Category Archive for: Oil [Return to Main]

Friday, July 15, 2016

The Outsized Impact of the Fall in Commodity Prices on Global Trade

Brad Setser:

The Outsized Impact of the Fall in Commodity Prices on Global Trade: Global trade has not grown since the start of 2015.
Emerging market imports appear to be running somewhat below their 2014 levels.
Creeping protectionism? Perhaps.
But for now the underlying national data points to much more prosaic explanation.
The “turning” point in trade came just after oil prices fell. ...

Wednesday, June 15, 2016

Still Living in a Fossil Fuel World

Tim Taylor:

Still Living in a Fossil Fuel World: An enormous number of pixels are spent on renewable energy, but when one looks at actual numbers, we are still living in a fossil fuel world. Here are some illustrative charts from the most recent annual BP Statistical Review of World Energy, released June 2016.
Here's a breakdown of world energy consumption. The big slices are all fossil fuels: green is oil; red is natural gas; grey is coal. The little slices are carbon-free sources of energy: nuclear is light orange, hydroelectric is blue, and renewables are darker orange. As the report notes: "Oil remains the world’s dominant fuel and gained global market share for the first time since 1999, while coal’s market share fell to the lowest level since 2005. Renewables in power generation accounted for a record 2.8% of global primary energy consumption."

Reserves of fossil fuels are not running down. Here are figures showing the years remaining of reserves of oil, natural gas, and coal. The figures show a breakdown by region, which isn't especially relevant given that energy can be shipped between regions. Instead, focus on the gray line showing reserves at the world level. Reserves of oil and natural gas, as measured by years remaining, are not declining over time. Reserves of coal are declining, but there is more than century of reserves remaining. It may seem obvious that reserves must decline over time, but technological change doesn't just work with renewables like solar and wind. It also finds new sources of fossil fuels and new methods of extraction.

In short, if your environmental goals involve a reduction in the use of fossil fuels over time, this goal is unlikely to happen because the world starts running low on fossil fuels. Instead, it's more likely to require some significant policy changes to discourage the use fossil fuels. For a more detailed version of this argument, along with a complementary argument that technological progress by itself is unlikely to drive a smooth shift over to renewable energy sources, a nice starting point is the article by Thomas Covert, Michael Greenstone, and Christopher R. Knittel, "Will We Ever Stop Using Fossil Fuels?" in the Winter 2016 issue of the Journal of Economic Perspectives.  (Full disclosure: I've worked as Managing Editor of JEP since the first issue back in 1987.)

Sunday, April 24, 2016

Causes and consequences of the oil price decline of 2014-2015 (Video)

Thursday, March 24, 2016

'Oil Prices and the Global Economy: It’s Complicated'

Maurice Obstfeld, Gian Maria Milesi-Ferretti, and Rabah Arezki::

Oil Prices and the Global Economy: It’s Complicated: Oil prices have been persistently low for well over a year and a half now, but as the April 2016 World Economic Outlook will document, the widely anticipated “shot in the arm” for the global economy has yet to materialize. We argue that, paradoxically, global benefits from low prices will likely appear only after prices have recovered somewhat, and advanced economies have made more progress surmounting the current low interest rate environment. ...
This outcome has puzzled many observers including us at the Fund, who had believed that oil-price declines would be a net plus for the world economy, obviously hurting exporters but delivering more-than-offsetting gains to importers. The key assumption behind that belief is a specific difference in saving behavior between oil importers and oil exporters: consumers in oil importing regions such as Europe have a higher marginal propensity to consume out of income than those in exporters such as Saudi Arabia. ...
To address this question, the forthcoming April 2016 World Economic Outlook compares 2015 domestic demand growth in oil importers and oil exporters to what we expected in April 2015—after the first substantial decline in oil prices. The lion’s share of the downward revision for global demand comes from oil exporters—despite their relatively small share of global GDP (about 12 percent). But domestic demand in oil importers was also no better than we had forecast, despite a fall in oil prices that was bigger than anticipated. ...

Skipping forward to the final paragraph:

Persistently low oil prices complicate the conduct of monetary policy, risking further inroads by unanchored inflation expectations. What is more, the current episode of historically low oil prices could ignite a variety of dislocations including corporate and sovereign defaults, dislocations that can feed back into already jittery financial markets. The possibility of such negative feedback loops makes demand support by the global community—along with a range of country-specific structural and financial-sector reforms—all the more urgent.

Sunday, January 24, 2016

'Can Lower Oil Prices Cause a Recession?'

