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Oil Price Speed Limit Presaging An Age Of Austerity?

Oil Price Speed Limit Presaging An Age Of Austerity?

It is a staple of oil industry apologists to say that the recent swift decline in the price of oil is indicative of long-term abundance. This kind of logic is leading American car buyers to turn once again to less fuel efficient automobiles--trading efficiency for size essentially--as short-term developments are extrapolated far into the future.

The success of such argumentation depends on a disability in the audience reading it. The audience must have amnesia about the dramatic developments in the oil markets in the last 15 years which saw prices reach all-times highs in 2008 and then after recovering from post-crash lows linger at the highest average daily price ever from 2011 through most of 2014. And, that audience must have myopia about the future. It is an audience whose attention has narrowed to the present which becomes the only reference point for decision-making. History is bunk, and what is, always will be.

The alternative narrative is much more subtle and complex. As I've written before, the chief intellectual challenge of our age is that we live in complex systems, but we do not understand complexity. How can cheap oil be a harbinger of future supply problems in the oil market? Here's where complexity, history and subtle thinking all have to combine at just the right intellectual temperature to reveal the answer. Related: Wall Street Losing Millions From Bad Energy Loans

Cheerleaders for cheap oil only seem to consider the salutary effects of low-priced oil on the broader economy and skip mentioning the deleterious effects of high-priced oil. They seem to ignore the possibility that the previously high price of oil actually caused the economy to slow and thereby dampened demand--which then led to a huge price decline.

If this is the primary driver behind cheaper oil, then cheaper oil in this case is not a sign of abundance, but of lack of affordability for many of the world's people. It suggests that there is an oil price speed limit now in effect for the world economy above which it cannot grow for long.

If the ultimate significance of high-oil-prices-turned-to-low-oil-prices is a worldwide recession, then we will have a better idea whether such a price speed limit applies. The past does not offer much hope that it's different this time. Economist James Hamilton has documented that 10 of the last 11 recessions were preceded by a significant rise in oil prices. Related: Is US Oil Production Finally About To Fall?

This time around we haven't had a spike in prices, but rather persistently high prices above $100 a barrel for more than three and a half years prior to the oil plunge. This produced a different kind of pressure on the economy, but pressure nevertheless.

The Chinese economy is slowing down. The European economy is stagnant. Russia is or shortly will be in outright recession. Canada is teetering on the edge of recession and it seems Australia might go there, too. Japan continues its stagnant ways despite record monetary stimulus.

Cheap oil in its own way may be presaging, not a period of abundance, but one of austerity. That austerity has already hit the oil industry itself as it undergoes deep cuts in personnel and exploration and development spending.

The big question now is: Can oil be both abundant and cheap in the long run? Or are we living through the first period in history in which oil can only be "abundant" at high prices? Related: 100,000 Layoffs And Counting: Is This The New Normal?

Of course, it's only abundant if you can afford it. So, demand for oil would likely remain subdued under a high-price scenario suggesting that we've burned through the cheap stuff and must find alternative low-cost energy sources or possibly suffer ever worsening recessions until we do. We can only hope that the 2008 crash is not a prelude to even deeper recessions ahead.

This would also suggest that we are perilously close to a ceiling on oil production mediated by a combination of affordability, geology and the limits of technology. The risk is plain, and yet, it is faith that sustains the optimists in a rock-solid belief that the future will be like past--until, of course, it isn't.

But faith isn't a good basis for energy policy, even if it seems to have worked in the past. An intellectually honest consideration of all the complexities of our energy situation reveals risks to adequate oil supplies worldwide from here on out that we can only ignore at our peril.

By Kurt Cobb

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  • Stephen Mayfield on March 24 2015 said:
    What is this? A well reasoned, well written article on oil. Thanks very much ... but Sir turn in your energy badge you have wandered off the oil hyperbole reservation!

    I would just like to add one comment: Despite spending over $2.4 Trillion, yes with a "T", dollars searching for new oil over the last two years we managed to replace less than half of what we burned world wide during that same time period. That, and not the price of oil today, should tell you all you need to know about our energy future.
  • Bradley Steeg on March 24 2015 said:
    I'm of the opinion that we have seen the end of oil prices above $60. Oil is primarily processed for use as a transportation fuel: moving freight and people. Light tight oil certainly shifted the supply and lower demand reduced prices. However, we are very close to changes in transportation due to automation. Self-driving cars favor a corporate owned fleet model of transportation operating from centralized hubs; maintenance and refueling will be concentrated. It's likely those centrally fueled fleets will rely heavily on alternatives such as natural gas due to the lower cost per mile and the fact that they won't need to rely on distributed fuel stations.

    Current market conditions will keep oil sub-$60 through 2020, at which point corporate owned autonomous vehicles operating within cities to transport people and freight will begin to reduce demand. In the meantime, conventional oil producers will be scaling up production capabilities to supply a demand that will not meet expectations.
  • Baby Rico on March 24 2015 said:
    "....Economist James Hamilton has documented that 10 of the last 11 recessions were preceded by a significant rise in oil prices...."

    Does that mean high oil prices were coincident with 10 out of the last 11 times of economic growth, i.e. before the recessions hit?
  • SqueakyRat on March 28 2015 said:
    A better question, Baby Rico, would be, "What proportion of significant rises in oil prices were followed by recessions?" James Hamilton is not a fool, so I'm sure that this question is not the same as the one Kurt takes him to have answered.
  • dodo on July 27 2015 said:
    mr. K. Cobb, are you a hack activist or a financial analyst? Oil is cheap at 100 dollars, as it is at 50. half of the oil price is made out of various taxes, and by the time it gets to the gas pump, it is almost doubled again through other taxes.. and available income is shrinking due to some third taxes. has nothing to do with "economy" as such.. oil production is as cheap today in real terms as it was when it was 10-20 dollars.

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