The Coming Oil Price Shock

Fatal Difference - Fatal Indifference - We need only to recap the experience of the 1970s and 1980s to understand why massive public national deficit financing of Keynesian-type spending to restore global economic growth will almost surely end with a 1970s style oil shock. That is oil price explosion, falling consumer confidence and corporate investment, falling economic growth, finance sector panic, competitive devaluation of world moneys and a catastrophic slump back into recession. Like the 1970s experience, the recession will be very inflationary.

The 1970s delivered two short-sharp oil shocks, with never-known-before massive rises in the oil price, unlike the slow but permanent oil shock that operated through 2003 to the collapse of the global economic growth surge in 2008. Rising oil and commodity prices until 2007-2008, neither ironically nor magically, surely levered up global economic growth in a process I call Petro Keynesian Growth and the IMF and Federal Reserve Bank of New York calls fast, near complete recycling of windfall gains by major capital surplus oil and gas exporter countries - including Russia, for example. The petrodollars and petroeuros are quickly recycled to the global economy, raising solvent demand. This didnt happen in the 1970s.

This growth levering process operated in the Petro Keynes interval of 2004-2007, before the traditional model, Deficit Keynes, was called in to rescue the imploded finance, bank and insurance sector of most OECD countries, from midyear 2008. While the petrodollar recycling stimulus was figured in the high giga dollar range, the new debt racked up by OECD political deciders rushing to save the banks and slow the plunging economy was tera dollar sized, with peta dollar ultimate wipeout no longer a fantasy notion when or if Weimar Republic hyperinflation surges as a result.

For students of history we can note the oil price rises in the 1970s shocks were about 295% in 1973-1974, about 115% in 1979-1980. Through the 9 years from 1999 to Q2 2008 prices rose about 950%, all measured in nominal dollars not inflation adjusted.

In 2010 another 100% hike, or doubling from the current price level around US$75 a barrel is possible or probable if there is any kind of global economic recovery. It is also possible or probable if both the Euro and the US dollar fall in value, following the present panic, inciting oil and gas exporters to cover near-term risk of further devaluation and/or inflation in the countries emitting these moneys. In a worst-case scenario, where we also have a rise in geopolitical insecurity as the USA finally quits Iraq and the Afghan war is declared an unwinnable high cost vanity project, and Israel runs a bungled regime change attempt against Iran, prices could triple from current levels very fast.

The big difference between the 1970s shocks and what has happened since around 2005 or 2006, is that the 1970s oil shocks were caused by short and sharp oil supply cuts for political reasons. Since 2005 or 2006 it is clear that global oil output simply doesnt respond to rising prices, in the exact same way gold production plays dead in response to record prices. Among the factors causing this we have the no-no for government friendly media, called geological depletion. Asking why BP drills 5 kilometres into the Earth's crust in 2 kilometre deep water instead of seeking "highly abundant" land-based oil reserves is a useful question: perhaps BP does this for technological kudos, to keep offshore rig builders in business, or for ecological experimentation with toxic dispersants ?

In the 1970s and 1980s world oil production capacity kept growing on the back of accumulated and large discoveries. Any prospect of physical supply shortage was removed from the scene for at least the next 20 years. Time then ran out.

Now we have a guaranteed short fuse, low ceiling, fast feedback on oil prices when global oil demand recovers. When we get to real Post Peak Oil and a net annual capacity outturn of zero, with any new capacity added only replacing lost, the price linkage will be even closer - and the splendid 75% price crashes like late 2008-midyear 2009 will be a thing of the past. The tilt to permanent high prices is totally predictable in the next 3 - 5 years.

With the Slump Dividend gone, we can focus on permanent high priced debt joining permanent high priced oil in the new inflation party. Ironically, this could save the party in the early lead-in phase, through 2010-2011.

Due to the Slump Dividend of sub-critical oil prices, barrel prices below about US$ 125, the Petro Keynesian lever is alive and well, and working to the benefit of China, India, Brazil, South Korea, Australia and other countries. Below the critical level, oil and energy prices are not high enough to impact food prices, industrial materials, sea transport and construction costs, and consumer confidence in those economies able to run with the Petro Keynes lever.