Jim Hamilton:

Can lower oil prices cause a recession?: ...A drop in oil prices means less money in the hands of oil producers but more money in the hands of oil consumers. Currently the U.S. is importing about 5.1 million barrels a day more than we’re exporting of crude oil and petroleum products. At $100 a barrel, that had been a net drain on the U.S. economy of $190 billion each year. That drain that will now be cut by more than half by falling oil prices.
We usually see consumers spend their extra income right away, whereas it takes more time for producers to alter their spending plans. As a result, even if the U.S. was not a net importer of oil, we might still expect to see a short-run positive stimulus from dropping oil prices. ... The conclusion I draw ... is that each consumer spent more than they would have if oil prices had not fallen, but that there were other macro headwinds at the same time that were offsetting some of the positive stimulus of falling oil prices.
In any case, we’ve now had plenty of time for cuts in spending by U.S. oil producers to start to have an economic effect of their own. If there’s an increase in spending by consumers of $1 and a decrease in spending by producers of $1, it’s not really a net wash for the economy. The reason is that the consumers are spending their money in different places and on different items than the producers are cutting. There is a lot of specialized labor and capital that’s involved in oil extraction that can’t move costlessly to some other sector when the oil patch goes sour. ...
And of course we’re talking here not just about the people who work in the oil industry itself but all the other industries and services that sell to the oil sector and more in turn who sell to these suppliers. ...
There are thus some reasons why a decrease in oil prices would be a boost to the U.S. economy and other reasons why it could even be a drag. A number of studies have looked at the effects of oil price decreases and concluded that these have little or no net positive effect on U.S. real GDP growth...

Sunday, January 17, 2016

'The Price of Oil, China, and Stock Market Herding'

Olivier Blanchard:

The Price of Oil, China, and Stock Market Herding: The stock market movements of the last two weeks are puzzling.
Take the China explanation. A collapse of growth in China would indeed be a world changing event. But there is just no evidence of such a collapse. ...
Take the oil price explanation. It is even more puzzling. Traditionally, it was taken for granted that a decrease in the price of oil was good news for oil importing countries such as the United States. ... We learned in the last year that, in the short run, the adverse effect on investment on energy producing firms could come quickly and temporarily slow down the effect, but this surely does not undo the general conclusion. Yet the headlines are now about low oil prices leading to low stock prices. ...
Maybe we should not believe the market commentaries. Maybe it was neither oil nor China. Maybe what we are seeing is a delayed reaction to the slowdown in the world economy... Maybe…
I think the explanation is largely elsewhere. I believe that to a large extent, herding is at play. If other investors sell, it must be because they know something you do not know. Thus, you should sell, and you do, and so down go stock prices. Why now? Perhaps because we have entered a period of higher uncertainty. ...
So how much should we worry? This is where economics ... gives the dreaded two-handed answer. If it becomes clear within a few days or a few weeks that fundamentals are in fact not so bad, stock prices will recover... If, however, the stock market slump lasts longer or gets worse, it can become self-fulfilling. Low stock prices lasting for long lead to lower consumption, lower demand, and, potentially, to a recession. The ability of the Fed, fresh out of the zero lower bound, to counteract a slowdown in demand remains limited. One has to hope for the first scenario, but worry about the second.

Saturday, January 16, 2016

'Oil Goes Nonlinear'

Paul Krugman:

Oil Goes Nonlinear: When oil prices began their big plunge, it was widely assumed that the economic effects would be positive. Some of us were a bit skeptical. But maybe not skeptical enough: taking a global view, there’s a pretty good case that the oil plunge is having a distinctly negative impact. Why? ...
I believe ... there’s an important nonlinearity in the effects of oil fluctuations. A 10 or 20 percent decline in the price might work in the conventional way. But a 70 percent decline has really drastic effects on producers; they become more, not less, likely to be liquidity-constrained than consumers. Saudi Arabia is forced into drastic austerity policies; highly indebted fracking companies find themselves facing balance-sheet crises.
Or to put it differently: small oil price declines may be expansionary through usual channels, but really big declines set in motion a process of forced deleveraging among producers that can be a significant drag on the world economy, especially with the whole advanced world still in or near a liquidity trap.

Sunday, November 29, 2015

Commodity Prices, Exchange Rates, and the Fed

Jim Hamilton's bottom line is worth noting:

Commodity prices and exchange rates: The dramatic decline in the prices of a number of commodities over the last 16 months must have a common factor. One variable that seems to be quite important is the exchange rate. ...
One would expect that when the dollar price of other countries’ currencies falls, so would the dollar price of internationally traded commodities. But it is a mistake to say that the exchange rate is the cause of the change in commodity prices. The reason is that exchange rates and commodity prices are jointly determined as the outcome of other forces. ...
For example,... the Great Recession in 2008-2009 ... meant falling demand for commodities. It was also associated with a flight to safety in capital markets, which showed up as a surge in the value of the dollar. It’s not the case that the strong dollar then was the cause of falling dollar prices of oil and copper. Instead, the Great Recession was itself the common cause behind movements in all three variables. ...
I had been giving a similar interpretation to the correlation since June 2014 ... – news about weakness in the world economy seemed to be a key reason for strength of the dollar..., and would also be a reason for declining commodity prices.
However, developments of the last three weeks call for a different explanation. The October 28 FOMC statement and subsequent statements by Fed officials have made clear that a hike in U.S. interest rates is coming December 16. An increase in U.S. interest rates relative to our trading partners is the primary reason that the dollar appreciated 4% (logarithmically) since October 16. Over that same period the dollar price of oil and copper each fell 16%. ...
I will offer the view, based on the market reaction so far, that if the Fed’s objective in raising rates is to lower U.S. inflation and GDP, it seems to have taken a significant step in that direction.

