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2011 February 26 Saturday
Oil Price Spikes And Recessions In The 2010s

Imagine the next recession happens before we are even half way recovered from the most recent recession. The US government will go into the next recession already running big deficits. The USG is currently running a fiscal deficit of about 10% of GDP. Tax revenues will plunge. The US government will be unable to use fiscal spending as a compensating stimulus. In fact, the US government will cut spending in the next recession if it comes at any time in the next few years. States and cities will go into the next recession with huge unfunded pensions for their employees and big debts on their underfunded unemployment programs.

With all this in mind let us take a look at the latest oil price spike. Jeff Rubin points out that prices had already spiked before protesters took to the streets in Cairo.

What’s easy to lose sight of in the chaos sweeping through the Middle East is where oil prices were trading before it began. The Brent futures contract, the world’s new benchmark oil price, had already broken $100 (U.S.) a barrel before protesters in Cairo started sweeping into Tahrir Square and demanding Hosni Mubarak’s head.

Rubin, author of Why Your World Is About to Get a Whole Lot Smaller: Oil and the End of Globalization (which I've read and recommend), sees these prices as noteworthy because of when they are happening versus the economic cycle. Says Rubin "These are the kind of prices that one might expect to encounter at the end of an economic cycle, not at the beginning of one." For some context see this graph of oil price spikes and recessions starting from the early 1970s. The only exception to the pattern of price spikes and recessions was the early 1980s recession caused by then Fed chairman Paul Volcker as he tightened credit to squeeze inflation out of the US economy. But that inflation was in part due to earlier oil price spikes.

UCSD economics professor James Hamilton, who has done a lot of work modeling the effects of oil prices on economies, thinks we are okay for avoiding a recession as long as oil prices stay below $130 per barrel.

The particular dynamic model from which the above Brookings figure came builds in quite strong nonlinearities and threshold effects. Interestingly, according to that specification, one wouldn't begin to anticipate significant effects on U.S. GDP until the price of oil got above about $130 a barrel, or until the second half of this year. Prior to that, according to that specification, we're still ok.

So, hey, we might still have 6 more months of economic expansion ahead of us barring another revolution in the Middle East. Such is life during the Peak Oil period. It gets even worse once world oil production starts declining every year.

So what about another revolution in the Middle East? On the Foreign Policy blog The Oil And The Glory Steve LeVine points to a Cameron Hanover note on the speed ot the spread of protests against Middle Eastern governments.

OPEC, namely Saudi Arabia, pledged to make up any oil lost from Libya, which exports around 1.6 million barrels of oil per day. Of course, that only works as long as Saudi Arabia avoids contagion. And we have not read of contagion ever spreading with greater speed than has been seen these last few weeks. The spread has rivaled the spread of the Black Plague 650 years ago. That very speed may be the factor that has oil markets most on edge.

My guess is that the violence in Libya is cooling some of the revolutionary ardor of the Arab middle classes for regime overthrow. But if the Saudi Shiites take to the streets then you better radically cut your living standard and prepare for a full blown economic depression. An even partial halt of Saudi oil flow would cause a world depression with banks failing left and right, sovereign debt crises, bankrupt states, massive layoffs, and governments powerless to lessen the blow.

The "Export Land Model" (more below) rears its ugly head as major media reporters notice the rapid growth in Saudi domestic oil consumption. Zero growth in Saudi production means declining exports as more oil gets consumed internally that used to be available for export.

The world currently is awash in oil, and Libya's missing volumes won't halt anyone's factory or vehicle. But if the oil flow becomes cut off from additional petro-states, what will happen? At Fortune, Colin Barr points out that Saudi's long-term rising consumption raises questions about its capacity for rescuing the world economy down the road.

According to the Export Land Model our problem with oil is made far worse by rapidly rising consumption inside of oil exporting states. So, for example, on flat production Saudi oil exports declined in December 2010.

Rising costs of oil production have become the bottleneck for Western economic growth. Rising Asian demand and rising Export Land demand make this problem much worse. The world is starting to look more like a zero sum game. We must prepare for this in our personal decision-making. Due to flat and eventually declining oil production the recessions of the 2010s will be much more painful than what we've seen so far. My advice: make career and lifestyle decisions to insulate you from what's coming. Want to buy a car? Make it a hybrid and make it small. Want to move? Move closer to work. Or switch to a job that is both closer to home and more likely to survive oil price spikes.

