The Connection of Depressed Wages to High Oil Prices and Limits to Growth

Posted on February 14, 2013 by Gail Tverberg

In my view, wages are the backbone an economy. If workers have difficulty finding a job, or have difficulty earning sufficient wages, the lack of wages will be a problem, not just for the workers, but for governments and businesses. Governments will have a hard time collecting enough taxes, and businesses will have a hard time finding enough customers. There can be business-to-business transactions, but ultimately somewhere “downstream,” businesses need wage-earning customers who can afford to pay for goods and services. Even if a business produces a resource that is in very high demand, such as oil, it still needs wage-earning customers either to buy the resource directly (for example, as gasoline), or to buy the resource indirectly (for example, as food which uses oil in production and transport).

It is not just any wages that are important. It is the wages paid by private companies (rather than governments) that are important, as the backbone to the economy. Governments tend to get their revenues from private citizens and from businesses, both of which are dependent on wages of private citizens. There are a few pieces outside of this loop, such as taxes on imports from foreign countries. With the advent of free international trade, this source is disappearing. Another piece outside the US wage-loop is taxes on resource extraction, if these resources are exported.

Instead of using the analogy of a backbone, perhaps I should say that wages are the base that ultimately determines the quantity of goods and services an economy can afford.

Figure 1. Author's view of structure of the economy. Non-governmental wages form the base of the entire economy.

Figure 1. Author’s view of structure of the economy. Non-governmental wages form the base of the entire economy.

Obviously there are other kinds of income, such as “rents,” but these, too, ultimately come from wage earners. Furthermore, businesses cannot earn money to pay dividends unless some consumer, somewhere, can afford to buy the goods and services their business is selling.

I have written recently about how the proportion of Americans with jobs rose to a peak, and since has been declining.

Figure 2. US Number Employed / Population, where US Number Employed is Total Non_Farm Workers from Current Employment Statistics of the Bureau of Labor Statistics and Population is US Resident Population from the US Census. 2012 is partial year estimate.

Figure 2. US Number Employed / Population, where US Number Employed is Total Non_Farm Workers from Current Employment Statistics of the Bureau of Labor Statistics and Population is US Resident Population from the US Census. 2012 is partial year estimate.

I decided in this post to look at the dollars these workers are earning. In particular, I decided to look at wages, other than government wages, adjusted to today’s cost level using the “CPI- Urban,” cost index of the Bureau of Labor Statistics.  I discovered that these wages are doing very poorly. I also discovered a disturbing connection between high oil prices and flattening or declining wages. Putting all of these pieces together suggests a connection to “Limits to Growth.”

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Our Investment Sinkhole Problem

Posted on February 8, 2013 by Gail Tverberg

We are used to expecting that more investment will yield more output, but in the real world, things don’t always work out that way.

Figure 1. Comparison of 2005 to 2011 percent change in real GDP vs percent change in oil consumption, both on a per capita basis. (GDP per capita on a PPP basis from World bank, oil consumption from BP's 2012 Statistical Review of World Energy.

Figure 1. Comparison of 2005 to 2011 percent change in real GDP vs percent change in oil consumption, both on a per capita basis. (GDP per capita on a PPP basis from World Bank, oil consumption from BP’s 2012 Statistical Review of World Energy.)

In Figure 1, we see that for several groupings, the increase (or decrease) in oil consumption tends to correlate with the increase (or decrease) in GDP. The usual pattern is that GDP growth is a little greater than oil consumption growth. This happens because of changes of various sorts: (a) Increasing substitution of other energy sources for oil, (b) Increased efficiency in using oil, and (c) A changing GDP mix away from producing goods, and toward producing services, leading to a proportionately lower need for oil and other energy products.

The situation is strikingly different for Saudi Arabia, however. A huge increase in oil consumption (Figure 1), and in fact in total energy consumption (Figure 2, below), does not seem to result in a corresponding rise in GDP.

Figure 2. Total primary energy consumed per capita, based on BP's 2012 Statistical Review of World Energy data and population data from EIA.

