On June 20, I participated in a 45 minute Roundtable teleconference on the topic, “The Real Causes and Wider Macroeconomic Effects of High Gas Prices,” put on by an organization called Focus. The Moderator was Scott Albro from the Focus Research, Inc. staff. Focus Research, Inc. is a market research company, but the exact relationship between the two organizations was not explained to me. The other participants, (besides me, Gail Tverberg), were
James Hamilton – Professor of Economics at University of California, San Diego. He also writes on Econobrowser Blog. He is the author of many academic papers, including Causes and Consequences of the Oil Shock of 2007-2008.
David Summers – Curators’ Professor Emeritus of Mining Engineering, Missouri University of Science and Technology. He is one of the founders of The Oil Drum. He also writes on his own blog, Bit Tooth Energy.
The teleconference was recorded, and can be heard at the Focus website. There is also a transcript of the call. This post gives some highlights of the call. Individuals can join Focus.com free of charge, and listen in on future expert roundtable calls.
Moderator: Where do you sit when it really comes to identifying the true causes or the true effects that truly drive oil prices, and gas prices by extension? Is this due to supply/ demand imbalance, broader economic drivers, or speculation?
Gail Tverberg: I think we have a variety of things going on. I think we have supply constraints in the sense that world supply has been roughly flat since at least 2005. At the same time, there have been more and more potential buyers who are wanting more oil. We also have the broader economic drivers with the recession setting in, and that acts to bring it back down again. I see speculation as playing a pretty minor role. The normal buying and selling by itself (or small changes in this if the market is very tight) could act to spike the prices up and down. So I see the big issues as being (#1) supply, (#2) the broader economic situation, and as a very distant (#3), speculation.
Moderator: Dave, are you in agreement with Gail?
David Summers: To a large degree. The situation is that OPEC controls about 30 million barrels of oil a day, give or take, and as they control how much of that they’re going to let on the market, so market demand is such that they largely control what the price is in gross terms. They’re deciding whether it is going to be $100.00 or $30.00, but in terms of whether it’s going to be $110.00 or $90.00, that’s much more a factor that’s based on speculation and the relative values of the currencies on that particular day.
Moderator: Okay. James, anything that you would add to those remarks?
James Hamilton: I think Gail had it exactly right in terms of supply and demand. Just to put some numbers on that, if you compare 2010 to 2005, we were only consuming an additional 1.2 million barrels per day over that five-year period, and that’s a period when there was phenomenal growth in the emerging economies, China and India and so on. In particular, China over that five-year period increased their consumption of oil by 1.7 million barrels a day. So as the world as a whole went up 1.2, China went up 1.7.
That means that all of the rest of us had to decrease our consumption by half a million barrels a day over five years, and what persuades us to do that? Well, it takes a pretty big increase in the price of oil. Yes, the day-to-day fluctuations can be driven by assessments of what’s going to happen, but the long-run fundamentals are very real and very significant.
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The moderator asked more about speculation. None of us thought it was very important. I observed that people in their experience aren’t used to seeing big increases and decreases in prices of other things they purchase, like food, or clothing, or a lawn mower. If there is a problem with inelastic oil supply, and prices move widely, they expect that there must be some explanation like speculation.
The moderator then asked me about the supply side of the oil and gas industry.
Gail Tverberg: Well, as we have already talked about, the oil supply situation is very tight. My perception is that, despite all of their fanfare, oil supply goes up a little bit with price going up–but not very much–and it goes down by quite a bit if price goes down.
So, they have all these meeting and they set quotas, but the actual production doesn’t match the quotas very well. When all is said and done, their actions correspond more to what they rationally would do in relation to the prices that are available in the marketplace. So I think they are more price takers than price setters. I’m doubtful that they have the excess supply they say they have, other than a little very poor quality crude oil that they can only sell at a low price.
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Dave Summers thought that OPEC was more of a price maker, adjusting supply to keep price up. James Hamilton had a view that was more similar to mine:
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James Hamilton: I would emphasize that there has been a real change in the role of Saudi Arabia in OPEC and world markets. Historically, Saudi Arabia was the world’s swing producer. They would cut down their production to try to keep prices from falling, increase production a little when they thought the demand was there, but that historical behavior changed pretty significantly during the last five years, where from ’05 to ’07, you say this big run-up in price, and the Saudis lost control of the price.
I think they did cut back a little bit in response to the fall in demand from the recession, and that looks a little bit like the old days. But the idea that they have vast amounts of more oil that they could sell on the market tomorrow, I don’t see a lot of support for that.
Even if it were true, I’m quite persuaded that they’re not going to increase their production significantly again despite what they say. As far as OPEC goes, yes, they have these big meeting and big pronouncements and the press hangs over every word, but as Gail was saying, OPEC itself ignores what they say in those statements.
They are currently producing about 5 million barrels a day more than their supposed quotas allow, and for several years they haven’t been able to agree on individual country quotas, and when they did agree, the countries routinely ignored them. So I think the whole role of OPEC can be overplayed here. As I say, even if you thought that they somehow could increase production and make a difference, the fact on the ground is they’re not doing it, and I think we have to recognize that reality and deal with it.
