk?
    So I’m curious what JDH means by “regulatory reform and infrastructure investment.” What happens if reglatory reform and infrastructure investment have equal and opposite effects? For example, what happens if regulatory reform encourages alternative propulsion sources but infrastructure investment builds pipelines that make oil cheaper? How do you resolve the contradiction between what’s good in the short run also being bad in the long run? If you’re faint from hunger then a delicious banana cream pie or jelly donut might be just the thing to get you going; but if you commit your resources towards ensuring a greater supply of banana cream pies and jelly donuts, then you will likely have some longer run problems. If we can’t say “no” to the banana cream pie when we’re not really all that hungry and healthy desserts are on the menu if we’re willing to pay a little more, then how do we expect to say “no” to that banana cream pie when the we’ve become addicted to banana cream pies? What we’re following is the Dick Cheney diet for both food and oil.

  25. SecondLook

    The random walk of crude oil prices from 2005:
    2005: $50.04
    2006: $58.30
    2007: $64.20
    2008: $91.48
    2009: $53.48
    2010: $71.21
    2011: $87.04
    2012: $93.02
    You could characterize the movement in a number of ways, but calling it a random walk is, I think, not one of them.
    Taking a slightly longer term perspective, the average price of oil has almost quadrupled over the last 10 years.
    One would think that would be a trend that would register profoundly with policy makers, if not the general public – but alas, both seem to have a memory span that is about 3 years, and a similar look ahead time frame.

  26. 2slugbaits

    SecondLook Well, JDH might disagree with you. Or at least that seems to have been his view back in 2008: “All of the above test results are consistent with the claim that the real price of oil seems to follow a random walk without drift.
    “Understanding Crude Oil Prices,” Dec 2008

  27. Jeffrey J. Brown

    Re: SecondLook
    At noted above, the WTI price is largely irrelevant to US consumers, since Mid-continent refiners are paying WTI based prices for crude, but charging Brent based prices for refined products. Thus, US consumers are fully exposed to global crude oil prices, while the good times roll for Mid-continent refiners.
    We have seen two (approximate) annual doublings in Brent prices, from $25 in 2002 to $55 in 2005, and then from $55 in 2005 to $111 in 2011, with one year over year decline, in 2009.
    So, the global annual price in 2011 was more than four times higher than the 2002 annual price.
    It remains to be seen if 2012 is going to show a year over year decline.

  28. Jared

    Excellent interview and oil prices certainly are volatile. The increases since 2005 have been almost impossible for the middle class to keep up with when it comes to transportation and heating. It doesn’t seem like much movement will be made either way in the next few months.

  29. kellys

    Maugeri’s report can be dismissed. He doesn’t even know the difference between decline rate and depletion. His assumed decline rate is 1.5-2%. That’s about three times as less as the IEA’s assumed decline rate(6.7 %).

  30. Imapopulist.now

    Excellent original post and excellent, thought provoking thread of commentary. A couple of thoughts.
    1) Yes. tight/shale gas and oil are costly to produce. But what are these costs? For the most part they are labor and capital intensive and domestically outsourced. Hence domestic oil production grows the GDP, jobs, investments, income. wealth, the tax base, etc.
    I think too many economists assume that everyone understands that “one moan’s cost is another man’s job”, when in fact many people do not naturally make these connections unless they are clearly articulated.
    2) Natural gas transportation initiatives. Free market economists argue against industrial policies of any sort – that the market is the best determinant of economic growth and direction, and I generally agree.
    However, it appears to me that some pragmatism is in order. There seem to be compelling arguments in favor of public policy interference in the markets with respect to natural gas transportation infrastructure.
    Much of this logic and reasoning is covered in Mr. Kopits’ discussions regarding the relationship of oil consumption to GDP growth.
    If we need to increase the GDP growth rate, for purposes of full employment, more balanced budgets, etc., and if the availability of oil appears to be constrained and hence will constrain economic growth, then the substitution of natural gas for oil should result in the acceleration of GDP.
    Thus, rather than being an inefficient use of pubic resources, reasonable incentives to overcome the barriers to entry in creating a natural gas transportation network would seem to be an reasoned public policy with strong upside potential in terms of economic growth.

  31. David

    One final comment to Kopits. I doubt that he reads this thread but a final correction is due.
    New supply grows about 0.8% a year now. That means slightly under 1 mb/d for the coming 2-3 years and then slighly above 1 mb/d for the remainding years – I’m including a recession in there too to even things out.
    If we use the 4.5 % decline rate from 2008, add a 0.1% each year to about 5 % this year and then go forward to reach about 5.7 % by 2020, shale oil in America will not make any consequential dent in the welfare of the nation.
    America may be insulated by oil, but it won’t be on economics as the world around it falls into pieces. Also, adding refinery gains is specious.
    Net energy, crude, NGL and biofuels, America produces slightly more than 8.7 mb/d by the summer of 2012.
    This can get to about 10.5 mb/d by mid-decade(again adjusted for net energy). That still leaves about 6 mb/d. Canada can only cover 1/3 of that, Mexico won’t ride to the rescue. Brazil? They’ve been stuck for over 16 months and the next two years are no different.
    It’s the Middle East again.
    Finally, America may be powerful, but it’s important to keep the perspective global, not navelgazing.
    The amount of oil needed towards 2020 will be about 30 mb/d in new production to offset increasing decline rates as well as tepid growth(again I’m using a very lowly based 0.8% constant oil demand growth rate per year).
    Even Maugeri’s report does not give way to all of this. And his production estimates are completely off the wall, he mixes NGL’s with crude oil(despite only 70 % of net energy content), he gives crude production a 2 mb/d higher starting point. The list goes on.
    Note that I give a low demand growth, much lower than yours, just to be generous. I also give the OECD – and America- lesser oil demand.
    But it won’t budge the overall a picture even one iota.

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