Lower Oil Prices - Not a Good Sign!

Only available on StudyMode
  • Download(s) : 53
  • Published : February 28, 2013
Open Document
Text Preview
Lower Oil Prices - Not a Good Sign!
Posted by Gail the Actuary on July 5, 2012 - 9:58am
Topic: Economics/Finance
Tags: debt default, default, high oil price, low oil price, oil prices, recession [list all tags] Are lower oil prices good news? Not really, if it means the world is sinking into recession. We know from recent past experience and from common sense that higher oil prices are a drag on oil importing economies, because if more $$$ are spent on the same amount of oil, there is less to spend on discretionary goods and services. In addition, oil money sent to oil exporting countries is likely to be spent within those economies, rather than being reinvested in the oil importing country that the funds came from.

Figure 1. A rough calculation of expenditure (in 2011$) associated with oil imports or exports, based on 2012 BP Statistical Review data, for three areas of the world: the Former Soviet Union (FSU), the sum of EU-27, United States, and Japan, and the Remainder of the World. (Negative values are revenue from exports.) A rough calculation based on 2012 BP Statistical Review data indicates that the combination of the EU-27, the United States, and Japan spent a little over $1 trillion dollars in oil imports in 2011–roughly the same amount as in 2008. Governments have been running up huge deficits and have been keeping interest rates very low to cover up this damage, but it is hard to make this strategy work. The deficit soon becomes unmanageable, as the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) countries in Europe have recently been discovering. The US government is facing automatic spending cuts, as of January 2, 2013, because of its continuing deficits. Furthermore, lower interest rates aren’t entirely beneficial. With low interest rates, pension funds need much larger employer contributions, if they are to make good on their promises. Retirees who depend on interest income to supplement their Social Security checks find themselves with less income. The lower interest rates don’t necessarily have a huge stimulatory impact on the economy, either, if buyers don’t have sufficient discretionary income to buy the additional services that new investment might provide. Below the fold, we will discuss what is really happening with oil prices, and consider reasons why lower oil prices may be a signal that the world is again headed for deep recession. Oil Supply is Not Rising Enough

The big issue is that oil supply is not rising enough–and hasn’t been for a long time.

Figure 2. Actual and fitted oil consumption based on BP 2012 Statistical Review. Fitted trend value of 2.0% is based on 1983 to 1989 actual data; fitted trend value of 1.6% is based on 1993 to 2005 actual data. When oil supply doesn’t rise fast enough, there are two opposite effects that can take place:

Figure 3. West Texas Intermediate (WTI) and Brent oil prices, in US dollars, based on weekly average spot prices from the US Energy Information Administration. (1) The most common effect is that prices will go higher. This can be seen in the upward trend in prices in the last eight years. (2) The other effect is that prices can drop quite sharply, as they did in late 2008. This happens when parts of the world are entering recession, and their demand is decreasing. It seems to me that this second effect may be happening this time around, as well. The down-leg we are seeing in the prices may have farther to go, as the recession plays out. One Problem Area: PIIGS Oil Consumption is Declining

If we look at three-year average growth rates for the PIIGS, we find that there is a close correlation between oil growth, energy growth, and GDP growth. Furthermore, in recent years, a growth (or drop) in energy use seems to proceed a growth (or drop) in GDP. Not all of this energy is oil, but for the PIIGS countries, even natural gas is a relatively high-priced import. Recently, oil consumption has been declining sharply, which could imply further...
tracking img