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Page added on May 20, 2015
What’s in A Price? Less Than You Think
Over the years, I have written a good deal about crude oil: crude oil prices, that is. I don’t presume to have any unique insights into the inner workings of OPEC or a comprehensive knowledge of hydraulic fracturing techniques. I do not have contacts at major energy producers. Nor do I have wildcatters checking in with their latest discoveries.
What I do have, apparently, is an understanding that a change in the price (P) of a stock, bond or commodity tells us nothing about the effect on the quantity (Q). “Never reason from a price change,” is how economist Scott Sumner, director of the program on monetary policy at George Mason University’s Mercatus Center, encapsulates a concept that should be enshrined in every economics textbook. “Drawing inferences from price changes is not really justified,” Sumner says.
And often incorrect, he might have added. When oil prices declined 60 percent between June 2014 and March 2015, economists assumed the collapse was solely a result of increased oil supply. They declared it an unqualified plus for the U.S. economy and a “big tax cut” for the consumer, whose savings from filling the tank could be spent elsewhere. Federal Reserve policy makers expected lower oil prices to “boost household purchasing power.” The net effect was “likely to be positive for economic activity and employment in the United States,” according to the minutes from the March 17-18 meeting.
Let’s see how that’s worked out. Investment in mining exploration, shafts and wells plummeted an annualized 49 percent in the first-quarter. Retail sales and industrial production have hit the skids. The first look at first-quarter real GDP growth was dismal: an increase of 0.2 percent. The second look, due on May 29, should show an outright contraction, based on subsequent data releases and revisions. The Atlanta Fed’s second-quarter GDPNow forecast is 0.7 percent. (The Atlanta Fed downplays the reliability of its estimate until more second-quarter data become available.)
As for employment, the Bureau of Labor Statistics reported a 6,800 decline in oil and gas extraction jobs since the recent high in December 2014. Companies that support oil and gas operations have cut 21,000 jobs since the September peak. Throw in oil-related manufacturing industries, such as steel, and by some estimates 100,000 jobs may have been eliminated as a result of lower oil prices.
This is hardly the first time economists have ignored Sumner’s mantra. In early 1986, the Saudis opened the spigots, sending oil prices tumbling to $10 a barrel in April from $35 in November 1985. The Fed was easing aggressively. The hype was pretty much the same as now: a big tax cut for consumers, unqualified good news for the U.S. economy. As it turned out, real GDP expanded 1.8 percent in the second quarter of 1986. Ex-post, economists discovered the devastating effect of lower prices on oil-producing states.
If economists can’t differentiate between price changes coming from the supply side versus the demand side when it comes to oil prices—often the source is impossible to ascertain in real time —imagine their confusion when it comes to interest rates. Sumner, who blogs at The Money Illusion and EconLog, takes many noted economists to task for reasoning from a price change. Nobel laureate Robert Schiller is guilty of viewing low real interest rates as an incentive for investment. (Not if those low rates are the result of reduced credit demand.) Larry Summers is guilty of equating low interest rates with easy monetary policy. (They can be a reflection of easy policy or a response to overly tight policy.) Paul Krugman, another Nobel Laureate, is guilty of (among other things) assuming higher interest rates lead to lower inflation, again failing to differentiate between cause and effect.
The Fed is equally confused when it comes to long-term rates. If you were to ask policy makers if interest rates move pro-cyclically, they would all answer yes. But when rising market rates become a reality, the cries go out that higher rates will damage the economic growth. At the same time, a decline in long rates is automatically assumed to provide economic stimulus. Alas, the expectation that the 100-basis-point decline in 10-year Treasury yields last year would boost investment was mugged by reality.
Getting back to oil prices, economists are still waiting (hoping?) for the oil-price-tax-cut to materialize. Bad weather is getting old as an excuse. More likely, the 60 percent June-to-January decline in U.S. benchmark crude prices was the result of a multi-year increase in global output, as technical innovation reduced the cost of extracting oil from shale, combined with a sudden cutback in global demand. The dive in prices coincided with negative economic news from Europe and slowing growth in emerging markets, including China. If supply and demand were in balance as recently as last June when oil prices were $100 a barrel, it is hard to explain the sharp, sudden price decline as a supply phenomenon.
If, on the other hand, prices fell because consumers were demanding less energy-related products at any given price than they did before, then lower prices are a result, not a cause of stronger demand in the future.
