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By Robert Rapier on Jul 12, 2010 with 15 responses

Oil Prices, Recession-Depression, and Investment

The following is a guest essay by Kevin Kane. Kevin is the author of the Energy Fanatic Blog.

Oil Prices, Recession-Depression, and Investment

Low Oil Prices Foster Future Oil Price Peaks

By Kevin Kane

As the global economy stalls, some economists including Paul Krugman argue that unless governments take action now, we risk slipping into a period of recession, or possibly even depression. If the world economy does double dip, ceteris paribus, oil prices will decrease following weak consumer demand. Should this double dip turn into a recession, or even worse, a depression, its long term impacts on oil supply additions and renewable energy innovation will be considerably negative.

Low oil prices are in general bad for consumers over the long run, particularly in a globalizing economy that has proven itself capable of expanding faster than the oil industry can bring on new additions to daily oil production capacity. We could sum this phenomenon up with the statement, “Low oil prices today are bad for consumers tomorrow.” This is true because,

(1)  A near-perfect linear relationship exists between oil prices and supply-addition investment—new supplies are added only when companies invest in discovering and developing wells with income gained from the sale of produced oil. Thus, higher oil prices today help to create lower prices tomorrow (See the Figure below that utilizes FRS Data); and,

(2)  Low oil prices result in governments and energy companies cutting energy R&D investment, which slows technological breakthroughs, diversification from oil, and the climb over the learning curve for costly substitutes.



Low Oil Prices Foster Future Oil Price Peaks

If we enter a recession and economic output declines, oil prices will follow along with investments in supply-additions and energy R&D. When prices increase again, our ability to offset these price movements with new supplies or substitutes will be limited—such a scenario portends a repeat of exactly what happened from the mid-1980s to August 2008.

Although the relationship between oil prices and future supplies proves to be straight forward, we need to apply something more technical other than a scatter plot to identify the causal relationship between oil price changes and investments in energy R&D

The Oil Price and R&D Connection: From Renewable to Nuclear Power

Oil prices directly influence changes in investment for government R&D in fossil fuel technology, nuclear power, batteries and energy storage, renewable energy, and efficiency technology. This is an empirical and causal reality extrapolated from multiple panel regression analysis in my thesis titled “Oil Cross-Price Elasticity of Energy R&D Demand: A 12-Country Panel Analysis.” This thesis shows that despite all the rhetoric, policy papers, institutions, and promises, government investment in energy R&D reflects shot-term erratic political behavior rather than keen and calculating long-term energy security strategies.

Even more alarming, statistical results in aforementioned thesis suggest that we are not learning from the past. With the exception of a few cases of sustained disinvestment, governments generally continue to change energy R&D investment with oil price fluctuations despite over-investment and under-investment experiences in the 1980s and 1990s, respectively.

If economic globalization continues as it has in the past, governments need to make a change by benchmarking their energy R&D investment levels on energy security goals rather than short-term market movements, perhaps by creating a more stable measure than oil price—changes in primary consumption demand serves as one example.

Whether we would like to substitute fossil fuels or use innovation to increase the supply of oil, whatever the timeline, a recession or depression scenario will slow this process, if not bring it to a halt. Unless governments break the pattern of benchmarking energy R&D investment levels to oil prices changes, history portends that a double-dip will have terrible implications for future energy security and the environment.

  1. By Rufus on July 12, 2010 at 3:49 am

    The IMF just raised its outlook for global growth to 4.6%. This would intimate an increase in oil demand of 3.01 Million barrels/day.

    Oh, and the “floating” storage is about gone. Buckle up, Buckaroos; this could get bumpy.

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  2. By Kevin Kane on July 12, 2010 at 4:50 am

    Rufus,

    In a sarcastic and humorous tone, “but what about the 2004 to 2008 oil price increases were all the result of those tricky futures and OTC market speculators.”