Global economic growth can or might pull the most-affected (that is most debt riddled) OECD countries out of their semi-structural slump, during the rest of 2010 and into 2011. By then, however, oil prices can again go critical leaving us with the 1970s default solution. Through 1974-1979 the response was to print money, like today, but to also accept the inflation caused by printing money. Today's political deciders in the debt riddled OECD countries maintain a herd facade of "struggle" against inflation being second only to "struggle" against Al Qaeda, and sometimes even in front of it, in the big list of national salvation quests.

Keeping the party going beyond end 2010 will mean accepting inflation. If this is linked to slow-or-no economic growth, it can tilt to hyperinflation. The coming economic recovery, if it comes, will be inflationary. In the famous slogan of Thatcher, parroted by generations of other great leaders: "There is No Alternative".

Geological shortage is not responsive to regime-change of oil exporter countries, as the Iraq situation shows, despite the brave words of its Chi'ite leadership bragging they can outproduce Saudi Arabia. Economic policy regime change is a lot easier, and is coming in the debt riddled OECD countries of Europe quite soon.

Inflationary growth, growth at any price, any cost, is the only way out. World oil demand will recover, oil prices will then again spiral as in 2007-2008 and with or without the help of Goldman Sachs structured products.

Using IEA and OPEC data, world oil demand in 2008-2009 declined at around 3.5% a year before stabilizing late in 2009, and showing low growth from the start of 2010. The bad news is that long-term contraction of world net export supply or "offer" (also caused by oil exporter countries actually consuming oil themselves) is likely already on a downslope of about 1% a year and will soon move up to 2.75% to 3% per year. Permanent recession becomes the default solution if oil prices are the bogeyman. Put another way, the present recession, described by the IMF as the worst since 1945, and the present OECD debt crisis the IMF tends not to talk about (because unprecedented) delivered a temporary cut in global oil demand at somewhat less than the coming long term trend rate for cutting global economic intensity of oil demand.

Demand compression will be difficult to set for India, China, Pakistan, Brazil and the main oil exporter countries like Russia, Saudi Arabia, Iran, Venezuela, UAE and others. This signals oil demand capping, and programmed year-on-year oil demand cuts will have to come from the OECD countries, essentially the (unacknowledged) basis of the European "20-20-20" plan, dressed up in climate-change frills. On average, the OECD countries use about 5 times more oil per head of population than China and 9 times more than India.

The main danger is that nice intentions on long-term oil intensity cuts will be shortcircuited by real world energy demand growth due to economic recovery in the real world near term. Previous instant remedy solutions of the Bush-Blair model, regime change of targeted oil producer countries to improve their export performance, are too slow and are always bungled, meaning that controlled cuts in oil intensity become the No Alternative.

Put another way, attempts at regime change to improve oil export performance will be decreasingly attractive due to very slim spare capacity margins for oil export supply. The sharp rise in oil prices through 2010 will have to be swallowed, because progress in restoring OECD economic growth is no longer an option - but a life or death need. Time is now short and oil intensity cuts are now urgent. Achieving perhaps a 75% reduction of oil, gas and coal intensity of the economy by around 2035 will need large investment, industrial restructuring, economic restructuring, legislative action, lifestyle change and consumer communication. Dressing this up as saving the world from climate catastrophe has not worked making the coming shaky economic recovery a period of epochal change

The challenge of energy transition is very clear. Organized dialogue between oil exporter and oil importer countries, aiming for stable and high but tolerable oil prices, in a transparent supply and pricing framework linked to energy transition. This will be vastly more productive than heroic attempts at printing money to beat the debt bulldozer or trying out new regime change adventures in oil exporter countries.

"Does it keep that long?"

"We may soon wish were storing it now for about $3 a gallon."

I have about 120 gallons in storage, I've added enough Stabil that it will be okay for two years.

I bought that gasoline at $2.43 a gallon. I store gas every year for the hurricane season....I hope I don't need to use it this summer.

