Articles in topic "Economics/Finance"
Recently, I explained how high oil prices can bring on financial collapse for oil importers. In this post, I’ll discuss the flip side of the situation: how oil exporters reach financial collapse.
Unfortunately, we have many examples of countries that were oil exporters, but are dealing with collapse situations. Egypt, Syria, and Yemen all have had political disruptions since 2011. These may not be called financial collapse, but they all took place as the country’s oil exports decreased and as the price of imported food rose. Another example is the Former Soviet Union (FSU). It collapsed in 1991, after a period of low oil prices, in what looks very much like a financial collapse.
There are several dynamics at work in the financial collapse of oil exporters:
- Oil exporters are often dependent on oil export revenue to fund government programs.
- The need for government programs grows as population grows and as the price of food rises.
- The amount of oil that can be extracted in a given year often declines over time, as initial stores are depleted.
- Exports often decline even more rapidly than oil supply, because of rising oil consumption as population grows.
In general, high oil prices are good for oil exporters (except the effect on food prices). At the same time, oil importers strongly prefer low oil prices. As a result, we end up with a price tug of war between oil importers and oil exporters.
One additional issue is declining Energy Return on Energy Invested. Countries often have the option of reducing their rate of decline by adding production in areas which are more expensive to drill (say deeper, smaller locations offshore Norway) or by using enhanced oil recovery methods. Such approaches add costs (and energy use), and further add to the price that oil exporters need for their product.
Egypt, Syria, and Yemen
Egypt, Syria, and Yemen are three countries that the press would say are suffering from the continuing impact of the Arab Spring revolutions, which began in 2011, or of civil war. The similarity of the oil production and consumption charts for the three countries (shown below) suggests that declining oil exports likely played a major role as well.
A friend asked me to put together a presentation on our energy predicament. I am not certain all of the charts in this post will go into it, but I thought others might be interested in a not-so-difficult version of the story of the energy predicament we are reaching.
My friend also asked what characteristics a new fuel would need to have to solve our energy predicament. Because of this, I have included a section at the end on this subject, rather than the traditional, “How do we respond?” section. Given the timing involved, and the combination of limits we are reaching, it is not clear that a fuel suitable for mitigation is really feasible, however.
Energy makes the world go around
Energy literally makes the world turn on its axis and rotate around the sun.
Energy is what allows us to transform a set of raw materials into a finished product.
Energy is also what allows an us to transport goods (or ourselves) from one location to another. Services of any type require energy–for example, energy to light an office building, energy to create a computer, and human energy to make the computer operate. Without energy of many types, we wouldn’t have an economy.
In my view, wages are the backbone an economy. If workers have difficulty finding a job, or have difficulty earning sufficient wages, the lack of wages will be a problem, not just for the workers, but for governments and businesses. Governments will have a hard time collecting enough taxes, and businesses will have a hard time finding enough customers. There can be business-to-business transactions, but ultimately somewhere “downstream,” businesses need wage-earning customers who can afford to pay for goods and services. Even if a business produces a resource that is in very high demand, such as oil, it still needs wage-earning customers either to buy the resource directly (for example, as gasoline), or to buy the resource indirectly (for example, as food which uses oil in production and transport).
It is not just any wages that are important. It is the wages paid by private companies (rather than governments) that are important, as the backbone to the economy. Governments tend to get their revenues from private citizens and from businesses, both of which are dependent on wages of private citizens. There are a few pieces outside of this loop, such as taxes on imports from foreign countries. With the advent of free international trade, this source is disappearing. Another piece outside the US wage-loop is taxes on resource extraction, if these resources are exported.
Instead of using the analogy of a backbone, perhaps I should say that wages are the base that ultimately determines the quantity of goods and services an economy can afford.
Obviously there are other kinds of income, such as “rents,” but these, too, ultimately come from wage earners. Furthermore, businesses cannot earn money to pay dividends unless some consumer, somewhere, can afford to buy the goods and services their business is selling.
I have written recently about how the proportion of Americans with jobs rose to a peak, and since has been declining.
I decided in this post to look at the dollars these workers are earning. In particular, I decided to look at wages, other than government wages, adjusted to today’s cost level using the “CPI- Urban,” cost index of the Bureau of Labor Statistics. I discovered that these wages are doing very poorly. I also discovered a disturbing connection between high oil prices and flattening or declining wages. Putting all of these pieces together suggests a connection to “Limits to Growth.”
Globalization seems to be looked on as an unmitigated “good” by economists. Unfortunately, economists seem to be guided by their badly flawed models; they miss real-world problems. In particular, they miss the point that the world is finite. We don’t have infinite resources, or unlimited ability to handle excess pollution. So we are setting up a “solution” that is at best temporary.
Economists also tend to look at results too narrowly–from the point of view of a business that can expand, or a worker who has plenty of money, even though these users are not typical. In real life, the business are facing increased competition, and the worker may be laid off because of greater competition.
The following is a list of reasons why globalization is not living up to what was promised, and is, in fact, a very major problem.
1. Globalization uses up finite resources more quickly. As an example, China joined the world trade organization in December 2001. In 2002, its coal use began rising rapidly (Figure 1, below).
In fact, there is also a huge increase in world coal consumption (Figure 2, below). India’s consumption is increasing as well, but from a smaller base.
We are used to expecting that more investment will yield more output, but in the real world, things don’t always work out that way.
In Figure 1, we see that for several groupings, the increase (or decrease) in oil consumption tends to correlate with the increase (or decrease) in GDP. The usual pattern is that GDP growth is a little greater than oil consumption growth. This happens because of changes of various sorts: (a) Increasing substitution of other energy sources for oil, (b) Increased efficiency in using oil, and (c) A changing GDP mix away from producing goods, and toward producing services, leading to a proportionately lower need for oil and other energy products.
