Monday, September 21, 2009

Oil factoids

It's been awhile since I've posted anything on the energy market, and I happen to have some interesting charts on the subject to share. This first chart is the real (in constant 2009 dollars, per the PCE deflator) price of crude oil going back to 1960. Oil has been trading around $70 for the past 3 months, and there is lots of talk about how inventories have risen and demand is on the verge of weakening, and thus we could see a big decline in oil prices soon. I'm not an expert on oil, so I don't have any strong views one way or another.

But I would note that oil today is almost as expensive as it was in the early 1980s. It stayed up at these levels for a few years, then it came crashing down and remained relatively cheap from the late 1980s to the late 1990s. The reasons for the big drop in oil prices were simple: the economy became more energy efficient, and world oil production increased. High prices do indeed work to bring prices down over time, though sometimes it takes many years for this to play out.

This next chart shows the percentage of personal consumption expenditures that is devoted to energy goods and services. Note that spending on energy was exceptionally high in the early 1980s, when oil was about as expensive then (in real terms) as it is now. Yet today, consumers are spending about half as much of their budget on energy as they were in the early 1980s. This is truly remarkable, and one reason that we are able to spend so much more of our budgets on healthcare.

This next chart shows why it is that energy consumes so little of households' budget. Simply put, it takes about half as much energy to produce a unit of output today as it did in 1980. Our economy has become far more energy efficient, thanks to technological improvements in fuel efficiency changes in consumers' buying habits (e.g., smaller and more fuel efficient cars, etc.).

The last chart shows how remarkable all of this is. Despite the fact that the U.S. economy has more than doubled in size since 1980 and the population has increased by some 35%, we consume about the same amount of oil today as we did back then. That's a truly remarkable fact: U.S. oil consumption has not changed on balance for the past two decades.

This collection of facts tells me a few things. For one, it will likely be very difficult for the U.S. to increase its energy efficiency as much in the next 20 years as it did in the past 20 years, regardless of whether we impose some form of carbon tax on ourselves. That's because there is likely a limit to the efficiencies that can be wrung out of oil-based energy technology—surely we have picked much of the low-hanging fruit already. Two, while energy is still quite expensive in real terms today, it represents a relatively small part of households' budgets; thus households don't have as much incentive to become more energy efficient today as they had two decades ago. Thus, a carbon tax might have to be punitive in order to produce the desired effect, and that in turn would have very negative (and politically undesirable) consequences for the economy. Finally, all of this illustrates that the free market is able to respond rather dramatically—given time—when rising prices signal a relative shortage of some key commodity like energy.


The Commodity Guy said...

I disagree that the low hanging fruit of energy conservation has been done. Much of the decline in energy consumption has had nothing to do with conservation. It's simply been the shift of the economy from energy-intensive sectors (construction and heavy manufacturing) to less so. This will continue since the US is basically built out.

The vehicles of 2006 vintage were less fuel efficient than those of 1987.

Scott Grannis said...

I'm not sure I buy your claim about the decline in fuel efficiency through 2006, but I'll bet lots of money that cars in the next few years will be more efficient.

I also don't see how energy-intensive sectors could have declined relative to other sectors by enough to account for the huge increase in overall energy efficiency.

The Lab-Rat said...

One for you Scott

Public Library said...

Lab Rat,

These are precisely the fears I have. Government officials running around believing they have an answer to the current crisis based on their assumptions about previous cycles.

Bernanke got it wrong in 2008. We should have kicked him out when we had the chance. Now he gets to double down.

It will be highly ironic that a so-called expert on Depression era economics ends up failing miserably.

Although this may be wishful thinking, it would be nice after the calamity to put the egotistical technocrats and their theories to bed.

They run roughshod over this country.

Blake Huber said...

Library --

Could you elaborate on what Bernanke got wrong in 2008 and what he/ the FED could have done better in order to respond to the crisis.

Not wanting to be critical, just want to understand more details about your point of view and alternative road that could have been taken.

Thank you,

Public Library said...