Update: Nomura analysts project that if all oil production in Libya and Algeria go offline then oil will spike to $220 per barrel. Our livelihoods and living standards depend on political stability in Arab dictatorships. Political stability would give us more time to prepare for Peak Oil. But I do not expect most people or governments prepare.

Share |      By Randall Parker at 2011 February 26 02:05 PM  Economics Energy


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Comments
James Bowery said at February 26, 2011 4:12 PM:

"Move closer to work."

Great idea. Move closer to the high population densities.

How about this:

"Move close to the food sources and deal only with locals and with businesses that don't demand you to be physically present 'where the jobs are'."

Peter said at February 26, 2011 5:06 PM:

Randall, It would be interesting to get your take on the huge Shale drilling boom that has now moved from natural gas to oil. I have been quite surprised at the number of new plays and the number of rigs starting operations in new areas like the Eagle ford shale in Texas. These formations may hold hundreds of billions of barrels (not counted in the recoverable estimates yet by any means, just what is actually in the rock). This could be a game changer, just as it has been in natural gas. The other big thing that seems economically inevitable if oil stays at 4 or 5X the price of gas on a BTU basis, is conversion of gas to liquids. Even if you give up half the energy in the gas to do this, there would be huge profit to be made.

Engineer-Poet said at February 26, 2011 9:21 PM:

The conversion of gas to liquid hydrocarbons is about 45% efficient.  Thermodynamically, the idea is insane; the only way it makes the slightest bit of sense is if the gas is "stranded" and can't be shipped to markets with lower losses any other way.  Gas produced in the USA can be used (in ascending order of merit) as LNG in vehicles, as CNG in vehicles, and as fuel for combined-cycle gas turbines generating electricity for electrified transport of all types.

A.Prole said at February 27, 2011 12:58 AM:

What we are really seeing is a Malthusian crisis by another name - it's the pay-back for massive population growth in the arab world 30-40 years ago, and the subsequent inability of the product of that population explosion to find sustenance.
Come back Paul ehrlich, all is forgiven!

Peter said at February 27, 2011 8:21 AM:

EP -This conversion is being done in a number of places such as Qatar with stranded gas, as you suggest. You are right in that the current energy conversion is around 45 percent. That still allows a good margin to be made when gas is otherwise useless, being flared off or re injected into an oilfield. I agree that compressed gas is much more efficient from an energy standpoint, but then again, we certainly have no shortage of energy per se on our planet. It is liquid fuels that are the real problem.
Also, I suspect that the conversion process could become more efficient over time. Since we are going from hydrocarbon to hydrocarbon, the thermodynamic efficiency limit should be much better than 45 percent.

California kid said at February 27, 2011 12:21 PM:

"Move closer to work".

Randall, we would like to move closer to work. We would like to live in the cities our ancestors built (we wouldn't even need a car). But we can't. And you know why.

Randall Parker said at February 27, 2011 5:18 PM:

James Bowery, California kid,

While some of the time moving closer to work does mean moving closer to crime and dysfunctional schools that is not always the case. But I take your point.

Another tactic: Move work closer to skilled workers. I expect to see more of this. A company can break itself down into a few pieces where one piece (with more highly skilled workers) gets an office building in a tony suburb. Office buildings could be build where shopping centers and strip malls now stand.

A.Prole,

As Jeff Rubin points out, Egypt's regime and people can not afford the high priced food that comes with Peak Oil:

Yet the population of Egypt has tripled to 80 million today from 27 million in the early 1960s. While the birth rate for an average Egyptian woman has fallen from six children to just over three, it still fuels more than 2 per cent annual growth in the population. At this pace, Egypt’s population will double to 160 million by 2050.

But the country is already importing 40 per cent of its food supply and 60% of its grain. Even a brutally repressive regime like Hosni Mubarak’s still spent 7% of the country’s GDP on food and energy subsidies. Can a replacement regime afford to spend more?

I'll do a post on oil and food and Egypt that ties this with Egypt's declining oil production.