The situation is strikingly different for Saudi Arabia, however. A huge increase in oil consumption (Figure 1), and in fact in total energy consumption (Figure 2, below), does not seem to result in a corresponding rise in GDP.
At least part of problem is that Saudi Arabia is reaching limits of various types. One of them is inadequate water for a rising population. Adding desalination plants adds huge costs and huge energy usage, but does not increase the standards of living of citizens. Instead, adding desalination plants simply allows the country to pump less water from its depleting aquifers.
To some extent, the same situation occurs in oil and gas fields. Expensive investment is required, but it is doubtful that there is an increase in capacity that is proportional to its cost. To a significant extent, new investment simply offsets a decline in production elsewhere, so maintains the status quo. It is expensive, but adds little to what gets measured as GDP.
The world outside of Saudi Arabia is now running into an investment sinkhole issue as well. This takes several forms: water limits that require deeper wells or desalination plants; oil and gas limits that require more expensive forms of extraction; and pollution limits requiring expensive adjustments to automobiles or to power plants.
These higher investment costs lead to higher end product costs of goods using these resources. These higher costs eventually transfer to other products that most of us consider essential: food because it uses much oil in growing and transport; electricity because it is associated with pollution controls; and metals for basic manufacturing, because they also use oil in extraction and transport.
Ultimately, these investment sinkholes seem likely to cause huge problems. In some sense, they mean the economy is becoming less efficient, rather than more efficient. From an investment point of view, they can expect to crowd out other types of investment. From a consumer’s point of view, they lead to a rising cost of essential products that can be expected to squeeze out other purchases.
A person might think from looking at news reports that our oil problems are gone, but oil prices are still high.
In fact, the new “tight oil” sources of oil which are supposed to grow in supply are still expensive to extract. If we expect to have more tight oil and more oil from other unconventional sources, we need to expect to continue to have high oil prices. The new oil may help supply somewhat, but the high cost of extraction is not likely to go away.
Why are high oil prices a problem?
1. It is not just oil prices that rise. The cost of food rises as well, partly because oil is used in many ways in growing and transporting food and partly because of the competition from biofuels for land, sending land prices up. The cost of shipping goods of all types rises, since oil is used in nearly all methods of transports. The cost of materials that are made from oil, such as asphalt and chemical products, also rises.
Most of us have heard that Thomas Malthus made a forecast in 1798 that the world would run short of food. He expected that this would happen because in a world with limited agricultural land, food supply would fail to rise as rapidly as population. In fact, at the time of his writing, he believed that population was already in danger of outstripping food supply. As a result, he expected that a great famine would ensue.
Most of us don’t understand why he was wrong. A common misbelief is that the reason he was wrong is that he failed to anticipate improved technology. My analysis suggests that there were really two underlying factors which enabled the development and widespread use of technology. These were (1) the beginning of fossil fuel use, which ramped up immediately after his writing, and (2) a ramp up in non-governmental debt after World War II, which enabled the rapid uptake of new technology such the sale of cars and trucks. Without fossil fuels, availability of materials such as metal and glass (needed for most types of technology) would have been severely restricted. Without increased debt, common people would not have been able to afford the new types of high-tech products that businesses were able to produce.
This issue of why Malthus’s forecast was wrong is relevant today, as we grapple with the issues of world hunger and of oil consumption that is not growing as rapidly as consumers would like–certainly it is not keeping oil prices down at historic levels.
What Malthus Didn’t Anticipate
Malthus was writing immediately before fossil fuel use started to ramp up.
The Oil Drum staff wishes Happy Holidays to all in our readership community. We are on a brief hiatus during this period, and will be back with our regular publications early in the new year. In the meantime, we present the top ten of best read Oil Drum posts in 2012. The fifth in this series is a post by Chris Cook, former compliance and market supervision director of the International Petroleum Exchange.
All is not as it appears in the global oil markets, which have become entirely dysfunctional and no longer fit for its purpose, in my view. I believe that the market price is about to collapse as it did in 2008, and that this will mark the end of an era in which the market has been run by and on behalf of trading and financial intermediaries.
In this post I forecast the imminent death of the crude oil market and I identify the killers; the re-birth of the global market in crude oil in new form will be the subject of another post.
Posted by Gail the Actuary on November 16, 2012 - 3:30pm
Tags: eroei, iea, imf, oil prices, recession, shale oil, tight oil, us oil production, weo 2012, world energy outlook [list all tags]
The International Energy Agency (IEA) provides unrealistically high oil forecasts in its new 2012 World Energy Outlook (WEO). It claims, among other things, that the United States will become the world’s largest oil producer by around 2020, and North America will become a net oil exporter by around 2030.
Figure 1 shows that this increase comes solely from the expected rise in tight oil production and natural gas liquids. The idea that we will become an exporter in later years occurs despite falling production, because “demand” will drop so much.
As U.S. retail gasoline prices once again near $4.00 a gallon, does this pose a threat to the economy and President Obama’s prospects for re-election? My answer is no.
EDIT - I originally wrote this post thinking that Prof. Hamilton was looking at a broader question: Can an economy learn to live with increasingly high oil prices? After looking again at his article again, I realize that he is talking about a narrow question: Using the figures he was looking at (average gasoline prices across all grades), prices were for the week of Sept. 17 near $4 a gallon, as they had been several times in the past, as they bounced up and down.
In that context, what he says is far closer to right than what my analysis of the broader question of whether an economy can learn to live with increasingly high oil prices, below, would suggest. There is a difference, because gasoline prices are not too closely tied to oil prices in short term fluctuations, and because the issue is likely to be as much one of consumer sentiment as anything else, as long as the issue is simply one of gasoline prices in a not-too-wide range. But I think there are some longer-term, more general issues we should be concerned about.