Slow Squeeze

I have been thinking a lot lately about the impact of $100+ oil prices on the world economy. Like many others, I am trying to work out the probable implications – for the overall economy, for the U.S. economy, for the energy sector, for my personal finances, and for the average person. I believe we have entered an era of permanently higher oil prices, because 1). Supply and demand are in a very tight balance; and 2). OPEC has been very disciplined about keeping a tight reign on supplies. I just don’t see demanding falling enough, nor supply growing enough, to make a major change in the status quo.

In the course of doing a little research, I ran across a couple of interesting graphs that I want to share. The first comes courtesy of a post by Khebab at Graphoilogy: How Probable is a US Recession if the Oil Supply is Shrinking?

Figure 1. Variations of the per capita GDP per capita and consumed oil barrels.

Note that this data was through 2005, and the trend over the past couple of years has already changed direction. But it shows the difficulty in growing the economy if the oil supply isn’t growing. This is the reason that I recently posed the question of whether peak oil – or even a supply plateau – would cause the U.S. economy to stop growing. I think the trends in the credit and stock markets will continue – at least for a while – if supplies can’t get ahead of demand and oil prices remain extremely high.

The next figure is courtesy of the Wall Street Journal:

Figure 2. The global per capita picture.

This figure shows that per capita consumption growth in the U.S. has slowed to a halt. And while this slowdown has mostly been accompanied by an expanding stock market, I think $100+ oil provides so much headwind that the stock market is going to flounder for a while. I think the U.S. economy is in a slow squeeze (I think Stuart Staniford first coined this phrase) brought on by higher oil prices, which are directly related to stagnant production. As long as oil prices continue to remain at these lofty levels, I don’t see light at the end of the tunnel yet.

On the other hand, based on Figure 1, the global per capita picture may be a good indicator that the markets will continue to fare well in places where global per capita consumption is increasing – especially in net exporting countries like Saudi Arabia and Russia. It may be time for me to start looking at some Russian mutual funds. China has certainly been growing quickly, but high oil prices have the potential to do a lot more damage to the Chinese economy than to the Russian economy – which will likely benefit as long as they remain an exporting country. Brazil would also be an interesting case, as their recent oil discoveries promise to turn them back into an exporting nation.

Of course certain sectors that aren’t especially sensitive to energy prices may fare well. There are lots of companies within the energy sector itself that should provide protection against high oil prices – since they benefit from high oil prices.

20 thoughts on “Slow Squeeze”

  1. I think we might be in a slow squeeze, if we hadn’t hit a credit crisis first.

    Unfortunately the credit crisis is so big that it overrides every other signal. Back in your investment thread I said that commodities looks bubble-like to me. I’ve got a big economist in my corner: Jim Hamilton

    As far as the scale of the problem, I think Tyler Cowen provides a good link round-up.

    In summary, I think this is exactly the wrong time to look at the economy in terms of oil, and in fact is the right time to think of oil in terms of the economy.

    (It should fall a little bit IMHO, as the recession takes hold and as commodity bubbles pop. The supply-demand situation, and possibly a peak-lite should hold it from falling too far.)

  2. It is surprising to me that The Netherlands uses so much oil. I thought everyone biked there?

  3. Commodities may be in a bubble. Seems like every time I come up with sound reasoning why prices will continue to go up, the bubble pops because of something I didn’t factor in.

  4. Actually, if I read the WSJ chart correctly, there is tons of good news there.
    Per capita consumption is declining in the United States, and most major consumers.
    Even more remarkable, per capita consumpion is declining in India (!). Is this chart accurate?
    One also sees how relatively minor China and India are as consumers. One hears India lumped in with China — the so-called “Chindia” — and yet India is miniscule, and their per capita oil consumption is declining.
    Even more encouraging, these trends do not capture improvements in 2007. Conservation efforst take time.
    The top chart shows U.S. demand fell by a whopping 8 percent per capita in the last price spike in 1980.
    In short, demand for crude oil is going to start falling, globally, if it has not already. We have seen Peak Demand.
    The interesting twist on this. in this cycle, is control of supply and the NYMEX.
    The real question now: Can OPEC, in collusion with sovereign funds (many oil-rich nation funds) and hedge funds, control oil prices?
    OPEC controls under 40 percent of world production, but they have trillions to invest. Can they “fix” prices on the NYMEX? In concert with announcements about production cuts etc?
    My guess is they can, for a while, maybe even two more years. I suspect that is what is going on now.
    The world has never seen such liquid, concentrated wealth as the sovereign funds. They may be able to control prices on the NYMEX.
    And the oil thug states — Mexico, Venezuela, Libya, Iran, Iraq, KSA, former Russian stats etc – are effectively crimping production through sheer boobery or worse.
    Still, it will be a first if crude prices can be sustained in the face of rising production and falling demand.

  5. Robert, you should stick to your expertise in energy. Like every economist at some point, you’ve been suckered into imbuing aggregate statistics with some kind of power that they do not have.

    Clearly economic growth and oil consumption have a positive correlation. Logically, this makes perfect sense. During periods of economic growth you almost always have higher levels of employment, industrial activity, and consumption.

    However, there is no definitive link between economic growth and oil consumption. You’re falling into a narrative rather than objectively looking at the situation. I believe you’ll find that the oil consumption/per unit of US GDP has been trending down for a long time; and there are even cases of reduced aggregate oil consumption with increased real GDP. In the ten year period between 1973 and 1983 real GDP increased by approximately a quarter while aggregate oil consumption fell by 12%.

  6. Benny “peak demand” cole:
    I think you read WSJ chart incorrectly: it shows that the growth of per capita oil consumption in US and India continues, but not as fast as in 1996-2000.

