The Oil Drum

On October 24th, Dr. James Hamilton of Econbrowser commented on The Tragic Consequences of the High Discounting of Oil Extraction [1] in his story Is peak oil irrelevant?

Figure 1 -- Click to enlarge

If Dave had gazed not at a century of prices but rather at just the last 15 years of the price of oil relative to the PCE deflator, would he have drawn the same conclusion? If all we had was the graph above, it would seem quite natural to conclude that a rising scarcity rent could well be one factor in the recent behavior of this commodity price...

... I am not at all prepared to dismiss the hypothesis that scarcity rents have indeed started to make a contribution to oil prices over the last five years, and will become more apparent over the next five...

Admittedly, if the oil price should fall from here down to $30, then I'll have to conclude that scarcity rents have had nothing to do with the recent price moves.

But if Dave is right about the geology, oil is not going to $30.

Not knowing of any good evidence to contrary, I'll just make the simplifying assumption that I'm right about the geology.

We'll return below to some of Hamilton's other observations as we consider what meaning to draw from the history of oil prices over the last several years.

Recession fears are being reported as affecting the oil markets. Oil prices tumble over fears of US recession is typical.

Oil prices have dropped to the lowest level in six months, as markets' concerns about geopolitical instability are replaced with worries about an impending US-led economic slowdown The plunge in oil prices has hit mutual funds for $4.5bn (£2.4bn), and there are fears that more investors could fall victim to unexpected falls in energy prices...

Hedge funds and oil traders are selling their crude holdings because of fears that the US economy could slump next year, dragged down by the stalling housing market. Figures released yesterday showed US house prices falling last month for the first time in over a decade, while the inventory of unsold houses was at its highest level for 13 years. Traders are concerned that an American slowdown would drag many other major oil importers down, causing worldwide energy demand to plunge.

"Worries about US growth are an important factor," said HSBC economist John Butler. "We are concerned about the possibility of recession in the US."

Before recently, all the fears were geopolitical in nature. Easing of those concerns—for no good reason at all—has been replaced by the specter of an American recession. Let's examine that possibility. As it turns out, the view here is that a recession—perhaps a severe one—may be more likely than not.

[editor's note, by Prof. Goose] Please folks, don't forget to go rate this story of Dave's at reddit and digg. This is one of his best, and he put a lot of effort into it. He deserves as many eyeballs as he can get!

[editor's note, by Dave Cohen] The closing NYMEX price for the crude oil October 6th contract was $63.33, up 11 cents on the day.

Since early August, oil prices have fallen considerably. From the EIA's latest This Week in Petroleum.

Oil Prices Continue to Drop

In the last 5 weeks, since August 7, oil prices, both for crude oil and petroleum products, have dropped substantially. The price of West Texas Intermediate (WTI) crude oil has fallen from $77 per barrel to below $64 per barrel. Retail gasoline prices have dropped 42 cents per gallon to $2.62 as of September 11, while retail diesel fuel prices, at $2.86 per gallon, are now about 20 cents per gallon lower than they were 5 weeks ago. Will the declines continue, or will they begin to level off and possibly increase later this year?

Let's examine the EIA's timely question. Combined with the Jack-2 Test Well, the dropping prices have served as fodder for those debunking peak oil claims.