[There's quite a bit more analysis in the full post.]

Wednesday, March 18, 2015

'Arezki, Ramey, and Sheng on News Shocks'

I was at this conference as well. This paper was very well received (it has been difficult to find evidence that news generates business cycles, in part because it's been difficult to find a "clean" shock):

Arezki, Ramey, and Sheng on news shocks: I attended the NBER EFG (economic fluctuations and growth) meeting a few weeks ago, and saw a very nice paper by Rabah Arezki, Valerie Ramey, and Liugang Sheng, "News Shocks in Open Economies: Evidence from Giant Oil Discoveries" (There were a lot of nice papers, but this one is more bloggable.)

They look at what happens to economies that discover they have a lot of oil. ... An oil discovery is a well identified "news shock."

Standard productivity shocks are a bit nebulous, and alter two things at once: they give greater productivity and hence incentive to work today and also news about more income in the future.

An oil discovery is well publicized. It incentivizes a small investment in oil drilling, but mostly is pure news of an income flow in the future. It does not affect overall labor productivity or other changes to preferences or technology.
Rabah,Valerie, and Liugang then construct a straightforward macro model of such an event. ...[describes model and results]...

Valerie, presenting the paper, was a bit discouraged. This "news shock" doesn't generate a pattern that looks like standard recessions, because GDP and employment go in the opposite direction.

I am much more encouraged. Here are macroeconomies behaving exactly as they should, in response to a shock where for once we really know what the shock is. And in response to a shock with a nice dynamic pattern, which we also really understand.

My comment was something to the effect of "this paper is much more important than you think. You match the dynamic response of economies to this large and very well identified shock with a standard, transparent and intuitive neoclassical model. Here's a list of some of the ingredients you didn't need: Sticky prices, sticky wages, money, monetary policy, (i.e. interest rates that respond via a policy rule to output and inflation or zero bounds that stop them from doing so), home bias, segmented financial markets, credit constraints, liquidity constraints, hand-to-mouth consumers, financial intermediation, liquidity spirals, fire sales, leverage, sudden stops, hot money, collateral constraints, incomplete markets, idiosyncratic risks, strange preferences including habits, nonexpected utility, ambiguity aversion, and so forth, behavioral biases, nonexpected utility, or rare disasters. If those ingredients are really there, they ought to matter for explaining the response to your shocks too. After all, there is only one economic structure, which is hit by many shocks. So your paper calls into question just how many of those ingredients are really there at all."

Thomas Phillipon, whose previous paper had a pretty masterful collection of a lot of those ingredients, quickly pointed out my overstatement. One needs not need every ingredient to understand every shock. Constraint variables are inequalities. A positive news shock may not cause credit constraints etc. to bind, while a negative shock may reveal them.

Good point. And really, the proof is in the pudding. If those ingredients are not necessary, then I should produce a model without them that produces events like 2008. But we've been debating the ingredients and shock necessary to explain 1932 for 82 years, so that approach, though correct, might take a while.

In the meantime, we can still cheer successful simple models and well identified shocks on the few occasions that they appear and fit data so nicely. Note to graduate students, this paper is a really nice example to follow for its integration of clear theory and excellent empirical work.

Monday, January 12, 2015

Paul Krugman: For the Love of Carbon

What's the real reason Republicans are pushing for the Keystone XL pipeline?:

For the Love of Carbon, Commentary, NY Times: It should come as no surprise that the very first move of the new Republican Senate is an attempt to push President Obama into approving the Keystone XL pipeline... After all,... the oil and gas industry — which gave 87 percent of its 2014 campaign contributions to the G.O.P. — expects to be rewarded for its support.
But why is this environmentally troubling project an urgent priority in a time of plunging world oil prices? Well, the party line, from people like Mitch McConnell, the new Senate majority leader, is that it’s all about jobs. ...
Let’s back up for a minute and discuss economic principles. For more than seven years ... the United States economy has suffered from inadequate demand. ... In such an environment, anything that increases spending creates jobs. ...
From the beginning, however, Republican leaders have held ... that we should slash public spending... And they’ve gotten their way... The evidence overwhelmingly indicates that this kind of fiscal austerity in a depressed economy is destructive...
Needless to say, the guilty parties here will never admit that they were wrong. But if you look at their behavior closely, you see clear signs that they don’t really believe in their own doctrine.
Consider, for example, the case of military spending. When it comes to possible cuts in defense contracts, politicians ... suddenly begin talking about all the jobs that will be destroyed. ... This is the phenomenon former Representative Barney Frank dubbed “weaponized Keynesianism.”
And the argument being made for Keystone XL is very similar; call it “carbonized Keynesianism.” ... But government spending on roads, bridges and schools would do the same thing. ... If Mr. McConnell and company really believe that we need more spending to create jobs, why not support a push to upgrade America’s crumbling infrastructure?
So what should be done about Keystone XL? If you believe that it would be environmentally damaging — which I do — then you should be against it, and you should ignore the claims about job creation. The numbers being thrown around are tiny compared with the country’s overall work force. And in any case, the jobs argument for the pipeline is basically a sick joke coming from people who have done all they can to destroy American jobs — and are now employing the very arguments they used to ridicule government job programs to justify a big giveaway to their friends in the fossil fuel industry.

