Ten Reasons Why a Severe Drop in Oil Prices is a Problem

Not long ago, I wrote Ten Reasons Why High Oil Prices are a Problem. If high oil prices can be a problem, how can low oil prices also be a problem? In particular, how can the steep drop in oil prices we have recently been experiencing also be a problem?

Let me explain some of the issues:

Issue 1. If the price of oil is too low, it will simply be left in the ground.

The world badly needs oil for many purposes: to power its cars, to plant it fields, to operate its oil-powered irrigation pumps, and to act as a raw material for making many kinds of products, including medicines and fabrics.

If the price of oil is too low, it will be left in the ground. With low oil prices, production may drop off rapidly. High price encourages more production and more substitutes; low price leads to a whole series of secondary effects (debt defaults resulting from deflation, job loss, collapse of oil exporters, loss of letters of credit needed for exports, bank failures) that indirectly lead to a much quicker decline in oil production.

The view is sometimes expressed that once 50% of oil is extracted, the amount of oil we can extract will gradually begin to decline, for geological reasons. This view is only true if high prices prevail, as we hit limits. If our problem is low oil prices because of debt problems or other issues, then the decline is likely to be far more rapid. With low oil prices, even what we consider to be proved oil reserves today may be left in the ground.

Issue 2. The drop in oil prices is already having an impact on shale extraction and offshore drilling.

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

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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Energy Leveraging: An Explanation for China’s Success and the World’s Unemployment

If an employer wants to maximize profits, it will want to leverage its use of high-priced energy sources.  From an employer’s point of view, there are basically three kinds of energy, from most to least expensive:

  1. Human energy
  2. Petroleum energy
  3. Everything else

If an employer wants to keep its costs low, it needs to minimize its use of expensive energy sources. The primary way it does this is by leveraging expensive energy sources with cheaper energy sources that help keep overall energy costs in line with what competitors (including overseas competitors) are paying. Thus, employers will want to use as little human and petroleum energy as possible, instead using cheap energy to substitute.

Human Energy

Human energy is the most expensive form of energy. It is very expensive because an employer needs to pay the employee enough to live on. This amount includes the cost of energy to fulfill the human’s needs, plus enough extra to cover taxes to cover the cost of energy for those who for some reason cannot work, plus taxes for maintenance of public infrastructure. An employer can keep his cost of human energy low by

  1. Substituting mechanical or electrical energy, which is usually cheaper.
  2. Hiring humans whose wage costs are low. Usually this means is humans who use little energy in their personal lives, and what energy is used, is cheap energy.
  3. Hiring in areas where taxes are low, usually reflecting a lack of benefits to employees. Continue reading

Renewables Are Overrated, We Need Cheap Oil – Interview with Gail Tverberg

This article originally appeared at Oilprice.com.

What does our world’s energy future look like? Does renewable energy feature as much in the energy production mix as many hope it will? Will natural gas and fracking help reduce our dependence upon oil and how will the world economy and trade fare as supplies of cheap oil continue to dwindle?

To help us take a look at this future scenario we had a chance to chat with Gail Tverberg – a well-known commentator on energy issues and author of the popular blog, Our Finite World

In the interview Gail talks about:

•    Why natural gas is not the energy savior we were hoping for
•    Why renewable energy will not live up to the hype
•    Why we shouldn’t write off nuclear energy
•    Why oil prices could fall in the future
•    Why our energy future looks fairly bleak
•    Why the government should be investing less in renewable energy
•    Why constant economic growth is not a realistic goal

Gail Tverberg is an independent researcher who examines questions related to oil supply, substitutes, and their impact on the economy. Her background is as a casualty actuary, making financial projections within the insurance industry. She became interested in the question of oil shortages in 2005, and has written and spoken about the expected impact of limited oil supply since then to a variety of audiences: insurance, academic, “peak oil”, and more general audiences. Her work can be found on her website, Our Finite World.

Interview conducted by James Stafford of Oilprice.com

Oilprice.com: Do you believe that shale gas is the energy savior we have been hoping for and can deliver all that has been promised? Or have we been oversold on its potential? Continue reading

The Close Tie Between Energy Consumption, Employment, and Recession

The number of jobs available to job-seekers has been a problem for quite a long tine now—since 2000 in the United States, and longer than that in Europe. If we look at the percentage of the US population who are employed, it is now back to 1984 or 1985 levels.

Figure 1. Total number of individuals employed in non-farm labor, and reported by the US Bureau of Labor Statistics, divided by US resident population, as reported by the US Census Bureau.

I have run into a number of clues about what is happening. In this post, I’d like to discuss what I am seeing. Part of the problem is that high oil costs squeeze the economy, reducing employment. Part of the problem is growing trade with Asia. It is even possible that the Kyoto protocol (which the US did not sign) has something to do with what we are seeing. Let me start by explaining a fairly strange relationship. Continue reading