  7. There is a post at Economist’s View that relates to this. First, a quote from Fed Vice Chairman Donald Kohn:

    Disentangling the various global forces influencing commodity prices can be useful in assessing the implications of those prices for domestic output and inflation, and hence monetary policy. For example, it matters whether a rise in oil prices results from demand factors, such as stronger global real activity, or supply factors, such as a hurricane that shuts down production. For an oil-importing country, a demand-driven price increase would have less negative implications for domestic real activity than a supply-driven increase because an expanding world economy would help boost demand for the country’s exports. For the United States, however, a rise in oil prices driven by stronger real Chinese activity would not necessarily lead U.S. export volumes to rise substantially, given the low propensity of China to import from the United States….

    Because monetary policy has a limited ability to counter short-term price surprises, the distinction between transitory and persistent influences on inflation from oil and other factors is critical. If we were to project a continued significant rise in energy prices over the medium run, we would need to factor that expectation into the outlook for overall inflation. Doing so could have important implications for the stance of monetary policy–all the more so if we expected rising energy costs to lead to higher inflation expectations and elevated wage gains.

    Still, a leveling out in oil prices seems the more likely scenario…

    And then a reply from blog owner Mark Thoma:

    A willingness to admit the inflationary consequences of higher oil prices, yes. But no willingness to admit that Fed policy might have just a little to do with those high prices. And certainly no discussion of how the denomination of that commodity in Dollars affect its pricing when those Dollars are rapidly falling in value. And make no mistake – Fed policy is not simply one of benign neglect of the Greenback. It is open season on the Dollar.

    It continues on. As a lot of people are saying this weekend, interesting times …

  8. Anon–

    The chart shows the US right on the cusp of negative growth in per capita consumption — surely into negative by 2007, given the trends.
    This has happened in just a few short years. Remember oil was very cheap into 1999, and has been rising since.
    Demand for oil is inelastic for a few years — then alternate fuels and conservation begin taking effect. We are there now.
    Also see other comment, also by anon., who points out negative oil consumption from 1973 through 1983, yet a rising GDP.
    Look for demand for oil to be negative in 2007 globally, or right on the cusp, and then negative in 2008. I cannot fathom why forecasters are predicting increases, given past tredns and reactions to higher prices.

  9. However, there is no definitive link between economic growth and oil consumption. You’re falling into a narrative rather than objectively looking at the situation.

    I firmly hope you are correct. However, in this situation oil consumption has been arrested because of very high prices. These high prices are causing a lot of money to flow out of the country. I fear that we may see some extended consequences on the economy.

  10. “However, in this situation oil consumption has been arrested because of very high prices.”

    In situations like this we should use the word “because” with care.

    High prices are certainly a factor, as is the loss of the wealth effect in housing, and the is even the impact of credit on new-truck purchases.

    (I’ve heard that most Ford 150 truck sales were financed by sub-prime loans, and as the credit for those loans dries sales are impacted.)

  11. The chart shows the US right on the cusp of negative growth in per capita consumption — surely into negative by 2007, given the trends.

    The major flaw in your math is that even if per capita growth is negative, overall demand can still increase. Can you think why?

    Unfortunately, looking at per capita stats in isolation easily becomes a meaningless exercise.

  12. However, in this situation oil consumption has been arrested because of very high prices.

    Or, very high oil prices have been arrested by a massive debt problem. Take your pick!

  13. There’s a lot of things all going on at the same time right now. Unwinding carry trades with Japan, China’s industrial expansion with their US dollar peg and the associated inflation in the US dollar, the busting of the global credit and associated real estate bubbles, increased energy and commodity prices, etc. Trying to make predictions for the future at the moment is very difficult due to the complexity of the situation. That said, I think the prognosis for the US is fairly bad at the moment.

    On the high consumption for the Netherlands, the Dutch are an oil producer like Saudi Arabia. If they have a lot of refinery capacity that consumes crude and exports finished gas & diesel, then those refineries will distort the oil consumption picture.

  14. Hello Robert,

    There is an esential issue in the GDP-oil link: the energy intensity of an economy is fairly inlastic in the short run, but very elastic in the long run.

    Now, there is a CLEAR definition of short and long run in energy economics:

    Short run refers to the demand given the fixed structure of capital; long run is when you take into account the capital depreciation and renewal.

    If you have a car with a gasoline engine, you will pay a lot for gasoline, but sustained high prices could make electrical or (more likely) natural gas cars more competitive.

  15. Robert,

    Wouldn’t the slow squeeze effect growth depending on the investment required to recover the previous productivity?

    In other words, if I’m driving an SUV at $2/gallon, and I pay about $50 per week to fill up the tank.

    Suddenly gas rises to $4/gallon and I’m paying $100 to fill it up.

    I get rid of the car (at the normal time), and replace it with a hybrid, and now I’m back to $50 per week (actually about 28 at current prices).

    So as long as high prices cause demand destruction without increased investment, then we can continue to have growth.

    But if I can’t do the same for industrial uses of oil, the same happens. Or if I have to invest significantly to get the reduction (e.g. I can’t afford a hybrid, so I have to save up, forgoing other spending).

    I would expect the demand destruction to come from other places as well.

    People will want to drive their big SUV’s. So instead of giving up that, they give up eating out, or $4 dollar lattes.

    Of course, this means they trade off domestic service jobs for foreign oil jobs, resulting in a flattening of the economy.

    Is there any sense of where the inflection points will be? And when people will start making the big changes that result in a step-down in the economy.


  16. If a country stops producing most of the consumer goods it uses and starts to import them from somewhere else, does that reduce that country’s per capita oil consumption?

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