2008 July 04 Friday
Global Recession Seen From $200 Per Barrel Oil

High oil prices and unemployment.

"Two-hundred dollar oil would break the back of the global economy," Deutsche Bank AG's chief energy economist Adam Sieminski said in an interview on Wednesday in Tokyo. "Next step after US$200 would be global recession and bad news for everybody."

This is why I think our current mild recession will be longer lasting and deeper. I wonder if this is one of the reasons Warren Buffett has commented that he expects a longer recession.

Sieminski states the obvious: We are in the process of finding out how high prices have to get to destroy enough demand.

“What we’re seeing is a very painful experiment to see what price will get demand to slow down,” said Adam E. Sieminski, chief energy economist at Deutsche Bank. “Four dollars a gallon is slowing consumption in the United States. But there is an awful lot of people in the developing world and they all want a car and they all want a better diet. That is putting a lot of pressure on food and energy prices.”

Goldman Sachs analyst Arjun Muri was not taken seriously when crude oil was only $40 and he foresaw a big upward spike in oil prices to over $100. Now we look nostalgically back on those good old days. Well, Murti sees oil hitting $200 within a couple of years. I do not think it will take that long.

IN 2004, ARJUN N. MURTI, A TOP ENERGY ANALYST AT GOLDMAN SACHS , published a report predicting "a potentially large upward spike in crude oil, natural gas and refining margins at some point this decade." It was a controversial call, with crude around $40 a barrel at the time. But it was right on the money. Four years later, crude is trading around 139. Murti sees energy in the later stages of a "super spike," in which prices rise to a point where demand drops off. In a note last month, he wrote that "the possibility of $150-to-$200-per-barrel oil seems increasingly likely over the next six to 24 months."

Murti says we are getting close to the end game. But a game implies a competition where we can win or lose. Well, we definitely lose on this one.

We are getting closer to the end game here, where despite eight years of rising energy prices, supply looks like it is going to barely grow this year. We have been bullish, but we didn't expect such a slow growth rate of supply. And demand outside the U.S., Europe and Japan has been more resilient than we expected.

But if the whole world goes into a deep recession next year then we could probably delay the $200 per barrel oil since the recession would dampen demand.

Doesn't sound bad enough yet? The next American President might decide to make our energy situation worse by cutting back on Alberta tar sands oil imports.

A senior adviser to Mr. Obama's campaign told reporters it's an "open question" whether oil produced from northern Alberta's oilsands fits with the Democratic candidate's plan to shift the U.S. sharply away from consumption of carbon-intensive fossil fuels.

"If it turns out that those technologies don't advance . . . and the only way to produce those resources would be at a significant penalty to climate change, then we don't believe that those resources are going to be part of the long-term, are going to play a growing role in the long-term future," said Jason Grumet, Mr. Obama's senior energy adviser.

Hopefully more rational heads will prevail once Obama gets elected. But I expected more mature and reasonable people would surround George W. Bush and we all know how that turned out. Other governments are making the world energy problem worse by subsidizing internal consumption. It is not that big of a stretch to expect the US government under Obama will continue to block offshore oil development and Alaska oil development and even to put obstacles in the way of Alberta oil development.

Share |      By Randall Parker at 2008 July 04 06:30 PM  Economics Energy


Comments
Wolf-dog said at July 4, 2008 6:48 PM:

But Obama did promise an Apollo Project to spend $15 billion per year on energy development, although we need $100 billion per year, and we need to call it Bronx Project instead of the former, which was not a national security project, while the latter name does indicate a national survival project.
http://money.cnn.com/2008/06/18/news/economy/apollo_energy/index.htm

Stephen said at July 4, 2008 7:56 PM:

New Scientist (I think) had a great illustration of what a barrel of oil represents - basically, one barrel of oil used to power a machine does the same work of five human labourers working full time for one year.

Maybe the coming years will be good for very low skilled males as they start to replace mechanical devices. Also, maybe those countries who have traditionally relied on manual labour will have a lot easier time adapting.