Sunday, January 11, 2015

'Demand Factors in the Collapse of Oil Prices'

Jim Hamilton:

Demand factors in the collapse of oil prices: The price of oil passed another milestone last week, falling below $50 a barrel, a level that I had not expected to see again in my lifetime.
It’s interesting that we crossed another milestone last week, with the yield on 10-year Treasury bonds falling below 2%. That, too, is something I had not expected to see.
And these two striking developments are surely related. I attribute sinking yields to ongoing weakening of the global economy, particularly Europe. And slower growth of world GDP means slower growth in the demand for oil. Other indicators of an economic slowdown outside the United States are falling prices of other commodities and a strengthening dollar.
A month ago I provided some simple analysis of the connection between these developments... The price of oil has fallen another $8/barrel since then, prompting me to update those calculations. ... On the basis of the above regression,... of the $55 drop in the price of oil since the start of July, about $24, or 44%, seems attributable to broader demand factors rather than anything specific happening to the oil market. That’s almost the same percentage as when I performed the calculation using data that we had available a month ago.
So what’s been happening on the supply side of oil markets is important. But so is what’s been happening on the demand side. ...

Sunday, January 04, 2015

'Let This be the Year When We Put a Proper Price on Carbon'

Larry Summers:

Let this be the year when we put a proper price on carbon: The case for carbon taxes has long been compelling. With the recent steep fall in oil prices and associated declines in other energy prices it is overwhelming. There is room for debate about the size of the tax and about how the proceeds should be deployed. But there should be no doubt that starting from the current zero tax rate on carbon, increased taxation would be desirable.
The core of the case for taxation is the recognition that those who use carbon-based fuels or products do not bear all the costs of their actions. ...
Progressives who are concerned about climate change should rally to a carbon tax as the most important step for mobilising against it. Conservatives who believe in the power of markets should favour carbon taxes on market principles. .... Now is the time.

Sunday, December 21, 2014

'The Net Petroleum Exporter Myth'

Bill McBride at Calculated Risk:

Katie Couric and the Net Petroleum Exporter Myth: To understand what the general public is hearing about oil, I watched a Yahoo video yesterday with Katie Couric explaining the decline in oil prices.

In general the piece was very good. Couric started by explaining that the decline in oil prices could be explained in two words: Supply and Demand.  She discussed reasons for more supply and softening demand. ...

But then Couric mentioned a myth I've heard several times recently. She said:

In fact, [the U.S.] is now the world’s largest producer of petroleum, and for the last two years, it has been selling more to other countries than it’s been buying. Who knew?

"Who knew?"  No one, because it is not true. Yes, the U.S. is the largest producer this year (ahead of Saudi Arabia and Russia), but the U.S. is NOT "selling more to other countries than it's been buying".

The source of this error is that the U.S. is a net exporter of refined petroleum products, such as refined gasoline. Here is the EIA data on Weekly Imports & Exports of crude oil and petroleum products.  The U.S. is importing around 9 million barrels per day of crude oil and products, and exporting around 4 million per day (mostly refined products). The U.S. is a large net importer! ...

Sunday, November 23, 2014

'Lower Oil Prices and the U.S. Economy'

Jim Hamilton:

Lower oil prices and the U.S. economy: ... The current price of gasoline is 80 cents/gallon below what it has averaged over the last 3 years. Last year Americans consumed 135 billion gallons of gasoline. That means that if prices stay where they are, consumers will have an extra $108 billion each year to spend on other things. And if the historical pattern holds, spend it they will. ...
But another thing that’s changed is that much more of the oil we consume is now being produced right here at home. While lower prices are a boon for consumers, they pose a potential threat to producers, especially the higher-cost operators. ...
If there are employment cuts in places like Texas, Louisiana, and North Dakota, that would obviously offset some of the gains to consumers noted above, and ultimately undercut the major force keeping the price of crude low for the time being, that being the success of small U.S. oil producers.
Nevertheless, there should be no question that at this point this is a favorable development on-balance for the U.S. economy. We’re still importing 5 million more barrels each day of petroleum and products than we are exporting. Importing fewer barrels, and paying less for the barrels we do import, is a good thing.

Sunday, October 19, 2014

'How will Saudi Arabia Respond to Lower Oil Prices?'

