Monday, April 5, 2010

Common Sense meets Intelligent Economic Analysis

Every once in a while, somebody, somewhere makes a breathtaking show of good common sense, and in this case, an understanding of the economics involved. Still no good deed goes unpunished... he will probably get fired for this.

Nobody ever talks about independence for other products. We don’t care about automobile independence, or bottled water independence, or underwear independence. We avoid asserting that those would be worthy goals, for a good reason: Free trade enhances our welfare by allowing us to import products from those who have a comparative advantage producing them.

Why should energy be any different? Three arguments are most commonly offered.

Fluctuating Prices

The first is that oil price fluctuations harm the economy, and that owning more oil would help inoculate against them. This is specious. If the U.S. does discover a mother lode of oil, that discovery will affect the global price of oil. After the price adjusts to the new supply, it will go on and fluctuate from there. Before the discovery, Americans would pay the world price of oil, and watch and suffer as it moves up and down. Ditto for after the discovery.

It might be nice, of course, to own the oil or oil companies if the price increases sharply. That way, U.S. citizens see their wealth increase to offset some of the damage of the higher price. But if that hedge is viewed as attractive, we don’t need to drill to acquire it. We could just encourage Americans to invest in the equities of publically traded foreign oil companies such as BP Plc, PetroChina Co. or Royal Dutch Shell Plc.

Fear of Embargo

The second reason sometimes given for more U.S. production is that a foreign enemy might decide to organize an embargo against us and shut off our supply of oil. Such an embargo might, indeed, harm the economy, as it did back in 1973.

Still, think about it. If we fear there might be an embargo in the future, the optimal response is to purchase more oil from abroad today, not less. We should try to get as much as we can before the spigot is turned off. We should also reduce domestic production, not increase it, secure in the knowledge that the oil is there, available when we need it, in places such as the Arctic National Wildlife Refuge. If we ramp up production today, then we may find ourselves facing an embargo down the road after we have drained all of our own domestic reserves.

The third argument one sometimes hears is that we should stop buying oil from evil-doers such as Iran, as that only provides them with resources they can use to do us harm. But the problem is, oil is a commodity, and if we do not purchase it from a given supplier, someone else will. Such a boycott has no effect whatsoever.



The price of crude oil in the market place is dangerously close to snuffing out the U.S. "nascent recovery" we hear tell about in the media (the data on employment and energy use in the U.S. do not give me a warm and fuzzy feeling about a "recovery" here. Still, the world economy probably IS growing, and since half of the S&P 500 profits come from international sales... well, I should have listened to "Coal Guy" - he posted back when the S&P was at 850 to look for 1250 or so... Oh, well... my precious metals have tracked the equity market, but my bonds sure haven't). Also, while the high price of crude oil might be bad for the U.S., there is somebody on the other side of that trade - and they are part of the "world economy", too. (Remember to ALWAYS look in the mirror: IF oil prices were to slide, that might really goose things along in the economy AND the stock market. That is the mirror image of the above.)

It is my sense that this last 36 months or so was the first of many waves in the price and supply of Oil to the U.S. as well as prices levels of everything else from stocks and bonds to corn and copper. I think we will see surges in the price of Oil and then full scale declines. Trading Oil futures will not be for the faint of heart - and irrespective of the price action by 2020 or so, imports of Oil into the U.S. will be a trickle of what they are now, which in turn is 75% of its peek of just 4 years ago - with all of the issues and outcomes attendant upon that.


Anonymous said...

I'm for energy independence for none of the three reasons listed above. And, I agree for the most part these reasons are specious. Regardless, energy independence will be visited upon us like a biblical plague, whether we want it or not. It will either come because supply dries up, or our international creditors will no longer lend us the money to buy oil (or anything else). Either way the result will be the same, we'll make do with what we produce ourselves. Any progress we make today to offset the decline in imports will make tomorrow that much easier. Financially, we'll have a lower trade deficit, and more energy will be available to support the economy.

I have read, (though I don't know the reliability of the source) that Obama's offshore drilling decree is less than above board, since the permitting rules have been changed to make it next to impossible to get regulatory approval. It doesn't look like there is a whole lot there anyhow.
Anybody know?


