Are lower oil prices good news? Not really, if it means the world is sinking into recession.

We know from recent past experience and from common sense that higher oil prices are a drag on oil importing economies, because if more $$$ are spent on the same amount of oil, there is less to spend on discretionary goods and services. In addition, oil money sent to oil exporting countries is likely to be spent within those economies, rather than being reinvested in the oil importing country that the funds came from.

A rough calculation based on 2012 BP Statistical Review data indicates that the combination of the EU-27, the United States, and Japan spent a little over $1 trillion dollars in oil imports in 2011–roughly the same amount as in 2008. Governments have been running up huge deficits and have been keeping interest rates very low to cover up this damage, but it is hard to make this strategy work. The deficit soon becomes unmanageable, as the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) countries in Europe have recently been recently been discovering. The US government is facing automatic spending cuts, as of January 2, 2013, because of its continuing deficits.

Furthermore, lower interest rates aren’t entirely beneficial. With low interest rates, pension funds need much larger employer contributions, if they are to make good on their promises. Retirees who depend on interest income to supplement their Social Security checks find themselves with less income. The lower interest rates don’t necessarily have a huge stimulatory impact on the economy, either, if buyers don’t have sufficient discretionary income to buy the additional services that new investment might provide.

Below the fold, we will discuss what is really happening with oil prices, and consider reasons why lower oil prices may be a signal that the world is again headed for deep recession.

The world is presently sharing a limited supply of oil. When oil prices rise, oil production doesn’t rise very much, if at all.

The issues then become: Which buyers get the oil? What uses get priced out of the market? Which countries are disproportionately affected?

It seems to me that this time around, Europe, and in particular the Eurozone, is the area of the world getting hit the hardest by high oil prices. Part of this has to do with the relative level of the Euro and the US dollar. If we look at the price of Brent oil (a European oil) in Euros (Figure 2), we find that prices are as high now as they were in mid-2008.

I recently attended the annual ASPO conference in Washington, D.C. This was only my 2nd ASPO conference; the other one I attended was in 2008 in Sacramento. There were many familiar faces, some of whom I had previously met and some I only knew by reputation. The mood seemed remarkably calmer than in 2008. That year, oil prices were just coming down from record highs, a pair of hurricanes were causing spot gasoline shortages, and the economy was headed into the toilet. The general mood was that things were rapidly unraveling. Three years later, the long-term outlook isn’t really any different, but I think some who predicted imminent doom are starting to change their views on how things are going to play out.

I noted during one of my talks that I don’t even like the term “peak oil.” That is because there are a number of misconceptions and negative connotations associated with it. I prefer to talk in terms of resource depletion and a supply/demand imbalance that includes multiple elements – all of which combine to keep upward pressure on oil prices. So what are those misconceptions about peak oil? Below are the ones I think are most common.

The issues we are confronted with today seem to be a subset of the issues foretold in the book Limits to Growth back in 1972. At some point, the economy cannot continue to grow as rapidly as it did in the past. It appears to me that the most immediate limit we are hitting today is inadequate low-priced oil, but there are other limits lurking not far away–inadequate fresh water and excessive pollution, for example. When the economy cannot grow as fast, or actually starts declining, recession sets in. Governments start having debt problems. Financial markets start behaving strangely.

This issue is a difficult one to talk about, because there really is no good solution. I have talked to a couple of groups recently (one a church group; one a peak oil group), about this issue. This is a copy of the presentation I used (Bumping up against the Growth Ceiling (PDF) or Bumping up against the Growth Ceiling (PowerPoint). In this post, I will discuss my presentation, omitting the section at the end called, "Where do we go from here?" The full post and discussion can be read at Our Finite World.