Engineer-Poet said at February 27, 2011 7:58 PM:

There's another issue in this, which is the diversion of food-quality grains for fuel.  A commonly-quoted figure is that one SUV tank-full of E85 uses enough corn to feed one person for a year, and each tank of E85 boosts the market price of corn somewhat.

This does suggest a trade solution to the immediate problem:  the oil-producing nations swap oil as a direct exchange for our corn, and take other measures to limit internal consumption including charging the full world price for motor fuel and fuel costs for electricity.  The impact on society can be ameliorated by shifting money from fuel subsidies to per-capita dividends.

Randall Parker said at February 27, 2011 10:13 PM:

Peter,

Regards North Dakota Bakken shale oil: It will certainly help. But read Gail Tverberg's take on it. Even if the optimistic scenario (2 mmbpd by 2015 and 4.7 mmbpd by 2020) happens we are still not going to use as much oil in 2020 as we did in 2006. High oil prices will assure that.

Put this in perspective: Before the financial crisis the US was using about 20.5 mmbpd. We only got back up to 19.1 mmbpd in 2010. I think we will be hard pressed to ever get back up to 20.5 mmbpd. I expect we will continue to get outbid by Asian countries, China especially.

Bakken, if it pans out well, will soften the Peak Oil blow on the United States. But I expect per capita oil consumption in the US to decline substantially between now and 2025.

James Bowery said at February 27, 2011 11:05 PM:

A.Prole, Ehrlich told the boomers coming into fertility that they should stop having kids. I know. I was a ZPG member in 1970. We did. Then right when the boomers were hitting menopause and realizing they had been had by the race replacement immigration nuts taking over the Sierra Club, Ehrlich changes the name of ZPG to "The Population Connection" and the lot of them basically say that the way to make up for the demographic vacuum left by the boomers is to import higher fertility populations to the US so they can have a higher per capita non-renewable resource consumption than they had where they came from. After all, its better to have high fertility populations moving into a high consumption society for the planet isn't it? I mean the _real_ problem is all those white people and who to abolish the white race! To hell with the planet.

no i don't said at February 28, 2011 2:24 PM:

The combustion engine is 100-year obsolete. Furthermore they continue to put these engines inside a thin, heavy and frail metal body. Can you think of anything more archaic than the automobile?? Unsafe, heavy, expensive, earth-damaging.

Well lets hope that the world really runs out of oil soon, for the sake of humans. Still no capitalist manufacturer has really had the guts to produce safer cars with alternative energies that have been available 20, 30 even 40 years ago!!

"Internal Combustion Engine"... Sounds Medieval!! Everything around us has evolved -computers, electronics, building and architecture, weapons, communications, media, publicity, space vehicles; everything except the automotive industry. It's just like a lousy sci-fi movie in which you have all these new electronic, solar powered, steam, hydrogen, magnetic cool stuff and also... the internal combustion engine still!! Are we for real??

Peter said at February 28, 2011 5:13 PM:

Randall,
That is what I am hoping for. Much more US production, combined with lower domestic demand from fuel switching and electric cars. The interesting thing about shale is that the Bakken is only one of several really large plays, such as Eagle ford (a 400 * 50 mile large field), the niobra in CO, and the montery in CA. I have also heard of several more. I wonder if we have mistook the rarity of oil for the rarity of oil formations that can be conventionally drilled.

Engineer-Poet said at March 1, 2011 5:57 AM:

"Much more" US production means not just new fields, but fields which more than compensate for declines elsewhere.  That's going to be hard to do; even opening ANWR will only bump the trans-Alaska pipeline back up to around 1.8 million bbl/day.  Maybe the Bakken can add 1 mmbbl/d too.

It's time to do all of that, but we shouldn't bet on these things; all the bets made since the 1970's have failed to close the gap between production and consumption.  Because of this, we need to cover our bets:  it's time to put another $2-$3/gallon in taxes on petroleum (not just road fuel) to internalize all the costs of pollution and defense and everything else that oil incurs.

If we posit a $10,000 price premium of a second-generation Volt over a Cruze Eco and 10,000 miles/year are powered by electricity (replacing gasoline at $6.00/gallon), the Volt saves about $1700/year and pays for itself around year 7.  We should see this about the time that battery pack prices fall to $450/kWh, which won't be long.


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