Of course, as a journalist this topic has proved to be extremely fruitful over the years. What other subject would provide an opportunity to write thousands of words when a single picture would suffice?
27 Comments on "What’s in A Price? Less Than You Think"
Plantagenet on Wed, 20th May 2015 7:57 pm
The current oil glut is occurring as oil production AND oil demand hit record highs in 2014-15.
The 50% oil price drop occurred as a consequence of the oil glut—its really pretty simple to understand.
shortonoil on Thu, 21st May 2015 1:15 pm
Until economists begin to grasp that energy has a value, and oil is a source of energy this debate about supply, and demand will continue. Half are saying that at first there were chickens, and half are saying it was an egg. Neither can prove their position?
Supply, and demand resembles the proverbial chicken, and egg. Cause, and effect are easily confused. That is often the case when a real third quantity is in control, and yet ignored. Supply, and demand are quantities which are created from the value of oil. The value of oil is not dictated by supply and demand; it results from the molecular structure of its hydrocarbons.
When the Price to Value ratio of petroleum is taken into consideration it is found that every time that it has reached 12% the price has collapsed. When fully appreciated it becomes evident that supply, and demand are effects, not causes. The Etp Model describes how a third quantity controls that function. We are merely attempting to put the chickens, and their eggs to bed!
http://www.thehillsgroup.org/
Northwest Resident on Thu, 21st May 2015 1:26 pm
“The 50% oil price drop occurred as a consequence of the oil glut”
This subject has been discussed and commented on numerous times on this forum and in articles posted around the internet on a wide range of websites. Very few opinions are taking the simple-minded MSM propagandized point of view stated above. That “talking point” is for idiots and ignoramuses. Plant’s job, of course, is to perpetrate that MSM propaganda talking point daily, multiple times, everywhere he can squeeze that lie in to a discussion. Whether he does it because he’s paid to do it, or because he likes stirring up the shit is hard to say — maybe both? But regardless, for anybody reading this article and these comments who doesn’t already know it, the oil price drop involves significantly more factors than merely a tiny “glut” buildup — most of that “glut” is condensate that has no market anyway — they’re just calling it a “glut” to confuse you and to hide the fact that the oil industry is going down for the count, and dragging industrial high-tech civilization with it. Don’t fall for simple-minded explanations offered by agents of subterfuge — stay informed, dig deeper and you’ll find the real truth.
shortonoil on Thu, 21st May 2015 6:00 pm
“Don’t fall for simple-minded explanations offered by agents of subterfuge — stay informed, dig deeper and you’ll find the real truth.”
The theoretical end of the oil age will come no later than 2030. That is, of course, unless some scumbag changed the laws of physics.
Davy on Thu, 21st May 2015 6:04 pm
Short realistically the oil age is coming to an end now systematically because of the theoretical situation in physics.
Apneaman on Thu, 21st May 2015 6:37 pm
Better hope that this spill is not near the intake pipe for the local desalination plant.
////////////////////////////////////////////////////////
Santa Barbara oil spill: Pipeline operator has long record of problems
“According to federal records, since 2006 the company’s incidents caused more than $23 million in property damage and spilled more than 688,000 gallons of hazardous liquid.”
http://www.latimes.com/local/california/la-me-oilspill-pipeline-20150521-story.html
California Governor Declares State Of Emergency As Santa Barbara Oil Spill Worsens Dramatically
http://www.zerohedge.com/news/2015-05-21/california-governor-declares-state-emergency-santa-barbara-oil-spill-worsens-dramati
Nony on Thu, 21st May 2015 9:36 pm
you can’t argue that it is a demand driven price drop when volume is up. QED.
Funny watching some of you try though. Not sure how much is from stupidity and how much from bias.
This includes Rock.
GregT on Thu, 21st May 2015 10:11 pm
Nony,
Ponzi schemes require a certain amount of growth, or they will collapse. While it is true that some economies are still growing, they are not growing quickly enough to maintain BAU. The fact that you continue to dismiss this fact, makes you look stupid and biased.
Nony on Thu, 21st May 2015 10:21 pm
It is not germane to the topic of supply and demand and what it means if volume is up and price is down.
Davy on Fri, 22nd May 2015 5:41 am
NOo, is it not germane to the topic of dynamic systems that volume is up and price is down? Tell me why there are not issues greater than the linear idea of supply and demand. What about the non-linear idea of a system that requires a narrow range of continuous long term growth encountering limits and diminishing returns.
