Is Cheap Oil Really Bad News?

Remember when Matt Simmons was betting a whole lot of money on high-priced oil? In August of 2005, oil exec and peak oil guru Matthew Simmons bet New York Times columnist and avowed techno-cornucopian John Tierney $10,000 that the, “year-end average of the daily price-per-barrel of crude oil for the entire calendar year of 2010 adjusted for inflation,” would be at least $200. Simmons died four months before that year’s end, but probably knew he would lose the bet.

In those days I was following The Oil Drum and Life After the Oil Crash and a few other sites. It was clear that the energy depletion crowd saw high oil prices and high fuel prices as a reliable bellwether of a severe economic collapse scenario, or what they called TSHTF. But while Simmons and others anticipated a price spike, few anticipated the subsequent price collapse and recovery to a wide range above and below $100/bbl. Few of them anticipated the boomlet in unconventional liquids (tar sands, tight oil, fracking, etc) enabled by those higher prices. The world economy absorbed a lot of big hits, but although a lot of people suffered, protested and were killed, the world economy did not collapse.

Today, Bloomberg tells us that the WTI per barrel price is $48.98 while the Brent per barrel price of oil is $51.99. A lot of folk in the US are very happy with lower fuel prices, but some of the same energy depletion gurus are telling us that falling oil prices are a bellwether of an economic collapse scenario. Does the last part of that sound familiar?

While it may sound funny to now fear low oil prices, I do believe that in a real sense the oil prices are low only because a lot of other folk – in the US and around the world – are persistently out of work. Whether those low prices will plunge us into chaos sooner rather than later is another matter. Here are three takes on lower oil prices. In, The peak oil crisis, Tom Whipple explains that too much was too much:

The reason for the current fall in prices is still in debate. The “oil” supply has continued to creep up in recent years, but starting last June the demand for $100+ oil was no longer there. While demand in the “rich” OECD countries has been down since the 2008 oil price spike, this year it seems to be the slowing Chinese economy and its reduced demand for raw materials that has been behind the sinking demand. Many of the developing economies have been growing and using more oil each year due to growing trade with the Chinese.

Someday conventional wisdom will conclude that oil at circa $100+ a barrel was simply too much to sustain high rates of economic growth and so the growth fell taking oil demand along with it. As nearly every action has a reactive feedback, we now are likely to see some sort of economic revival in those countries that have had to import a large share of their energy during the time of higher prices. Conversely the many states that have benefited from having large quantities of excess oil to export will not be doing so well for a while.

That sounds like good short-term news for the business-as-usual crowd in the US and Western nations, but lousy news in the third world. But since they make and buy a lot of our stuff, bad news for the rest of the world has a way of catching up with the West.

In, How increased inefficiency explains falling oil prices, Gail Tverberg asserts that expensive oil made almost everything else less efficient:

Since about 2001, several sectors of the economy have become increasingly inefficient, in the sense that it takes more resources to produce a given output, such as 1000 barrels of oil. I believe that this growing inefficiency explains both slowing world economic growth and the sharp recent drop in prices of many commodities, including oil.

The mechanism at work is what I would call the crowding out effect. As more resources are required for the increasingly inefficient sectors of the economy, fewer resources are available to the rest of the economy. As a result, wages stagnate or decline. Central banks find it necessary lower interest rates, to keep the economy going.

Unfortunately, with stagnant or lower wages, consumers find that goods from the increasingly inefficiently sectors are increasingly unaffordable, especially if prices rise to cover the resource requirements of these inefficient sectors. For most periods in the past, commodities prices have stayed close to the cost of production (at least for the “marginal producer”). What we seem to be seeing recently is a drop in price to what consumers can afford for some of these increasingly unaffordable sectors. Unless this situation can be turned around quickly, the whole system risks collapse.

Everything I read claims that US workers are more efficient than ever (when we’re not browsing the internet) but are still paid like it was the 1980s. Gail is blaming inefficiency for stuff being too expensive, but I think the income gap plays a large part. Maybe we can’t afford to be that efficient anymore.

In, This Oil Thing Is The Real Deal, Ilargi at The Automatic Earth predicts devalued currencies and war:

Well! WTI below $50 and Brent below $53 when I start writing this. Who knows where they’ll be by the time I’m finished?! The euro down below $1.20, US stocks flirting with -2%, major European ones off -3%, Italy and Greece over -5%. Welcome to the real world, baby! Didn’t think you’d see it again so soon, did you? Welcome to the world where the Kool-Aid recovery does not reign supreme.

Not that you’re not going to hear that anymore, and 24/7 incessantly so, but there’s no recovery with these oil prices, no matter what anybody says. The damage must be gargantuan by now. Everybody’s invested in oil. Sure, lots of shorts and stuff by now, but that’s not going to do much good. Not for pensions funds, or for governments. This thing will not blow up or over softly.

There’s not an oil major or minor or a producing country left that makes a profit at these prices, and there’s no sign anywhere to be seen that the drop will stop. If this keeps going, someday soon somebody’s going to go to war. Maybe domestically, maybe across a border, but it’ll happen.

Frankly I feel like we already are at war. We’re already dropping drones (whenever the secret courts allow – which means whenever we want). And third worlders are forming armies, exploding bombs, cutting off heads and advocating terrorism in the West. Another proxy war won’t be a big surprise, but I don’t think it will drag the economy down.

I’ve become leery of predictions that the world will collapse next week. My feeling is that it will be a painfully drawn out process.

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