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We talked more about OPEC and quotas and how much Saudi Arabia might actually raise production. We also talked about whether the Saudi’s thought alternative energy was a threat to their market. Dave Summers remarked that the alternatives wouldn’t be the alternatives we think of, like biofuels. Instead, they would be things like Canadian oil sands and natural gas, if we could make use of natural gas as a transportation fuel, since these were more likely to be scalable than traditional alternatives.
We also talked a little about demand–about the rising demand from China, India, Brazil and the oil producers themselves. I offered my comment about shifts in oil demand being tied to jobs.
Gail Tverberg: I think that employment tends to be very much tied in with demand. If you don’t have people who are working, then they don’t have salaries that they can use to buy the things that are made with oil, so demand tends to be low. As we layoff people in this country and send the jobs to China, the workers in China then have the salaries that they can use to buy oil products. The people who are here no longer have salaries, so they are no longer able to buy oil products. So the demand shift goes through the workers.
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We also talked about whether China is going to make enough investment in alternative energies to offset growing demand for oil and gas. Dave Summers made the point that most of the alternative energy was electricity, so didn’t really help out in the oil supply/demand balance. Eventually we got to the question of the impact of oil on the American economy.
Moderator: The first question I’d ask James, is the primary economic impact of higher gas prices reduced consumer spending? How should we think about the economic impact here?
James Hamilton: That’s one important mechanism by which the economic effects often begin. Most people (at least for the short term, when the price of gasoline goes up) try to keep on buying the same amount of gasoline as before, and of course that means you have to cut back your spending somewhere else. This is particularly the case for the lower-income households. They’re spending a pretty significant fraction of their income on energy and don’t have much of a buffer to fall back on. So we often see quite significant responses in consumption spending. Then that ends up meaning losses in jobs–for example, in the US auto sector. And as those people’s incomes decline, there is reduced spending in other areas.
In addition, there are some effects on consumer sentiment that you certainly see in the data. People don’t like it when gasoline prices go up. That affects a variety of behavior, and it can also interact with other things, for example the housing market. One of the things that happened in the earlier part of this decade was people moving farther and farther out from city centers, and then when gasoline prices went up you saw some of those farther-out prices decline quite a bit. That was one factor, not the only factor by any means, but I think it was one contributing factor in a part of what we saw happen in that area. It also ends up affecting investment spending. Industries such as airlines are heavily affected, but I think the first area that we do look for an effect is in terms of consumer spending and consumer sentiment.
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Dave Summers remarked that the relatively low level of natural gas prices was acting in the opposite direction of the high oil prices, help to offset the effects James Hamilton noted.
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We then talked a little about whether a particular price level has a psychological effect. I think we all thought the “real” element was more important than any psychological effect. We closed by talking about where oil prices would go from here.
Jim Hamilton thought that it was possible that we would see further decreases in gas prices this summer, but talking about a few years from now, he said, “Longer term, I think we have a significant challenge.”
I agreed with the near term decreases, especially if we start seeing more lay-offs from the governmental sector, and these layoffs push us more toward recession.
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With that, we ended the discussion. I thought that the Focus moderator, Scott Albro, had done a good job. Participants (including the panelists) had submitted written questions in advance. The moderator picked some out, arranged them in a reasonable order, and added some context when asking the questions. The call participants could hear the panelists on the call, but the panelists could not hear the participants.
This was my first involvement with one of these events. Afterward, we thanked Focus for inviting us to be involved with the Roundtable.
I can think of a more scary scenario, let’s assume that there is another recession and the oil prices do drop to 40$. Now we know for certain that KSA cannot afford a 40$ oil for more than a month since they have to supply arms and money all over the peninsula to keep the local population from rising up, moreover they themselves will suffer it’s consequences as their GDP drops.
What happens in that case. Will the OPEC cut their production in that case to increase prices ? In that case we will have a recession with high energy prices. The worst situation you can imagine.
Hadn’t thought of that. I suppose it could happen.
When I look at my neighbors (in a well-to-do suburb) I see amazingly little impact from high gas prices or the economy at large. People still drive their SUVs. There are expensive new Priuses (Prii?) in the driveway. The lawn guys still come. The young people, although unemployed and living with their parents, still tote their iPads and Starbucks.
When I look at my parents’ rural Ohio neighbors, however, the family car is a few years older, the clothes aren’t keeping up with the television shows anymore, the lawn isn’t mowed quite as often, people are growing gardens and canning again – it’s a return to the early ’80s for Mom and Dad. But the young people, although unemployed and living with their parents, still tote their iPhones.
What happens from here?
I think a lot of the problems are hidden over in the governmental sector, one way or another. Interest rates are artificially low (created by government, and helping prop up government). If they start going up, everyone is going to be affected.
Governments at all levels are spending far more than they are taking in. If they raise taxes, that has a recessionary effect; if they cut employment or benefits to citizens that also has a recessionary effect. So there really is no option that really works.
All of the government guarantees are a problem as well–Fannie and Freddie; banks; pension plans. There is no official guarantee of insurance companies, but if they start to fail, the government will want to step in as well, as with AIG.