It is very likely we have volume up and price down now because of an economy in disequilibrium. I would like you to explain the Fed and other central bank’s monitarization of debt and repression of interest rates. Please explain why the economy is showing multiple indicators of stagnation but the equity markets are frothy.
NOo you dismiss bad news out of hand at all levels. This is a typical agendist technic. In your case it is a cornucopian agenda and in your case particularly concerning our foundational commodity oil. While I agree you have an excellent grasp on the innards of the oil complex where you fail is connecting all the other connections to the greater economy and the global system. IOW POD and dynamics systems underlying the global system.
We are an ecosystem NOo. Like all ecosystems and with the greater earth ecosystem we have limits. We show every indication to be at or near limits to consumption and carrying capacity of our 7BIL population. What is important to understand is dynamic systems thought says as you approach limits you encounter turbulence. Turbulence is unsteady and any system when it enters an unsteady state begins to encounter decay. If that decay is long enough with unsolved problems a bifurcation can occur to a lower level of systematic stability. We appear to be in the vicinity of this bifurcation event at multiple levels and possibly at the highest levels of the global system and the earth ecosystem.
You and so many other corns dismiss these connections as irrelevant to the human system with its markets and technology continually overcoming problems through substitution, efficiency, and innovation to progress. IOW you see humans as exceptional and transcendent to the earth ecosystem and natural dynamic system realities.
Long story short with the above ideas we are likely in a demand stagnation from resource limits and diminishing returns especially to efficiency gains. We are in an oil oversupply caused by malinvestment in the oil sector. This malinvestment was from central bank policies of unnatural liquidity, low rates, and risk on yield searching. This yield searching ended up in the oil sector and allowed the shale boom that allowed a excess supply at a time of stagnating global growth.
NOo remove the shale component to the US economy and tell me how growth was over the last 5 years. Sure we may be growing at some levels. You can cherry pick the definition of real aggregate growth and cherry pic the indicators to support your cherry picked growth goal seeking.
NOo you are an specialist with an agenda. Your agenda is peaker bashing. You dismiss any and all negativity to your message although you cleverly acknowledge POD and systematic turbulence as a clever tool that is nonetheless dismissive.
You are delivering a dangerous message. It is not your specialties with the data that is dangerous it is your interpretations of this as a distortion of the truth with fact selectivity. At this time in our human history with consumption stagnating and population clearly in excessive overshoot we cannot afford poor interpretations of our global systematic situation. If oil is really at or near peak oil dynamics we have systematic dangers that can bring down our global system. This system requiring growth to maintain just in time global production and distribution of all the vitals to our delocalized locals.
Locals can no longer function safely without a healthy global. The global is showing every sign of being in disequilibrium. The ecosystem and climate are showing multiple examples of decline and localized failures. Population continues to grow, food productivity is stagnating, water stress in widespread, and our foundational commodity oil is clearly in higher level depletion phase. NOo, wake up boy and hear the thunder. A shit storm is approaching.
nony on Fri, 22nd May 2015 7:46 am
Yawn. If volume is up and price is down, supply excess not demand drop must be the cause.
Davy on Fri, 22nd May 2015 8:42 am
I often yawn too NOo. You are so boring with your endless mindless peaker bashing. So can we agree one bore to another?
nony on Fri, 22nd May 2015 9:22 am
Go read about supply and demand. You claim to know complications and don’t even know basics before complication. Word salad fluff head.
Northwest Resident on Fri, 22nd May 2015 9:37 am
Nony — You repeatedly prove that you just don’t get it. Volume is “up” because of ZIRP, QE and mountains of digital money looking for somewhere — anywhere! — to find yield. Lots and lots of shale/unconventional producers are hard at work, pumping away, still in business ONLY because of constant fresh infusions of cash to burn through, without which they would have gone bust long ago. They must pump to survive another day, and there are a lot of them doing it. The whole demand/supply equilibrium has been distorted beyond recognition. It isn’t all that extra crap they’re pumping at a loss that is driving the oil price down — it is the fact that nobody wants or can afford whatever it is they’re selling. As more people lose more jobs and sink further into poverty, and as the “quality” of the average barrel of oil declines, they have no choice but to lower the price in order to find sufficient buyers to keep the lights on for another day. Your analytical method may have worked back in the good ol’ days — and that would be a long time ago — but the ground has shifted under your feet and you haven’t made the proper adjustments.