Jim Hamilton:

How will Saudi Arabia respond to lower oil prices?: Oil prices (along with prices of many other commodities) have fallen dramatically since last summer. Some observers are waiting to see if Saudi Arabia responds with significant cutbacks in production. I say, don’t hold your breath. ...
Last week I discussed the three main factors in the recent fall in oil prices: (1) signs of a return of Libyan production to historical levels, (2) surging production from the U.S., and (3) growing indications of weakness in the world economy. ...
In terms of surging U.S. production, the key question is how low the price can get before significant numbers of U.S. producers ... move into the red..., it’s in the Saudis’ longer-term interests to let that pain take its toll until some of the newcomers decide to pack up and go home. If U.S. production does decline, prices would quickly move back up. But if that happens after a shake-out, the next time there would be less enthusiasm for everybody to jump into the game...
My guess is that Saudi Arabia would lower prices rather than cut production as long as that’s the name of the game. ...

Sunday, October 12, 2014

Factors Behind Lower Oil Prices

Jim Hamilton:

Lower oil prices: For the last 3 years, European Brent has mostly traded in a range of $100-$120 with West Texas intermediate selling at a $5 to $20 discount. But in September Brent started moving below $100 and now stands at $90 a barrel, and the spread over U.S. domestic crude has narrowed. Here I take a look at some of the factors behind these developments. ...

One factor has been weakness in Europe and Japan, which means lower demand for commodities as well as a strengthening dollar. ...

In terms of factors specific to the oil market, one important development has been the recovery of oil production from Libya. ...

But the biggest story is still the United States. Thanks to horizontal drilling to get oil out of tight underground formations... Just how low the price can go before some of the frackers start to drop out is subject to some debate. ...

Thursday, February 06, 2014

'Do Oil Prices Predict Inflation?'

Apparently not:

Do Oil Prices Predict Inflation?, by Mehmet Pasaogullari and Patricia Waiwood, FRB Cleveland: Some analysts pay particular attention to oil prices, thinking they might give an advance signal of changes in inflation. However, using a variety of statistical tests, we find that adding oil prices does little to improve forecasts of CPI inflation. Our results suggest that higher oil prices today do not necessarily signal higher CPI inflation next year, although they do help to explain short-term movements in the CPI. ...

Monday, February 03, 2014

'Keystone: The Pipeline to Disaster'

In case you want to talk about this (I don't have a well-formed opinion on the pipeline itself, I haven't done enough reading about it, so hoping to learn something from the comments):

Keystone: The Pipeline to Disaster, by Jeff Sachs: The new State Department Environmental Impact Statement for the Keystone Pipeline does three things. First, it signals a greater likelihood that the pipeline project will be approved... Second, it vividly illustrates the depth of confusion of US climate change policy. Third, it self-portrays the US Government as a helpless bystander to climate calamity.. ...
The pipeline will ... facilitate the mass extraction and use of Canada's enormous unconventional supplies. Therein lies the problem. ... The economic implications of the climate science are clear. Either we keep some of the world's oil, gas, and coal reserves under the ground..., or we wreck the planet. ... The most important single step is to keep most of the coal from being burned. ...
The Keystone pipeline is crucial to the global carbon budget. If the world deploys massive unconventional oil sources like Canada's oil sands we will exceed the carbon budget,... cheaper, (relatively) cleaner, and lower-CO2 oil is available. ...
Herein lies the tragic, indeed fatal, flaw of the State Department review. The ... State Department simply assumes ... that the oil sands will be developed and used one way or another. ... According to the State Department, in other words, the US Government is just a passive spectator to global climate change. Either the pipeline is built or the oil will be shipped by other means. ...
But do not lose hope. ... The vast majority of Americans want safety for themselves, their children, and the rest of humanity. Our generation can still turn the tide against environmental disaster.

Sunday, November 17, 2013

Posts on Gasoline Prices and Secular Stagnation

I'm visiting my son Paul in Seattle today (he works at Amazon as an analyst), so just a quick post for now on two topics. First is Jim Hamilton on oil prices. He explains why the "boom in domestic drilling is bringing some real benefits to the U.S. economy. But a lower gasoline price for U.S. consumers isn't one of them":

Lower gasoline prices: "U.S. gasoline prices have fallen to their lowest level in nearly 33 months amid a boom in domestic oil drilling", the Wall Street Journal declared last week. That's a true statement, but there's more to the story.
Americans are indeed facing the lowest gasoline prices in almost three years, but not by much. ...

Second, at the risk of having a thin set of links for tomorrow, Paul Krugman's discussion of Larry Summer's recent talk on secular stagnation has generated quite a few responses:

Summer's presentation at the IMF Research Conference
Krugman's first post: Secular Stagnation, Coalmines, Bubbles, and Larry Summers


Dean Baker: Bubbles Are Not Funny
Paul Krugman: Me Too! Blogging
Gavyn Davies: The implications of secular stagnation
Jared Bernstein: Paul, Larry, Secular Stagnation, and the Impact of Negative Real Rates

Sunday, September 15, 2013

'The Peak in World Oil Production is Yet to Come'

Jim Hamilton:

The peak in world oil production is yet to come: World oil production stagnated between 2005 and 2007, which given rapid growth in demand from emerging economies sent oil prices shooting up. Some observers suggested that production might never rise much above the levels seen in 2005. Among those who raised this possibility, two of the more thoughtful have changed their mind. Euan Mearns last month summarized what he saw as three (or four) nails in the coffin of peak oil. And Stuart Staniford, an early editor and contributor for the Oil Drum, declared a few weeks ago that the data have spoken. ...