I've never seen an FR thread populated by commenters that are such conspiracy minded ninnies. What is it about oil and gasoline markets that make otherwise rational people see dark forces behind every gas pump?

Here's the deal: Everybody involved in getting oil out of the ground and gas into your tank is in it for themselves; just like you are. They all try to maximize their profits from their investment and labor, just like you do. Millions of people acting in their own interest, individually and collectively, along with natural forces and mishaps cause prices to go up and down. When you suspect that people are conspiring to get as much money from you as they possibly can for the goods they provide you, you are exactly correct. These people are behaving just as you do every day. Never trust or respect anybody that claims it should be otherwise.

I don’t trust ANYONE who’s after my money.

If the government wasn’t into so heavily regulating oil and gasoline, all for the good of the environment and ultimately our own good therein, I’d agree with you.

It is and I DON’T trust the government which wouldn’t let a crisis go to waste.

Control energy and you can hit people in the pocketbook. Control gasoline production and you control how much people can travel and how independent they are.

What is it about oil and gasoline markets that make otherwise rational people see dark forces behind every gas pump?

Because there are few sectors of our economy so seemingly random and manipulated. For my life I have always heard "supply and demand"... yet I have seen gasoline prices go up when demand dropped and supply went up. I have seen oil prices skyrocket over the smallest of hiccups. I have seen the government manipulate the prices through taxes and through threats of regulation.

And few sectors directly affect my pocketbook in such a volatile manner as gasoline prices.

I have watched gas stations raise prices repeatedly in the same day - all without even receiving a delivery. I have seen prices drop unexpectedly as well. But it is all about the uncertainty.

And lets look at this from another angle - Obama plays a game of saying he is going to allow exploration/drilling offshore- and how long goes by and we have this "disaster" come up. This comes from the same president/part that has openly stated they want us to "make sacrifices". The global warming scam is running out of steam - thus the Crap and Tax bill is losing momentum, and the progressives are still adamantly trying to find ways to control our lives (driving). The environmental nutjobs have already shown themselves more than willing to do ANYTHING it takes to assault capitalism.

Snore. “Oh he wants to buy something cheap and store it for later! He’s one of those conspiracy nuts!”

I wish I had bought and stored a lot of things when they were cheaper than they are now. Has nothing to do with thinking there is some conspiracy.

When I know something is going to be more expensive later on why wait to buy it when it is more expensive? That’s just throwing away money.

Conversely to that I refuse to buy other things when I know they are going to be much much cheaper later on, particularly in electronics. Like above, it’s just throwing money away.

Seller can play the price game all they want. Buyers can play the discount game just as easily. Capitalism is buyers AND sellers, not just sellers.

The oil industry is probably the most manipulated industry in the country. The Government has stopped drilling on public land and refuses to allow oil shale development. The refuse drilling off shore. The taxes are extreme. One of the oil comprise made $5B profit and the liberals went crazy but refused to say that the government made $39B in taxes. $250B was sent to the Arabs. I am stuck with so poor of gas that my gas millage is low and so much alcohol that it eats up the diaphragm on my ATV. There is $.44 per gallon tax that the state pays off unions, gays, environmentalists and who knows who.

I guess ignorance is bliss.

Looks like it.

There’s plenty of oil to be found in this country, if the government would allow drilling, which it doesn’t.

And perhaps Minn could explain to us all just WHY it doesn’t allow drilling. ONE good reason would be a nice start.

The other issue is that every time we come close to alternative fuel sources, oil and gas prices mysteriously tumble far enough to make it not economically feasible any more.

Then the pressure for alternative energy is off again.

Then prices start to gradually rise again, so that like the frog in the pot, we don’t really notice the heat is being turned up. When prices get to be too much of a burden, research on alternative energy begins in ernest again, and gas and oil prices predictably tumble, again.

I would like to see compete systems without subsidy so they could stand on their own. Jimmy Carters solar plan was mostly a failure. Lets get something that really works. Solar electric and wind power cause pollution here because coal fired plants have to increase and decrease production causing pollution like a buss accelerating. We are so manipulated by the environmental religion that things can not progress normally.

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