Coal Guy.

Greg T. Jeffers said...

Obama seems to have realized that even he must play politics.

There is little Oil in the regions approved by the measure - and the areas where the Oil IS has not been approved for drilling. Obama has satisfied the "drill, baby, drill" (well, the uniformed portion) crowd, while not pissing off his core.

westexas said...

For the sake of argument. . . if we extrapolate Chindia's recent rate of increase in net oil imports and take our best case scenario for combined net exports from the (2005) top five net oil exporters (Saudi Arabia, Russia, Norway, Iran and the UAE), then Chindia's net imports, expressed as a percentage of combined (2005) top five net exports, will have risen from 19% in 2005 to 100% in 2018.

If we define "OECD Top Five Oil" as the volume of oil left over after Chindia takes what they want from the (2005) top five, then we are currently depleting post-2005 OECD Top Five Oil at the rate of about one percent per month.

bureaucrat said...

If the oil prices don't snuff the economy, the interest rates will. 10-year yield hit 4% today for the first time in a long time. Moving towards 5% will be very tough.

It's the start of another 30 year interest rate cycle. Interest rates went up from 1950 to 1980, and then down from 1980 to today, and now they are going back up again (for 30 years probably).

Either way, since the solution to high prices is high prices, something is going to quash this little economic recovery, cost-wise.

bureaucrat said...

If those places offshore had any oil, someone would have politically forced the drilling of those areas. There's very little oil off the Atlantic and Florida coasts.

Greg T. Jeffers said...


Stop stealing my thunder.

Anonymous said...

Re: Westexas

There is an old term that was commonly used in the oilfield to describe the mental disorientation that occurs from toooooo long at the drilling site. It's called "Crispy Critters".

If Westexas is any where close in his estimates, we USAers are going to be exactly that- Crispy Critters.

Best, Marshall

bureaucrat said...

A great investor finds a low-cost resource and capitalizes on it. :)

Anonymous said...

It's just what I thought...

Obama has created a sound bite the the press will loop every time someone claims he is not for developing American energy resources. It's just like the single nuclear power plant he is allowing to be licensed. He has a pro-nuclear sound bite, too. He's taking this energy thing head-on. I miss GWB.


Coal Guy

bureaucrat said...

In case anyone is interested, I thought the pump prices were rising for Summer Driving Season a little early this year (rising since early March in Chicago), and I didn't know if that was unusual. So I graphed the prices in Chicago since 2004 and drew a line at April 1. For every year prior to this year, the gasoline pump prices were indeed increasing even before April 1. Most months seem to have its summer increase starting right at the start of the new year.

So, there's nothing unusual about prices rising early in the year, even tho the summer vacation peak is usually in late July.

bureaucrat said...

Sorry, not most months .. most YEARS

Dextred1 said...

I think we are starting to see the seesaw effect. Can't do much about it, but change my own habits. Joined a Gym five miles away so I can ride my bike there. Great Cardio and shortens the walks on the treadmill. It is next to the grocery store and other useful services. Saving money and getting healthy

Greg T. Jeffers said...


I love it, Bro! I only ride my bike to the gym (the weather in Fla makes it easy), and I don't need a gym when I am on the farm. Why the heck would I walk on a tread mill when I can walk or ride to the gym?

On another non energy note... When I am not on the farm I try to walk 4 miles per day - it takes me a little over an hour and I usually push one of the kids along in a stroller... as long as I do, I can eat without concern...

westexas said...

I wonder if we might propose a new model--PLM (Pension Land Model).

Just as oil exporters only (net) export after domestic demand is met, various government entities only spend money after current pension obligations are paid (in many cases this is the law). With declining revenue and rising pension obligations, less and and less money will be "exported" out of various governments in the form of government services and aid to residents.

And just as exporters with high levels of consumption have more rapid net export declines, governments with large underfunded pension programs will have more rapid declines in non-pension related government spending.

I think that we are headed toward something of a virtual civil war between current and retired government workers on one side and taxpayers on the other side.