Kenelm Digby said at July 5, 2008 5:07 AM:

In my opinion, the western nations must seriously re-think the 60 year old fetish for free trade (it is clearly NOT in the interest of the west - as it all it seems to be doing is raising Chinese consumption at the west's expense), and fall back on an unashamed policy of autarky and severely restricted access to scarce resources.
-This will definitely NOT happen though.
Politicians are generally very vain, shallow and stupid people.The way for a politician to appear 'clever' (something they all cherish - second only to achieving power) is to parrot bollocks they have read in such ass-wipe as the WSJ and The Economist, and then say to themselves smugly 'Oh what a clever boy am I'.
So expect more of the same indefinitely.Ie the west being priced out of oil at $200 a barrel, rampant poverty and stagnation, the Russians and Saudis rolling in cash - and the Chinese with the entire World sewn-up and in their pockets.
Mark my words.

Stephen said at July 5, 2008 5:18 AM:

The Chinese can't afford $200 barrel oil, they're not rich like the west.

In any event, look forward to a significant (relative) drop in the price of oil when George finishes his Presidency - you know that guy who was elected by the American people.

Twice.

Greg said at July 5, 2008 6:00 AM:

I am convinced that Obama is mistaken, very gravely mistaken, on this course of action.
If McCain would recognize this, he could beat Obama like a drum on this issue alone.

An Apollo project might work, but it would take longer than 10 years. The state of art was further along with Apollo than it is with alternative energy. By the time Kennedy made his goal public, a manned mission to space had already taken place. We would need a demonstration of the necessary technology that could replace oil in order to be at an equivalent position. To my knowledge, we have not done this yet. In addition, the Apollo project was for only a limited objective of a few manned missions to the Moon. The scale for producing vast quantities of replacement energy is much, much more ambitious than the Apollo project. Not to mention that we don't have 10 years. If we go into deep recession, because of a lack of energy supplies, then the government will be forced to deal with other problems that rise in consequence of the recession. Priorities will have to change in order to manage the difficulties that will ensue.

All of this assumes that alternatives will be found. Has anyone even bothered to consider the possibility that no alternatives will discovered anytime soon? In such a scenario, what would we do then?

A better course of action would be to increase supplies of conventional energy now, along with conservation strategies. This will enable the country to afford the research and development for alternative energy that only has the potential to replace oil.

Kenelm Digby said at July 5, 2008 6:46 AM:

Stephen,
You're dead wrong.Recently, the Chinese lifted a price restriction on gasoline - the price of oil immediately shot upwards.Traders made the call that pent-up demand was so strong in China that the end of the price restriction and the impostion of a realistic price would actually increase oil demand in China, due to the immense wealth that has been builty up amongst China's 300 million odd urban well-heeled population.
FACT: China bankrolls the USA, therefore China'has more money than the USA'.

mark said at July 5, 2008 7:43 AM:

Digby is right..free trade is only justifiable if it produces a balanced trade; if the Ricardo theory were to be correct the accounts between ourselves and China would be fairly even. That they are grossly out of balance indicates the fix is in. The 21st century undid the theory. Cheap labor is exploited so easily by multinationals, the information age is stateless and the unusual nature of the USA immigration policy has rendered all the assumptions of that theory invalid. Perhaps we will see the endgame within a half century; a world of extremely concentrated wealth with teeming slums, paramilitaries and criminal cartels terrorizing everyone in the slums. Woops....my mistake..we're already there!

Mirco said at July 5, 2008 12:11 PM:

Economy 101 tell, also, that "balanced trade" don't exist.
If the US import more than export, this is because it have too much money and not enough goods and services.
So it give its surplus money for the China's surplus goods.

Randall Parker said at July 5, 2008 12:56 PM:

Stephen,

I expect we'll less less stuff getting made rather than a shift toward more use of muscle power. Look at real estate construction. With less buying power comes demand for smaller homes that take less muscle to build.

I came across an analysis a few months back of the energy costs of growing hay and other horse feed that concluded that it was more efficient to use oil to directly generate horsepower than to use oil to grow food to feed horses to use them to do work. Sorry, no URL. But what stuck with me is that less oil means just less work done.

As for whether we or the Chinese can afford $200 oil: Which country exports more than it imports? The Saudis, Kuwaitis, Russians, and other oil producers want goods in exchange for their oil. Countries running big trade surpluses are in a better position to supply goods in exchange for oil.

Randall Parker said at July 5, 2008 1:31 PM:

Stephen,

I read a lot of energy news on biz news sites. When the Chinese raised internal diesel and gasoline prices the traders predicted the refiners would import more oil because they could now afford to do so. The lower prices within China were causing shortages as refiners couldn't afford to sell at below market prices. Now they can afford to buy the oil since they can sell for a profit. So sales will surge.