He ends with:

Those who thought that world oil production would peak in 2005 have been proven to be wrong. But so, too, were those who thought the run-up in oil prices of the last decade would be a temporary disruption until we found a way to return to the world as it had been for a century up until that point.

Thursday, July 25, 2013

Hamilton: Krugman's Worries about China

Jim Hamilton says to keep your eyes on China's economy:

Worries about China, by Jim Hamilton: Paul Krugman is among those starting to be concerned about an economic downturn in China. Here are my thoughts on this issue.

... What rings alarm bells for me is the recent sharp spikes in interbank lending rates..., such moves could definitely be signaling some financial fragility. ...

Paul Krugman writes:

Suppose that those of us now worried that China's Ponzi bicycle is hitting a brick wall (or, as some readers have suggested, a BRIC wall) are right. How much should the rest of the world worry, and why?

I'd group this under three headings:

1. "Mechanical" linkages via exports, which are surprisingly small.
2. Commodity prices, which could be a bigger deal.
3. Politics and international stability, which involves some serious risks.

To Paul's list, I would add a fourth: financial linkages. If there are significant disruptions to China's system for funding credit, that could have implications for anyone borrowing from or lending to Chinese entities.....

I'd also like to add an observation to Paul's second point involving commodity prices. A significant economic downturn in China could well mean a collapse in oil prices. One would think that, as a net importer, this would be an overall favorable development for the United States, and certainly it would be a significant plus for many individual U.S. firms and producers. But it's worth remembering what happened after the collapse in oil prices in 1986. In the years leading up to that, just as today, there had been a dramatic economic boom in the U.S. oil-producing states... When oil prices collapsed, domestic producers took a significant hit. ...

My bottom line: China is worth watching.

Tuesday, May 21, 2013

Energy and Economic Growth

I did an interview with James Stafford of

Energy and Economic Growth

It covers a few other topics as well.

Sunday, February 10, 2013

'Why the Prices of Oil and Gasoline are Climbing Again'

Jim Hamilton says:

Those who have been told that oil production is booming may be wondering why the prices of oil and gasoline are climbing again.

Here's his explanation.

Tuesday, November 27, 2012

'By 2035, We Project Oil Imports into the US of Only 3.4 Million Barrels a Day'

Fatih Birol, chief economist of the International Energy Agency and chair of the World Economic Forum’s Energy Advisory Board, discusses his projection that "the United States will become the world’s leading oil producer within a few decades":

Q. The new report has attracted great press attention for its projection that the United States may soon become the world’s leading oil producer. Can you discuss what you see as the greatest implications of this change, in terms of energy security, geopolitics and carbon emissions?

A. The most striking implications concern U.S. oil imports and international oil-trade patterns. The upward trend in production is partly responsible for a sharp fall in U.S. oil imports. By 2035, we project oil imports into the United States of only 3.4 million barrels a day, which implies a substantial (60 percent) reduction in oil-import bills. North America as a whole actually becomes a net oil exporter. In international oil markets, this accelerates the shift in trade patterns toward Asia, raising the geostrategic importance of trade routes between Middle East producers and Asian consumers.

But what should attract equal attention … is the essential role played by energy efficiency. I believe that energy efficiency has been an epic failure by policymakers in almost all countries. Its potential is huge but much of it remains untapped. Compared with today, savings from more rigorous vehicle fuel-economy standards could prompt a 30 percent fall in U.S. oil demand by 2035.

Wednesday, November 14, 2012

Carbon Taxes and the National Debt

I am hearing a lot lately about using a carbon tax to fill the budget gap. I'm all for a carbon tax, internalizing externalities so that these markets work better is a good idea if we can somehow get through the political barriers, but we shouldn't be overly optimistic about how much revenue such a tax will bring.

In order to get support for such a tax and to implement it equitably, some groups will need to be compensated for the higher energy costs they will face. For example, these proposals often come with a proposal to return some of the tax as a lump-sum payment to lower income households (the microeconomics of a tax on carbon combined with lump-sum payments can be found here). Presumably, the higher the threshold for "low income," the easier it will be to get support for a carbon tax proposal, so there will be pressure for the compensation to extend, perhaps on a sliding scale, to middle class households.

And, at least in the initial years, there are other groups that will likely need to be compensated (okay, bought off) in order to garner the necessary political support.

All of these attempts to insulate various groups from the consequences of the tax (through fancy schemes that retain te incentive to save energy) will eat into potential revenue, and the fact that the response to the tax will be greater as more time passes -- for example as people switch to more efficient cars and appliances -- will also reduce revenue (this is not a problem in a larger sense, such substitutions are the whole point of the tax, but it does reduce the revenue).