Here, In Hungary Europe the same thing happens. Few years ago half of the country travelled to south to Croatiia or Italy or to other mediterranien county. (That means more than 1000 kms one direction.). We have to pay about twice as much for the gas than in the US because of the taxes! Just a few of us are goint to spend their vacation abroad – who wants to pay for gas that i so expensive.
That you mentioned about US youth that is true for hungarians also. However we went through a big change at the end of Soviet Union. I can say that the change that credit crunch caused has smaller effect than the change we had in 1990. So we are somehow prepared in comparison to US.
Thanks for writing. I am sure you have read the writings of Dmitry Orlov. (I am a big fan of his!) He talks about how the USSR was better prepared for collapse than the USA. http://www.energybulletin.net/node/23259
Thank you for the link.
I think there is a really huge difference between the collaps of SU and what can happen to US.
In case of SU (and Hungary) we knew the new system that is to be created : capitalism. So we could prepare a plan how to transform one system to another. The goal was set clearly.
Through this planned transformation a lot risk occured, like unemployment. For example in Hungary we hab about 5 million (out of 10) employed in 1989, but we had only abut 4 million in 1993. (Actually we have 4 million at this time). So the employment has not been able to be built back up in 20 years!
The new system the capitalism was known and tested in practice. We got “help” from Word Bank and IMF – how to do that.
In case of US the transfer cannot be prepared as the “new system” is not known. I have red some articles that compared US to the Roman Empire. Since in case of SU there were a new system so we can speak about the transformation. But in case of the Roman Empire a clear collapse happened – there is no new system.
US is huge – not only to keep the system but the transfer also needs a lot of energy. If this energy is not available then a big and complex system will broke up and gets simpler (physical rule).
I would not compare the SU and US since there is generic difference. In case of SU we talk about transform but in case of US can we talk about that?
Perhaps the Roman Empire would be a better analogy, but there it is so long ago and so clearly led to collapse that it is hard to use.
The Soviet Union and Hungary were in different worlds in the 1990s than we are now. Then the world as a whole was growing economically, and it looked like there was a way to join the crowd. Now, what we will see is many countries in poor financial shape, struggling with decline, overwhelming debt defaults, and promised programs they cannot pay for. If politicians have to go back to the voters, they will lose face (and the next election).
I don’t see a good transition to a new system that they can come up with–perhaps getting rid of military spending, reigning in health care spending, taxes on imported goods and services, and taxes on accumulated wealth in excess of $2 million could be part of a new plan, but would be opposed by most. Just cutting existing programs by a few percent won’t do much at all.
I agree that people are trying to use the same amount of gasoline that they used before and are cutting in other areas, (my dentist friends are seeing some dramatic declines in the past year
here in central PA). Though i would say they are trying to do the same mileage just with different
vehicles. Here, the suburbans and full sized pickups have disappeared from the road unless it really is a work truck filled with tools and supplies, not commuting to a job in the city.
What I think IS changing is in the youth, they are not being bought cars, not being allowed to
have an unlimited gas budget on their parents nickle etc. Again from a central PA perspective, which while suburban tends to be more conservative economically.
I also wonder about vacations. My wife and I for years tell each other every year, this maybe the last vacation we take due to fuel/economics. when we turned a research project into a vacation
this year near Charleston SC, I had a conversation with another couple that said the same thing.
“Driving 750 miles for a vacation is going to be a thing of the past for us and most people, real soon” is how they put it – and they were two doctors. Admittedly they were not ultra consumerists, but giving people, who volunteer for the poor on the side.
I’ve always wanted to goto Greece and Egypt but I think my little cabin in the mountains (paying
$150/yr in taxes),seven miles down a dirt road with 1200 watts of PV is where I’ll be vacationing in the future.
The youth are the ones who are bearing the brunt of the changes, as you say. They are not being bought new cars. They are also not getting jobs while they are in high school, and once they get out of high school or college, they are disproportionately unemployed. The college educated ones get jobs, but many of the jobs are minimum wage jobs–not something they were dreaming of as they worked hard on their studies. With their limited incomes, they much less able to buy cars and go on vacations, than those of us in the parents generation.
Just a few years ago, we vacationed in Ireland every few years. We always flew with Aer Lingus and could count on getting a round trip fare for around $500 (maybe a bit less) and this included taking our bikes along at no extra charge (it was just our 2nd bag). As we traveled by bike, stayed in B&Bs (some of our friends camped half the time), and ate mostly in small cafes or “take out” from grocery stores, our trips were really quite economical. And, quite wonderful!
We don’t plan on doing this again – although I’d surely enjoy one more go at it! Partly it is our age, but mostly it is the combination the higher travel costs and less discretionary income. The $500 round trips in any suitable weather for a bike vacation are pretty much history. It’s more like triple in the prime time and almost double even in late September. The Euro exchange rate doesn’t help either. Neither does all the airport hassle when you have a big box full of hardware with you as baggage.
There is also the fact that flying around globe for pleasure is not a planet healthy behavior – a few years ago we were blissfully ignorant of this factor. I’m not sure if I should thank or blame Gail for this education!