China runs a big trade surplus. So China can afford to continue importing oil.

Robert Hume said at July 5, 2008 3:43 PM:

"the unusual nature of the USA immigration policy has rendered all the assumptions of that theory invalid"

The other, perhaps more important, flaw in the theory that "free trade" raises all ships is that the Ricardo theory assumes that only goods are traded. But in addition to people, US industry also uses capital that would be used in the classic theory to enhance the US's comparative advantage ... to China and other third world countries. Our capital is being used to enhance their competitive advantage. See the economic publications of Herman E. Daly.

John said at July 5, 2008 11:21 PM:

Mirco, I think that may also be phrased as don't let your outflow exceed your income or your assets will be in jail.

Kenelm Digby said at July 6, 2008 5:07 AM:

The irony is now at present China is so economically strong (and will only get stronger), that ANY action the uSA might take in trade policy will have zero effect (but terrible repercussions on the USA)on china's economic growth.
Put simply China can well manage with the USA cut out entirely from its trade orbit.
This is of course, acomplete turnaround of the situation that pertained only 10 or so tears ago, when America could actually have done something.
The moral is that the 'China-monster', in a Frakensteinlike way has turned on its creator.

averros said at July 6, 2008 8:41 PM:

> The other, perhaps more important, flaw in the theory that "free trade" raises all ships is that
> the Ricardo theory assumes that only goods are traded.

It does not make that assumption, period.

In fact, money is a good; there's nothing special about money. It is accepted by people in exchange for goods because they believe that they will be able to exchange money for other goods in the future. (With government-mandated fiat money this belief is correct, for some time, until the scheme collapses, as it always does with fiat money).

Same goes for labor - it is also a good which is exchanged for other goods. So is information. A good does not have any intrinsic value - it is only valuable to specific consumers, in specific circumstances, and its value is only apparent when a voluntary exchange between parties is observed.

The only reason for "trade imbalance" between US and China is the fact that US exports fiat money by the virtue of Feds creating more of it from thin air. The newly created money lowers the price of money everywhere - but because it is created within US, it allows US consumers to get more goods in exchange for excess amount of money - until that excess dissipated equally in all places. Meaning that money goes out, goods come in. Chinese, in fact, get ripped. As we are ripped in turn by the bankers.

If you really want to understand what money is, please read Murray Rothbard's "What Has the Governement Done to Our Money?" - it is short, and to the point.

Randall Parker said at July 6, 2008 9:05 PM:

averros,

No, the reason for the US trade deficit with China is that the Chinese government controls the exchange rate between the US and Chinese currencies. All Chinese companies must take the dollars they receive from selling abroad and deposit them in a Chinese bank and get local internal currency at a set exchange rate. Then the Chinese government uses those dollars to buy US government bonds.

This has several distorting effects. First off, the US interest rate is lower than it ought to be. So that causes excessive monetary expansion and misallocation of capital in the US as well as greater debt build-up in the US. Also, it reduces sales of US goods to China and increases sales of Chinese goods to the US.

averros said at July 7, 2008 9:56 PM:

> No, the reason for the US trade deficit with China is that the Chinese government controls the exchange rate between the US and Chinese
> currencies. All Chinese companies must take the dollars they receive from selling abroad and deposit them in a Chinese bank and get local
> internal currency at a set exchange rate. Then the Chinese government uses those dollars to buy US government bonds.

Why Chinese are exchanging perfectly good physical goods for green papers is irrelevant. Most likely that's because their government has mercantilist ideas about how economy works. They are being punished for that. (Only an idiot buys long-term US bonds in large quantities nowadays... one look at the US Govt balance sheet shows perfectly clear that it will default on its obligations no matter what it does). In fact, by now Chinese are afraid to rock the boat by off-loading their holdings of USD-denominated assets, since it'll trigger immediate financial collapse of the entire dollar zone.

> First off, the US interest rate is lower than it ought to be.

"US interest rate is lower than it ought to be" is another way of saying "Fed expands money supply". The money is injected by offering loans to the banks (that's how Fed controls the prime rate), which allows banks to offer loans at artificially low interest rate to consumers and businesses. Which then buy Chinese goods for these fictional dollars which were created as "loans".