Davy on Fri, 22nd May 2015 9:52 am
NOo, I have a degree in finance. I had multiple Econ classes. I know enough to know enough. You on the other hand base your life upon it. Everything revolves around the idea. Maybe that is why you are in a pussy drought. I am saying there is more to life and understanding of reality than your Econ 101 cornucopian religion.
marmico on Fri, 22nd May 2015 12:31 pm
NOo, I have a degree in finance. I had multiple Econ classes
ROTFLMFAO. Fool me once with word salad prattle. This ain’t baseball, dimwit. Two strikes and you are out with your demand destruction BAUtopianism bull shit.
Your 10 year old peakoil.com case is the infield fly rule, collapsenik. The EIA has invoked the latest ruling. December 2014 oil production is the new monthly high @ 79.3 million barrels per day.
GregT on Fri, 22nd May 2015 12:42 pm
“The greatest shortcoming of the human race is our inability to understand the exponential function.”
This is exactly why you have it all wrong Marmico.
Northwest Resident on Fri, 22nd May 2015 1:07 pm
marmico — “December 2014 oil production is the new monthly high @ 79.3 million barrels per day.”
That’s called “the peak”.
Roll around on the floor and laugh your fucking ass off while you can. You look like a FOOL doing it to those of us who know which way this thing is headed. Your insane laughter will turn to unbearable grief soon enough, and we’ll be getting the last laugh.
In the meantime, continue on with your obnoxious, rude and insulting ways. It becomes you.
Davy on Fri, 22nd May 2015 1:53 pm
Captain, your back. The NOo has been getting hammered here lately. Glad you are back to give him a hand. He is in a pussy drought also maybe you can give him some advice. Meanwhile I echo N/R, you look like a fool spoofing your suck here.
Nony on Fri, 22nd May 2015 3:01 pm
NWR:
It’s irrelevant to the matter at hand if the increase in demand is from a bubble of QE speculation or is from the most sound economic expansion in the universe. It STILL RULES OUT a price drop from demand dropping if instead demand is up. QED.
P.s. What is funny is when you people start talking about bein fact based and science and so much better than the Fox News denier sheople. And you’re total fluff heads.
Nony on Fri, 22nd May 2015 3:03 pm
Davy:
I brought marmie out of the sock drawer to keep you amused. Should I go out and try to meet some women tonight? Am on travel, on a project. Cute town.
Northwest Resident on Fri, 22nd May 2015 3:26 pm
Nony, what makes you think there is an increase in demand??? Demand in China is dropping. Demand everywhere is dropping. Where do you get your fluffy data from?
IEA sees 2015 oil demand growth much lower — STRONG SUPPLY, WEAK DEMAND
http://www.reuters.com/article/2014/10/14/us-iea-oil-idUSKCN0I30TD20141014
P.S. Nony, ignore the portion of that article that attempts to argue that the oil price decrease is due to oversupply. They threw that propaganda point into the mix for knuckle heads who are too stupid to read the REAL story, which IS, decreasing demand, weak demand.
Seriously, Nony, you’d rather kick up a cloud of B.S. and spew a bunch of non-facts than have to deal with the actual facts. Name calling (“total fluff heads”) is the last resort of a rascal caught in a lie — counterattack with bullshit is what you do when your ass has been pinned to the wall.
Guilty as charged!
Davy on Fri, 22nd May 2015 3:58 pm
NOo, you sound like a hip guy. You should check the traps see if you can find a girl. NOo, just don’t talk to her about POD issues. Keep it to discussions on your house, car, and travel.
Northwest Resident on Fri, 22nd May 2015 4:01 pm
A great pickup line for Nony: “Hey babe, have you heard about the oil glut?”
That’ll get her all hot and bothered. Oh yeah!
Davy on Fri, 22nd May 2015 4:10 pm
N/R, just think NOo could probably pick up planter that way. He is a softy for gluts.
Northwest Resident on Fri, 22nd May 2015 4:12 pm
Davy, I thought Planter IS a female. That’s why I recommended that pickup line to Nony. He’s sure to reel in a hot sweet Planter babe with a cool line like that. (upchuck…)
Slow day at work. When do I get to go home!? Why am I wasting my time here at work? I have important stuff to do!!
Nony on Sat, 23rd May 2015 2:34 am
Nony, what makes you think there is an increase in demand???
duh…volume, ya moron!