Overall, the point is a simple one: don't overestimate the revenue from a carbon tax.

Sunday, October 21, 2012

'Reducing Oil Imports'

Jim Hamilton:

Reducing oil imports, by Jim Hamilton: ...In 2011, the U.S. imported $462 billion of petroleum and petroleum products, or more than a billion dollars every day (see BEA Table 4.2.5). The fact that we import goods from other countries is not a problem per se. Standard economic theory teaches that if the U.S. imports some goods and exports others, the country overall will be richer than in the absence of trade, because the value of what we gain in imports is higher to us than the value of what we sell as exports. But in the current U.S. situation, our oil imports aren't balanced by other exports. Last year the U.S. spent $568 billion more on imported goods and services than we sold to other countries, with petroleum imports accounting for more than 80% of the total current account deficit
When we import more than we export, we have to pay for the difference either by selling off some of our assets or by borrowing more from foreigners. Notwithstanding, running a current account deficit could still be a way to make the country richer. If we use the imported goods and borrowed funds to invest in productive capital and useful infrastructure, we should have plenty of future resources to pay back all that we borrowed, with more left over for ourselves. In such a case, a big current account deficit could still be a win-win situation.
But what if we're not investing, and are just using the imports and foreign borrowing to enjoy a temporarily higher standard of living, leaving it to the future to pay the bills? That, too, could be economically optimal if what we most value as a nation is having more consumption spending right now.
But I'm not convinced that's the future that most Americans want. ...
I agree with the position taken by both President Obama and Governor Romney that presidential decisions need to encourage more oil production in the United States.
However, I would add that policies that discourage U.S. consumption of petroleum would also achieve the same goal. For example, trying to make more use of our natural gas resources for transportation is an idea that should appeal to Americans on both sides of the political spectrum. ...
I retain the hope that, whoever wins the election, they might seize the opportunity to move the country in a more positive direction by focusing on some goals and strategies on which both political parties should be able to agree.
Increasing U.S. oil production and decreasing U.S. oil consumption should be two such goals.

I see more difference between the candidates on the drill versus conserve continuum, and I'd guess I tilt more toward the conservation/find new energy sources end of the spectrum than he does. In addition, I wish the externalities associated with energy use and the need to use some form of regulation to reduce them (e.g. carbon tax, cap and trade, etc.) -- regulation that should discourage consumption -- had been mentioned (a point where the two parties clearly differ -- it matters who is elected).

Wednesday, September 26, 2012

Are Oil Prices 'Determined Solely by Fundamentals'?

Jim Hamilton on what determines prices in oil markets:

...The Wall Street Journal carried this account last week:

Oil prices dropped more than $3 in less than a minute late in the trading day on Monday, just as trading volume spiked. The move also dragged down prices of gold, copper and even the euro.

"Traders were looking like deer in the headlights," said Peter Donovan, a floor trader... "I called four different desks, and they all said, 'we don't know.' " ...

The move sparked talk of an erroneous trade—called a "fat-finger" error in industry parlance—or a computer algorithm gone awry.

Fat finger or no, there was an even bigger drop on Wednesday...

Those who doubt that oil prices are determined solely by fundamentals would naturally ask, what aspect of the supply or demand for oil could have possibly changed in the course of less than a minute last Monday? The obvious and correct answer is, there was no change in either the supply or the demand for physical oil over the course of that minute. The minute-by-minute price of a NYMEX contract is determined by how many people are wanting to buy that financial contract and at what price, not by how much gasoline motorists burned in their cars that minute. But since changes in the price of crude oil are the key determinant of the price consumers pay for gasoline, doesn't that establish pretty clearly that the whims or fat fingers of financial traders are ultimately determining the price we all pay at the pump?
In one sense, the answer to that question is yes-- last week's decline in the price of crude oil will soon show up as a lower price Americans pay for gasoline. But here's the problem you run into if you try to carry that theory too far. There are at the end of this chain real people who burn real gasoline when they drive real cars. And how much gasoline they burn depends in part on the price they pay-- with a higher price, some people use a little bit less. Not a lot less-- the price of gasoline could change quite a lot and it would take some time before you could be sure you see a response in the data. That small (and often sluggish) response is why the price of oil can and does move quite a bit on a minute-by-minute basis, seemingly driven by forces having nothing to do with the final users of the product.
But if the price of oil that emerges from that process turns out to be one at which the quantity of the physical product that is consumed is a different amount from the physical quantity produced, something has to give. Indeed, the bigger price drops we saw on Wednesday followed news that U.S. inventories of crude were significantly higher than expected ...

Wednesday, June 20, 2012

Peak Oil and Price Incentives

Jim Hamilton, in a post called Peak oil and price incentives:

... We like to think that the reason we enjoy our high standards of living is because we have been so clever at figuring out how to use the world's available resources. But we should not dismiss the possibility that there may also have been a nontrivial contribution of simply having been quite lucky to have found an incredibly valuable raw material that for a century and a half or so was relatively easy to obtain. Optimists may expect the next century and a half to look like the last. Benes and coauthors are suggesting that instead we should perhaps expect the next decade to look like the last.