    These arguments are humorous since they are based on not one single shred empirical and non-correlative piece of evidence. lol. Whatever the fate of oil in the near future, it has everything to do with macro-economy: expanding or contracting.

    I don’t buy the speculator conspiracy for one second. I am cautious of any explanation that pander’s to a persons desire to escape fear.

    Kevin

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  3. By Kevin Kane on July 12, 2010 at 4:52 am

    Correction: “but what about the fact that the 2004 to 2008 oil price increases…”

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  4. By Takchess on July 12, 2010 at 7:50 am

    Holding on to a contrary strategy of exploring when prices are low may be a profitable one. Due to the discovery to production lag times, those finds would start to produce when pricing changes.

    It would be interesting to hear of those companies results who have held that philosophy in the past. Anyone know?

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  5. By Benny BND Cole on July 12, 2010 at 12:28 pm

    Kevin Kane-

    I think I have a different point of view than yours–mine is that each oil price spike is another nail in the coffin of the oil industry.

    Historicially, after price spikes, crude demand goes down and does not recover for a long time, and sometimes only recovers when oil is cheap again.

    Witness the price spike of 1979–global oil demand did not recover for 10 years, and by then oil was cheap.

    Thanks to the price signal, I think we are on the cusp the end of the oiil era–and the transition will be relatively easy, and have the side benefit of a cleaner enviueonment (especilly fo urban residents, which is where the globe’s population is concentrating).

    Imagine back in 1979 when OPEC cut off supplies–there was no Nissan leaf, no GM Volt, not Lincoln MKZ luxury car that got 41 mpg. There was no widespread adoption of CNG vehicles.

    Europe and Japan have proven that oil consumption can fall for decades in a row, even while living standards rise, and cleaner environments are obtained–they have proven it for the last 30 years.

    Why the gloom in the face of such success?

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  6. By rrapier on July 12, 2010 at 4:23 pm

    Historicially, after price spikes, crude demand goes down and does not recover for a long time, and sometimes only recovers when oil is cheap again.

    Meanwhile, Lloyd’s is now issuing warnings about the potential impacts of peak oil:
    http://www.guardian.co.uk/busi…..disruption

    One of the City’s most respected institutions has warned of “catastrophic consequences” for businesses that fail to prepare for a world of increasing oil scarcity and a lower carbon economy.

    The Lloyd’s insurance market and the highly regarded Royal Institute of International Affairs, known as Chatham House, says Britain needs to be ready for “peak oil” and disrupted energy supplies at a time of soaring fuel demand in China and India, constraints on production caused by the BP oil spill and political moves to cut CO2 to halt global warming.

    RR

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  7. By Benny BND Cole on July 12, 2010 at 4:50 pm

    If we in fact have higher sustained oil prices, look for a boom in sales of high mpg vehicles, and of natural gas–and both results will permanently crimp oil sales. The guy who switches his car to LPG or CNG is not going to quickly switch back. The guy who buys a 41 mpg Lincoln MKZ is not going to sell it quickly for a 20-mpg car, if oil prices come down.

    Indeed, one or two more oil price spikes, and we may see consumers buy high mpg cars even when gasoline is cheap–they will anticipate and expensive future. Europeans use half the BTUs we do, and I don’t notice that they are usffering.

    Frankly, I think declining oil consumption in the United Strates will only mean higher incomes and cleaner air here. The less oil we import, the more dollars stay circulating in our economy, and the less oil we burn, the cleaner our urban air will be.

    Using less oil strikes me as a win-win. Bring on that day, I say.

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  8. By paul-n on July 12, 2010 at 8:38 pm

    Benny, I agree, bring on that day. Actually, I hope Canada gets to that day sooner than the US, so then we can sell you all the oil we are not using, while you are still using it.

    Being so dependent on oil imports is a mug’s game, and despite the fact that 8 presidents have tried and failed to change this, change it must.  It’s just a question of whether the country jumps or is pushed, and I think it will be pushed.

