Oil prices are still high. Ten reasons that's a problem.
Oil prices are still high, Tverberg writes, and will continue to be so if we expect to have more tight oil and more oil from other unconventional sources. Tverberg offers 10 reasons why high oil prices are a problem.
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If salaries don’t rise, and prices of many types of goods and services do, something has to “give”. This disparity seems to be the reason for the continuing economic discomfort experienced in the past several years. For many consumers, the only solution is a long-term cut back in discretionary spending.
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Gail Tverberg, an actuary with a background in math, analyzes energy and financial matters from a perspective that the world has limited resources. For more of Gail's posts, click here.
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4. Spikes in oil prices tend to be associated with recessions.
Economist James Hamilton has shown that 10 out of the last 11 US recessions were associated with oil price spikes.
When oil prices rise, consumers tend to cut back on discretionary spending, so as to have enough money for basics, such as food and gasoline for commuting. These cut-backs in spending lead to lay-offs in discretionary sectors of the economy, such as vacation travel and visits to restaurants. The lay-offs in these sectors lead to more cutbacks in spending, and to more debt defaults.
5. High oil prices don’t “recycle” well through the economy.
Theoretically, high oil prices might lead to more employment in the oil sector, and more purchases by these employees. In practice, this provides only a very partial offset to higher price. The oil sector is not a big employer, although with rising oil extraction costs and more US drilling, it is getting to be a larger employer. Oil importing countries find that much of their expenditures must go abroad. Even if these expenditures are recycled back as more US debt, this is not the same as more US salaries. Also, the United States government is reaching debt limits.
Even within oil exporting countries, high oil prices don’t necessarily recycle to other citizens well. A recent study shows that 2011 food price spikes helped trigger the Arab Spring. Since higher food prices are closely related to higher oil prices (and occurred at the same time), this is an example of poor recycling. As populations rise, the need to keep big populations properly fed and otherwise cared for gets to be more of an issue. Countries with high populations relative to exports, such as Iran, Nigeria, Russia, Sudan, and Venezuela would seem to have the most difficulty in providing needed goods to citizens.
6. Housing prices are adversely affected by high oil prices.
If a person is required to pay more for oil, food, and delivered goods of all sorts, less will be left over for discretionary spending. Buying a new home is one such type of discretionary expenditure.
US housing prices started to drop in mid 2006, according to data of the S&P Case Shiller home price index. This timing fits in well with when oil prices began to rise, based on Figure 1.
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7. Business profitability is adversely affected by high oil prices.
Some businesses in discretionary sectors may close their doors completely. Others may lay off workers to get supply and demand back into balance.
8. The impact of high oil prices doesn’t “go away”.
Citizens’ discretionary income is permanently lower. Businesses that close when oil prices rise generally don’t re-open. In some cases, businesses that close may be replaced by companies in China or India, with lower operating costs. These lower operating costs indirectly reflect the fact that the companies use less oil, and the fact that their workers can be paid less, because the workers use less oil. This is a part of the reason why US employment levels remain low, and why we don’t see a big bounce-back in growth after the Great Recession. Figure 4 below shows the big shifts in oil consumption that have taken place.
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