Figure 2. Total primary energy consumed per capita, based on BP’s 2012 Statistical Review of World Energy data and population data from EIA.

At least part of problem is that Saudi Arabia is reaching limits of various types. One of them is inadequate water for a rising population. Adding desalination plants adds huge costs and huge energy usage, but does not increase the standards of living of citizens. Instead, adding desalination plants simply allows the country to pump less water from its depleting aquifers.

To some extent, the same situation occurs in oil and gas fields. Expensive investment is required, but it is doubtful that there is an increase in capacity that is proportional to its cost. To a significant extent, new investment simply offsets a decline in production elsewhere, so maintains the status quo. It is expensive, but adds little to what gets measured as GDP.

The world outside of Saudi Arabia is now running into an investment sinkhole issue as well. This takes several forms: water limits that require deeper wells or desalination plants; oil and gas limits that require more expensive forms of extraction; and pollution limits requiring expensive adjustments to automobiles or to power plants.

These higher investment costs lead to higher end product costs of goods using these resources. These higher costs eventually transfer to other products that most of us consider essential: food because it uses much oil in growing and transport; electricity because it is associated with pollution controls; and metals for basic manufacturing, because they also use oil in extraction and transport.

Ultimately, these investment sinkholes seem likely to cause huge problems. In some sense, they mean the economy is becoming less efficient, rather than more efficient. From an investment point of view, they can expect to crowd out other types of investment. From a consumer’s point of view, they lead to a rising cost of essential products that can be expected to squeeze out other purchases.   Continue reading →

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Why is US Oil Consumption Lower? Better Gasoline Mileage?

Posted on January 31, 2013 by Gail Tverberg

United States oil consumption in 2012 will be about 4.7 million barrels a day, or 20%, lower than it would have been, if the pre-2005 trend in oil consumption growth of 1.5% per year had continued. This drop in consumption is no doubt related to a rise in oil prices starting about 2004.

Figure 1. Comparison of Actual US Oil Consumption, with that that would have been expected if prior growth trend held. Actual based on EIA data.

Figure 1. Comparison of Actual US Oil Consumption, with that that would have been expected if prior growth trend held. Actual based on EIA data.

Oil prices started rising rapidly in the 2004-2005 period (Figure 2, below). They reached a peak in 2008, then dipped in 2009. They are now again at a very high level.

Figure 2. US crude oil prices (based on average prices paid by US refiners for all grades of oil based on EIA data) converted to 2012$ using CPI-Urban data from the US Bureau of Labor Statistics.

Figure 2. US crude oil prices (based on average prices paid by US refiners for all grades of oil based on EIA data) converted to 2012$ using CPI-Urban data from the US Bureau of Labor Statistics.

Given the timing of the drop off in oil consumption, we would expect that most of the drop off would be the result of “demand destruction” as the result of high oil prices. In this post, we will see more specifically where this decline in consumption occurred.

A small part of the decline in oil consumption comes from improved gasoline mileage. My analysis incidates that about 7% of the reduction in oil use was due to better automobile mileage. The amount of savings related to improved gasoline mileage between 2004 and 2012 brought gasoline consumption down by about 347,000 barrels a day. The annual savings due to mileage improvements would be about one-eighth of this, or 43,000 barrels a day.

Apart from improved gasoline mileage, the vast majority of the savings seem to come from (1) continued shrinkage of US industrial activity, (2) a reduction in vehicle miles traveled, and (3) recessionary influences (likely related to high oil prices) on businesses, leading to job layoffs and less fuel use.
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How High Oil Prices Lead to Recession

Posted on January 24, 2013 by Gail Tverberg

There is ample evidence that spikes in oil prices leads to recession, at least in the US, which is an oil-importing nation. James Hamilton has shown that 10 out of the last 11 US recessions were associated with oil price spikes. How does this happen? An analogy can perhaps help explain the situation. This analogy also sheds light on a number of related economic mysteries:

  1. How can oil have a far greater impact on the world economy than its share of the world GDP would suggest? After all,  BP’s World Energy Outlook to 2030 shows the world cost of oil is only a little over 4% of world GDP.
  2. How can high oil prices continue to act as a “drag” on the economy, long after the initial spike is past?
  3. Why isn’t a service economy insulated from the problems of high oil prices? After all, its energy use is relatively low.

