Jeff Rubin has a new blog over at Globe and Mail to help promote his new book.
His blog discusses the impact of oil prices on the world economy. His thesis is that the world will be getting much smaller as oil prices rise. Globalism which depends heavily on transcontinental shipping, rail and truck will become more costly.
Jeff says that oil prices will rise because of shrinking production and growing demand. He predicts oil prices will hit $200 a barrel within the next two years.
“Of course we’re not running out of oil. We’re just running out of the oil that we can afford to burn.”
I however disagree. Not with the previous quote but with the argument that oil prices will rise undisturbed over the foreseeable future. The argument makes sense in a fixed economy. But I'd like to propose an alternate theory that actually makes sense in a capitalist economy.
Here it is:
The world economy dictates the price of oil. Not the oil markets.
The world economy is unlikely to change drastically in the next two years with regards to energy consumption. Structurally the economic use of oil will be very similar to today.
So what happens if oil rises in a short term speculative boost to $200 a barrel and gas at the pumps hits $2.00 a litre? What then?
Do we all run out to invest in oil?
Well no. We won’t be able to afford to buy it at that price. Our economy just doesn’t have the excess spending power to pay for it.
We will be forced to stop buying big vehicles, we will cut all non essential trips, industries reliant on heavy energy use will go bankrupt and we’ll cut purchases of products that are no longer attractively priced: plastic, imported foods, imported manufactured goods.
Demand for oil would collapse.
The world would go into a very deep recession as we restructure our consumption. The price of oil would be forced to fall to a point where it can be supported by the world economy.
If that price is below what oil can be profitably extracted and refined from unconventional sources than that supply will go offline. And private business models that rely completely upon profitable extraction from such sources as tar sands, deep ocean beds or shale would potentially go bankrupt.
Months after this initial shock, supply would start to shrink as unprofitable extraction ceased and demand recovered. In the months to come this would boost oil prices.
The increased price would cut into the profit margins of the recession battered industries. Within months of rebounding oil prices, consumers and businesses would have no choice but to reduce their consumption of oil once again.
You may have noted that this sounds eerily familiar. This of course started in 2008. Car companies failed, transcontinental shipping collapsed, consumption of plastic crashed, manufacturing collapsed and all non essential transportation was cut.
2008 was a bad storm of course: rising gas prices, falling home values and insolvent banks.
In a matter of months oil fell from over $140 a barrel to $30. Note that the price of oil fell so hard because of the severity of the restructuring of demand that occurred when it went so high.
So now think about this: The problems today are worse then they were in 2008.
Credit is now contracting in the US; The banks are even more broke when they were then, but its hidden thanks to not marking to market; Debt has exploded as governments use fiscal and monetary policy to stimulate their economies into buying up plenty of resources they would never otherwise purchase; Manufacturing has continued to shrink; The stock market, using price to earnings for the trailing 12 months, is the most expensive it’s ever been on record; Unemployment has doubled; US incomes have fallen 5%.
If we couldn’t afford it in 2008, what makes anyone think we can afford it in 2009 or 2010? We of course cannot afford to pay a higher price for oil. In fact we can afford much less than we did in 2008.
So if the cost of oil rises due to production costs it should be crystal clear to everyone how the world economy will react.
The economy would be forced to shrink until oil falls to a price that it can afford.
Therefore oil has only one direction to head in the long term and that’s down. Each time oil pushes for a higher price, it will be forced only months later to an even lower price.
And as the economy shrinks time and time again, it can afford less and less. Oil will continuously hit new lows.
Essentially this is a deflationary recession that I’m describing. And that in my opinion is what is the most likely outcome
in a capitalist economy.
These pressures are on top of the deflationary pressures of a credit collapse that I have spoken much about in previous posts.
Thus expect deflation to curb oil prices in an extremely volatile manner.
The world economy may rebound when it restructures itself from oil dependence. But restructuring to rely on cheaper alternative sources of energy won’t bear well for oil either. Thus peak oil may be reason to be bearish on the oil markets in the long term. Not bullish.
Jonathan Tonge
www.americacanada.blogspot.com
Please note that this post is not to be interpreted as an investment recommendation. Please speak to a certified financial/investment advisor to create an investment strategy that is the right fit for you.
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