Obviously, this game cannot be played endlessly - that's what current mortgage bust is about. Too much funny money was chasing too few creditworthy debtors - with the inevitable result of lowering lending standards.

> Also, it reduces sales of US goods to China and increases sales of Chinese goods to the US.

Actually, the first half of the sentence is incorrect. Giving cheap loans increases ability of consumers to buy goods from China, but it also gets more dollars into the hands of Chinese - which can then buy goods in US. And they do buy (because China is seriously plutocratic the money ends up in hands of the "elite" - so the purchases are usually quite large. Like IBM's PC business.)

Randall Parker said at July 7, 2008 11:10 PM:

averros,

Again, the Chinese are manipulating currencies to cause their trade surplus.

You claim I am incorrect when I say that a weak Chinese currency reduces Chinese demand for US goods. But a weak Chinese currency increases the price of US goods and therefore reduces their demand. High prices reduce demand.

US interest rate is lower: When the Chinese buy lots of bonds they bid up the prices of those bonds and by doing so they lower the effective interest rate on those bonds.

I'm talking basic economics. You are driven by ideology to not see it. Give up the ideology. Use basic reasoning. You have the intellectual capacity to understand the world.

Kenelm Digby said at July 8, 2008 5:27 AM:

In fact the US treasury might conjure up dollars 'out of the thin air', but these dollars are still accepted universally in exchange for real tangible goods and assets such as company stock, property, commodities etc.
By all accounts the Chinese off-load those dollars and use them to but up real wealth as soon as possible, hence current commodity inflation - and the fact that Chinese labor is actually fully fungible for real wealth.
The notion that the Chinese are some how being 'ripped off' into buying 'worthless paper' from the USA is pure nonsense - but the fact that 142 sheets of the same paper are necessary to purchase one barrel of oil is very real and salient.

averros said at July 11, 2008 1:39 AM:

> Again, the Chinese are manipulating currencies to cause their trade surplus.

Yep, their government are mercantilists. The rank-and-file Chinese are much poorer for that. You may want to visit China someday... and stray for couple dozen miles from a city.

> But a weak Chinese currency increases the price of US goods and therefore reduces their demand. High
> prices reduce demand.

Translation: artificially weak currency reduces material wealth of citizens because they cannot afford more goods. That's exactly what I've been saying. So Chinese banks accumulate dollars while citizens cannot buy stuff for themselves with their undervalued rinimbi. How nice.

> US interest rate is lower: When the Chinese buy lots of bonds they bid up the prices of those bonds and
> by doing so they lower the effective interest rate on those bonds.

The fundamental price of any securities is based on expected future returns. What you are saying is that too much money is chasing relatively few future goods. Now, where all that money came from, again?

> I'm talking basic economics. You are driven by ideology to not see it. Give up the ideology. Use basic
> reasoning. You have the intellectual capacity to understand the world.

You're saying "A" but then forget to follow through on your train of thought to "B".

Please, lay aside your condescending tone. Sure I have intellectual capacity - I also have a ton of real-life experience of living in different economic systems (and being successful in all of them; I know how become a decorated "builder of communism" with all attendant priveleges just as well as I know how to become a millionaire under capitalism - I did both).

What I'm saying is the common knowledge among economists of Austrian school. It has absolutely nothing to do with ideology. I looked at other schools of economic thought, and they all are based on obvious logical fallacies - and keep failing to predict anything resembling real-world economic events. At least Austrian school managed to offer the only explanation of business cycle which amounts to more than just saying "spirits of market did that", and managed to predict collapse of socialist countries long time before that collapse actually happened. (Oh, yes, and if you worry about price of oil and mortgage crisis - Austrian ecomonists predicted that too, years ago, which is easily confirmed if you just read old archives on mises.org).

Kenelm - please read before you reply. "Fictional" is not the same as "worthless". You constructed a strawman and valiantly fought it, but, really, what I said is quite different from what you claim I said (you claim that I call dollars literally worthless, while I what I said is that value of fiat currencies is in the belief that they can be exchanged for tangible goods in the future - and that belief can collapse virtually overnight; I lived through two such collapses, and they aren't pretty). Meanwhile, I'm quite happy that I kept my savings in gold rather than in green paper-denominated accounts or stocks.


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