The Oil Analogy

An oil product, such as jet fuel, is in some ways analogous to a specialized employee, with skills different from what human employees have. Let’s think of an airline. It has human employees–pilots, copilots, flight attendants, baggage workers, mechanics, and airport check-in personnel. None of these human employees can actually provide the energy to make the jet fly, however. It takes jet fuel to do that.

What happens if the price of jet fuel triples? Jet fuel is now more that than triple the price (near $3.00 gallon) it was in the late 1990s (under $1.00 gallon, at today’s prices).

Figure 1. Jet fuel price in December 2012 $. Jet fuel price per gallon is Spot Gulf Coast price from EIA; price adjustment based on CPI-Urban, from US Bureau of Labor Statistics.

Figure 1. Jet fuel price in December 2012 $. Jet fuel price per gallon is Spot Gulf Coast price from EIA; price adjustment based on CPI-Urban, from US Bureau of Labor Statistics.

The high cost of jet fuel is analogous to the jet fuel employees’ union demanding triple the wages they were paid previously. So what is the airline to do? With very high aviation fuel prices, many tourists who might buy airline tickets will be “priced out” of the market for long distance travel. The airline can sell some airline tickets at higher prices, but not as many.

One thing airlines can do is to cut the number of flights, taking the least fuel-efficient planes out of service and reducing flights on routes with the most unfilled seats. According to a recent Wall Street Journal article, airlines spend 34% of revenue on fuel. With such a high fuel cost, even with these changes, airline ticket prices will remain high. But perhaps with fewer flights, the airline can make a profit.

If an airline cuts its number of flight, this leads to an “across the board” cut in the goods and services the airline buys. The airline will use less jet fuel (and thus use fewer “jet fuel employees”). If it is able to retire quite a few fuel-inefficient jets, “jet fuel employees” will be cut to a greater extent than human employees. It will use fewer human workers, at all levels: pilots, copilots, flight attendants, and ground workers of all types. The airline will reduce its electricity usage because it needs fewer gates in airports for its operations. The airline will also need less gasoline because it will operate fewer baggage-transport vehicles and other ground vehicles.

In many ways, the airline is simply shrinking in size to reflect reduced demand for its high-priced services. When this happens in multiple industries, the result looks very much like recession. I described this situation earlier in a post called How is an oil shortage like a missing cup of flour?. In that post, I said that if oil supplies are short, the situation is not too different from a baker who does not have enough flour to make a full batch of cookies. If he still wants to make cookies, he needs to make a smaller batch, and so needs to cut back on all of the other ingredients as well.

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Ten Reasons Why High Oil Prices are a Problem

Posted on January 17, 2013 by Gail Tverberg

A person might think from looking at news reports that our oil problems are gone, but oil prices are still high.

Figure 1. US crude oil prices (based on average prices paid by US refiners for all grades of oil based on EIA data) converted to 2012$ using CPI-Urban data from the US Bureau of Labor Statistics.

Figure 1. US crude oil prices (based on average prices paid by US refiners for all grades of oil based on EIA data) converted to 2012$ using CPI-Urban data from the US Bureau of Labor Statistics.

In fact, the new “tight oil” sources of oil which are supposed to grow in supply are still expensive to extract. If we expect to have more tight oil and more oil from other unconventional sources, we need to expect to continue to have high oil prices. The new oil may help supply somewhat, but the high cost of extraction is not likely to go away.

Why are high oil prices a problem?

1. It is not just oil prices that rise. The cost of food rises as well, partly because oil is used in many ways in growing and transporting food and partly because of the competition from biofuels for land, sending land prices up. The cost of shipping goods of all types rises, since oil is used in nearly all methods of transports. The cost of materials that are made from oil, such as asphalt and chemical products, also rises.  Continue reading →

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