Read this article with loads of direct quotes from Bernanke. There are too many for me to list.

He was a MILE!

Here is one classic:

BERNANKE: Well, I guess I don't buy your premise. It's a pretty unlikely possibility. We've never had a decline in house prices on a nationwide basis. So what I think is more likely is that house prices will slow, maybe stabilize: might slow consumption spending a bit. I don't think it's going to drive the economy too far from its full employment path, though.

__ said...

Or read last year's FOMC statements: and recall that last summer the market was pricing 100bp of hikes by Dec-09!

Public Library said...

In answer to what they could have done differently.

Firstly, Lehman should have been stabilized. I doubt anyone disagrees with that statement.

Secondly, they should have swallowed up all the failed institutions and dissolved them over time in an orderly fashion.

The ramifications of zombie companies siphoning off taxpayers will plague us for decades to come. Nobody should be surprised by this. Do not kid yourself into believing we are making them stronger. Or America stronger.

Thirdly,it was Greeny and Bernanke with their low rate medicine that helped fuel the fires. Every time the market sneezed, the Fed was there with a helping hand.

The Asian flu, Russian default, LTCM, dotcom, 9/11, and now this. When will we let the market allocate and fluctuate on its own accord? The Fed is no better at micro-managing the economy than I am.

Bernanke will make the same mistake of keeping rates too low for too long. It is the only thing they know how to do with certainty.

These are just a few things to get started sir..

The Lab-Rat said...

the dollar must be causing the big boys some serious headaches and sleepless nights.....if i was fed i would nudge rates up a quarter point asap, otherwise the dollar pain will go on and we will all suffer...

Scott Grannis said...

The Fed suffers from its own hubris. They think monetary policy is so powerful that they worry that a quarter point might jeopardize the recovery. Ha! If only they could understand that confidence, sound money, and a strong and stable dollar are far more important to the economy than a point or two of interest rates.

Let's see what they have to say after the FOMC meeting tomorrow.

Public Library said...

SG is absolutely right...

kb said...

Scott, what is your opinion of the "debt bomb"?

You've probably addressed this previously so maybe you can point me in the right direction. thanks.

Scott Grannis said...

I've addressed this question at least somewhat in this post:

I'm not saying the numbers aren't extremely bad and scary, just that there are ways that this can work out that will not be catastrophic for the economy.

It's time for the electorate to get VERY concerned about all this unfunded spending and put a stop to it. But there is no reason yet to panic and sell everything.

I would also note that Japan and Italy survived for many years with deficits larger (as a % of GDP) than what are being projected for Obama's tenure.

Douglas said...

Scott, I don't see how an increase (before the recession dampened demand some)from around 15 million barrels to over 20 million barrels a day can support the statement: "U.S. oil consumption has not changed on balance for the past two decades." Some of the increase in energy efficiency within the economy, relative to productivity, has to do with the shift of manufacturing to China. The fact is that total consumption of petroleum has increased by 35% as you said. This is the usual pattern, as efficiency increases so does overall consumption, demonstrating a great deal of inelasticity of demand. It would be interesting to see the chart with the color bands indicating recessions applied to see the correlation of oil (energy) price and recession. It is really overall consumption that makes the difference when talking about a non-renewable resource upon which the whole system depends.

Scott Grannis said...

Doug: I think I misspoke. I meant to say that oil consumption has not changed at all for three decades (since 1979). The chart is accurate.

I suspect that you are correct about some portion of the increased efficiency being due to the outsourcing of some energy-intensive activities to places like China. But I really doubt that it is a significant amount. After all, whatever is produced in China and consumed here must pay shipping (i.e., energy costs) costs to get here. And we wouldn't be going to all that trouble if it still weren't energy efficient and economical for all parties concerned.

Be that as it may, the most impressive fact here is that the economy has more than doubled, but energy use has only risen 35%. China cannot explain away that impressive fact. Energy demand in the U.S. has proven to be sensitive to price; rising prices have been the major factor spurring conservation and increased technological efficiency.