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29 comments on Why Oil Intensity Changed in the US Economy

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isaiah on October 21, 2005 - 7:55am

great post Stuart. your breakdown reveals a good deal.

i'm guessing Greenspam is trying to say that we wouldn't need to have another 50% decrease in oil intensity if prices spiked similarly again. because, he would argue, we can produce more GDP with less oil, so the economy would intrisically be more resistant to oil input cost increases.

from the article, oil went from $1.80 (1970) to $39 (1981). though this is not inflation adjusted, this would be a 20X increase in real dollar price. This equates to about a 5X spike in constant dollars. (using rough numbers from http://www.inflationdata.com)

if we again had this increase in oil prices the effect on the US economy would be 0.50 times as much as before: the price spike is effectively halved. Thus to respond to the shock similarly (we're calling those 30yrs "the response"), the economy would only need to reduce its oil intensity by 25% (i am assuming the economy behaves linearly: half the price spike = half the reduction in oil intensity required). as oil intensity continues to drop, the required reduction in oil intensity, given future spikes, falls proportionally. this would seem to be the argument greenspam is making.

still seems like a monumental task, given the efficiency increases and fuel switching that has already taken out much slack in the system.

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Eroie Van Tanstaafl on October 21, 2005 - 11:35am

Bingo. For each dollar of GDP, we use 50% less energy than in 1979, and less of that energy comes from oil. So when oil prices spike, they hurt, but not as much as they used to.

Illustration:
Your economy requires 10% of your GDP to buy oil. If oil doubles, then you need an additional 10% of your economy to get the same amount of oil.

If, over time, your economy has diversified its energy sources, and also is more energy efficient, then your economy requires only 6% for energy, of which 4% (two-thirds) are oil. Now if oil doubles in price, you only need to spend 4% of your GDP to cover the increase.

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Stuart Staniford on October 21, 2005 - 2:45pm

Ok - but what you're saying in effect is the elasticity is effectively doubled. The same relative price spike corresponds with half the supply saving. Or to put the same thing another way, the same proportional savings requires twice the price hike. So far, we agree in general qualitative terms. Now the question is, do oil shocks come in natural price units, or natural units of supply percentage? Answer: supply percentage. Oil shocks typically arise because of a war or revolution in some particular country, and that countries production is the natural size of the oil shock. Thus Saudia Arabia is a potential 12% oil shock, Iran is a potential 5% oil shock and so on. So I argue oil shocks will be significantly worse in the future (and the expression of this in price terms is they will cause prices to go higher and cause more economic contraction).

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Joseph Somsel on October 21, 2005 - 4:20pm

Personally, I had thought that the decline in oil consumption for electric generator fuel had a larger impact that what Stuart has shown. Still, it was significant although a major change for the electric industry.

I likewise agree that offshoring of energy-intensive industries has been a major factor in the domestic energy intensity decline. Look at aluminum and other electrochemical industries for example.

We can't look at oil alone. As I've preached here and elsewhere, an even bigger risk is North American peak gas. Before, if oil increased in price or decreased in availability, we could shift some demand to surplus natural gas, at least for non-transportation uses. We've seen a lot of that with Northeast home heating, switching from heating oil to natural gas. Fortunately, we could restore some gas production by opening off-limits areas to exploration and extraction - especially the Rockies.

Today, we have no idle production capacity for gas in reserve and we've max'ed out LNG importation facilities.

Hence our short-run exposure is increased over yesteryear by having NO energy fallback. Our back is to the wall.

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Bigelow on October 21, 2005 - 4:57pm

Stephen Leeb The Oil Factor maintains the U.S. economy does cope with anything short of a year over year oil price increase of 80% without falling into recession. Greater increases tank the economy.

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