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This chart shows the spot price of Arab Light Crude, and I feature it because oil prices have moved to new post-recession high ground in the past few weeks, after having been range-bound for most of the recovery. As with the story behind commodity prices, I think there are two things driving higher oil prices: 1) accommodative monetary policy from almost every central bank in the world that is weakening the purchasing power of currencies, and 2) an ongoing and probably-strengthening global economic recovery that is causing the demand for commodities and energy to exceed the expectations of commodity producers.
This chart shows the price of Arab Light Crude in constant dollars (using the PCE deflator). In real terms, oil today is not only at a post-recession high, but also higher than it was in the early 1980s. I've argued before that this is not necessarily an ominous development, since U.S. consumption of oil per unit of output has fallen by more than half since the early 1980s. In other words, we are much less reliant on oil to run the economy, so higher prices are less harmful than they were before.
The chart below compares the real price of crude (using the CPI) to the worldwide drilling rig count. Not surprisingly, higher prices are providing an extra incentive to producers to increase drilling and exploration activity, and that should eventually bring more supply to the market, thus capping the rise in prices.
The last chart compares the price of crude to the price of gold, and it shows that crude prices are roughly in line with the gold prices from an historical perspective. The ramifications of this are many, however, and I'll have to leave that for later.
18 comments:
High oil prices signal just about every recession...
But they have a long way to go before they get to be really high. The other thing that signals every recession is a significant Fed tightening, and that is a very long way off....
Oil prices today are a lot different than your father's oil prices.
Huge sovereign wealth funds can trade on the NYMEX or other exchanges, and identities can be cloaked. Speculation is rife; something like 20 digital barrels are traded for every real barrel.
Scott Grannis likes to say for every buyer there is a seller; what if it is the same party pushing prices up? Sure, if I am Russia, I will happily trade oil at $100 a barrel on the NYMEX buying and selling enough from myself to keep the entire market price up. Remember, global contracts are tied to NYMEX or other exchanges. Oh, I am sure Putin would never do something like that.....
Obviously, OPEC can influence the market at any point with an announcement, or real product cutbacks.
The good news is that OPEC is probably playing a loser's game. I know of no business model that advises "treat your customers to repeated supply and price shocks, and raise worries about future supplies by establishing unreliable administration and thug states."
The world will likely begin moving on from fossil oil within 10 years, migrating to PHEVs and CNG vehicles. Some predict doom from Peak Oil, but likely it will be a non-event.
The key is to let the price signal work, or even amplify it through gasoline taxes. I rarely support taxes, but in cases where our national and economic security is obviously threatened, I make exceptions.
The problem is, as always with our federal budget, the large representation in the Senate of rural farm states.
Rural residents, often poor due to weakling rural economies propped up by subsidies, resent higher gasoline prices and taxes. They have to drive long distances, usually on federally subsidized roads. So the odds of higher gasoline taxes are limited.
The more you understand the federal budget, the more you will detest the Red State Socialist Empire.
I worry about producer efficiency compared to consumer efficiency. Consumers have more room to adapt.
I too, am following the gold to oil price ratio with great interest -- and yes, the implications are many:
http://wjmc.blogspot.com/2010/12/gold-to-oil-ratio-1946-2010.html
I continue to urge investors with dollar denominated investment accounts to prepare for inflation accordingly...
Dr. McKibben:
Inflation? How long have you been predicting inflation, and during that time what has happened to the inflation rate?
Did Japan suffer inflation after its equity and property markets began going down 20 years ago?
Ben, like the frog in the pot of ever warming water, I understand your reluctance to accept what's pretty clearly happening, but no matter how long you've been waiting at the station, sooner or later the train does leave. Betting otherwise is ill advised. Inflation by any measure other than the Boskin revised CPI is alive and well. Ignore it at your investing peril.
Love this it saved my ass when I was getting wobbly about my portfolio. Thanks Scott
Love this blog. Kept me from getting wobbly on the market and making some bad choices. Thanks Scott.
Steve-
The Cleveland Fed has devised their own inflation gauge, and it is microscopic too. Others have pointed out that the standard CPI was posting increases in housing costs even as house prices were collapsing.
I can tell you it is far cheaper to buy a house in Los Angeles today than three years ago, while phones are cheaper, computers are cheaper, gas is about the same. It is cheaper to live in LA than three years ago, as housing is such a large component of living costs. Dollar stores are everywhere, and you can get a haircut for $5 in East LA. I bought an old-fashioned hair-wiz, and now I don't pay for haircuts,
Health care is up, college education is ever up, military hardware is way up. If public money goes in, it gets more expensive every year, not less like things in the private sector.
But all in all, if you see inflation you are disregarding what well-devised methods for measuring inflation are finding.
If what you say is true, then living standards have been falling in the US, while rising in socialized Europe for the last 20 years. (Unless you also say that European governments are gaming their inflation gauges too).
I gotta say, if inflation is going to boom (unlike Japan, which has had deflation), the bond markets are blissfully unaware.
My guess is that Bernanke saves the day, and we have low inflation for many years.
By the way, the oil producing nations are certainly in a festive spirit this Christmas season:
http://wjmc.blogspot.com/2010/12/record-11-million-christmas-tree.html
Let's hear it for the Christmas spirit!
Interesting question asked by Scott Sumner at The MOney Illusion. He sometimes writes for Cato, and also National Review.
Sumner asks, "if you think monetary policy drives commodities prices, then do you believe monetary policy was much too tight in 2008, when commodities tanked by half?"
Answers, anyone?
Yes
Hi Benjamin,
You said that “if inflation is going to boom..., the bond markets are blissfully unaware.” Here is some evidence to the contrary:
http://wjmc.blogspot.com/2010/12/are-states-too-big-to-fail.html
Again, I urge investors to prepare for inflation, which is imminent at this point…
Dr. McKibben:
According to Bankrate.com, I can borrow 15-year fixed at 3.375percent, and 30-year fixed at 4.125percent.
This is fear of inflation?
As a property owner, every night I pray to the Money Dieties that we have a nice round of inflation, and each post by you and Grannis gives unto me hope.
But then, reality keeps rearing its ugly head. Deflation seems equally likely.
In fairness, Grannis recently posted that it may be years before we see any serious inflation.
Don't forget about the drilling moratorium in the GOM that has become what the industry calls a "permitorium". Taking all those marginal barrels out of the market is a large factor in the upswing in prices. For an administration that needs every last job and that ought to not want $4 gas going into the next election cycle, this is playing with fire. We all know that the marginal barrel is super important...
Donny,
What is going on there is back door cap-and-trade, no messy legislation (which is DOA now anyway) required. The academic quacks who make up the Obama inner circle have convinced themselves that morally superior "green jobs" will be sprouting up everywhere in an era of higher fossil fuels.
Paul-
You are right but the "green job" clique is going to get a rude awakening when fossil fuel energy prices soar, green technology languishes/disappoints and they all continue to get voted out of office. Between today and our putative idyllic green future, consumers will still chafe at $4 gas and $3 home heating oil and they will still blame sitting politicians.
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