    This recession and the ‘stimulus’ spending was a missed opportunity.  For less money than was spent bailing out wealth destroying banks, the country could have made major changes to transportation to minimise oil usage, and created a lot of useful jobs – new urban transit, truck and bus CNG conversions, conversions of farm equipment to ethanol, replacement of any remaining oil fired electrical generation and heating oil usage, retiring more “clunkers” etc etc.

    Much as the cliche is overused, oil in the US is the equivalent of addiction.  And usually to end addiction some kind of “event” or “intervention” is needed, and so too is the case here, and this recession should have been that event. As long as the economy remains dependent on oil, it is dependent on unsavoury parts of the world – not a good place to be.

     

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  9. By Kevin Kane on July 13, 2010 at 4:14 am

    Unfortunately, reducing oil imports will not do make American energy secure from oil due to financial integration. If one country is impacted by an oil shock, every country will be impacted–even countries that do not import oil. Please see my article “American Freedom From Oil: A Bipartisan Pipedream”

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  10. By russ on July 13, 2010 at 6:58 am

    Kevin wrote – I don’t buy the speculator conspiracy for one second.

    Agreed – remember when the Hunt brothers tried to corner the silver market – and dropped a rather large fortune! The oil market is a bit big for that type of game – makes for good press though and fits in with the conspiracy therories people love so much.

    Good article!

    I consider Krugman’s Nobel prize to be political and about as meaningful as Obama’s.

    The globalized economy means that the price of any commodity is a world wide price – not local – so even energy independence has no meaning as far as cost goes. It would mean more dollars spent at home and would be a great boost in that manner.

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  11. By paul-n on July 13, 2010 at 1:54 pm

    I think energy (oil)  independence has a  great benefit – if it can be achieved.  Apart from the cost/money drain issue, there is also the fact that the country then does not have to spend any time or effort worrying about securing oil supplies.  Businesses that invest there know they are (reltively) insulated from oil price shocks.  And in an oil price shock, countries and companies that are oil independent (or better yet, oil free) will do much better than those that aren’t.

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  12. By OD on July 13, 2010 at 3:42 pm

    The oil market is a bit big for that type of game – makes for good press though and fits in with the conspiracy therories people love so much.

    Is it? We had this story out earlier this year where one drunken trader was responsible for 69% of the volume trader for oil futures. One trader was able to push up the price of crude.

    http://www.guardian.co.uk/busi…..banned-fsa

    Of course the entire run-up in price in ’08 was not solely due to speculation, but to ignore its role completely would be naive, imo.

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  13. By russ on July 13, 2010 at 3:53 pm

    @ Paul N – Agreed that energy independence would have many benefits but insulation from world market prices I don’t see as one. 

    A company will sell their product where the best price is and the price will be world price.

    The same oil routes would still be guarded – doubt there would be any change there at all. 

    @OD – Read the article again – they are talking about Brent crude only and ‘At times he was responsible for 69% of the volume traded’. The entire period in question was 19 hours? This was a minor blip for 19 hours and nothing more.

     

     

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  14. By OD on July 13, 2010 at 4:23 pm

    You entirely missed the point Russ. That’s ok.

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  15. By paul-n on July 13, 2010 at 9:28 pm

    Russ, I don’t mean insulation from prices, I mean insulation from volume.  Consider, for example, if Australia, a net oil importer, was able to reduce its oil usage to 1/10th its current level, by various means.  Assume it still had to import the remainder (at world prices), so they fluctuate, but the amount of money leaving the country on oil has been reduced by 90%.  

    You can handle something being expensive if you don’t need much of it anymore.  No one can limit the price (though the US makes a good effort), but you can limit what you use.  Countries that do that will be the winners.

    If you are an exporter like Canada, especially with oil exports in pipelines,  not ships,  then its a double win.  Canada’s oil pipelines to the US are like an intravenous drip!

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