Sunday, June 17, 2012

Kenya: Oil and Isolation

Will then discovery of oil in the Turkana region of Kenya lead to civil conflict that rips the country apart?:

Oil and Isolation, by Juliet Torome, Commentary, Project Syndicate: In Kenya, there is a running gag that sums up how far away the Turkana people live from the rest of us. When a Turkana man leaves for the capital, Nairobi, the joke goes, he tells his family, “I’m going to Kenya.” ...
The Turkana people are, as the joke suggests, as far away from Nairobi as one can be without being foreigners. For this reason, we know very little about them. In schools, we learned about them only within the context of the Leakey family’s decades-long work excavating the Lake Turkana basin in search of fossils of humans’ ancestors. This could be one reason why Kenyans have historically looked at the Turkana people as archaic beings, millennia away from “civilization” and with different needs from most of the country.
The lack of adequate infrastructure in the Turkana region is evidence of this. Unlike the Maasai, the Turkana inhabit a region that, until now, was of little or no value to the country. There are no wild animals to attract tourists, and, although the Turkana, like the Maasai, have preserved their indigenous culture, they are not renowned around the world, perhaps because of their distance from Nairobi. ...
The discovery of oil presents Kenya with a rare opportunity to end the Turkana community’s marginalization. Discussion of how the oil exploration and extraction will proceed needs to start now, and the health of the environment surrounding the Turkana people must be paramount. ...
Some of the precautions... to safeguard ... welfare include establishing a regulatory body that fosters transparency in contract negotiations; balancing oil production with conservation of the area’s unique biodiversity; enforcing high standards of corporate responsibility; and regulating land sales to prevent conflicts. Finally, the government should ensure that Turkana people are trained to understand and participate in the new sector.
If Kenya approaches oil exploration and extraction ... and fails to implement these common-sense recommendations, a few years from now Kenyans might be sorry that oil was ever found. Indeed, Kenya could end up with a conflict similar to the one in Nigeria’s Niger Delta, where local people took up arms to fight the oil industry’s degradation of their environment.
Unfortunately, the foundation for such a conflict has already, sadly, been laid. Many people in the Lake Turkana region are already armed with AK-47s and other weapons originally intended for protection from cattle rustlers. If Kenya’s government fails to protect the Turkana from the oil companies as well, its people might well start shooting.

Wednesday, June 06, 2012

Fed Watch: Supply and Demand

Tim Duy has a question:

Supply and Demand, by Tim Duy: I caught this via Brad Plummer:


Am I the only one who finds this kind of chart uncomfortable?  Because it seems to say that quantity demanded is consistently higher than quantity supplied, which could only be maintained via a perpetual inventory drain on the order of what looks to be a couple of million barrels a day. I don't think that's happening.  If production is really at the levels indicated in this chart, what stops prices from rising and collapsing quantity demanded down to quantity supply?  
What am I missing?

Saturday, April 21, 2012

"Speculation in Oil Markets? What Have We Learned?"

More on the impact, or lack thereof, of speculation in oil markets (one of the issues is how to define speculation, and what types of speculation are good/bad according to some metric -- see here and here for more on that topic):

Speculation in oil markets? What have we learned?, by Lutz Kilian, Vox EU: A popular view is that the unprecedented surge in the spot price of oil during 2003–08 cannot be explained by changes in economic fundamentals, but was driven by the increased financialization of oil futures markets.1 It is well documented that, starting in 2003, there was an influx of financial investors such as index funds into oil futures markets. At about the same time, both spot and futures prices of crude oil began to surge, soon reaching unprecedented levels and peaking at a record high in mid-2008. A popular view among pundits and policymakers is that this sustained oil price increase was facilitated by the financialization of oil futures markets. Non-academics such as Michael Masters and George Soros testified before the US Congress that financial investors were taking speculative positions that resulted in rising oil futures prices, which in turn were responsible for a surge in the spot price of oil. The accuracy of this view is not obvious at all and much of the academic debate centers on the evidence, if any, supporting this hypothesis. 
One reason that the Masters hypothesis has received a lot of attention among policymakers is that it seems to provide an obvious remedy to the problem of rising oil prices. To the extent that financial speculation is the cause of the problem of rising oil prices, policies aimed at controlling trades in oil futures markets can be expected to prevent increases in the price of oil. This interpretation has informed recent policy efforts to regulate oil futures markets as part of a larger effort by the G20 governments to impose more control on financial markets. While these policy reactions are perhaps understandable within the broader context of the global housing and banking crisis, they are not based on solid evidence.
In a recent CEPR Discussion Paper (Fattouh et al 2012), my co-authors and I review the evidence in support of the Masters hypothesis from a variety of angles, mirroring the evolution of the academic literature on this subject. The study concludes that the existing evidence is not supportive of an important role of speculation in driving the spot price of oil after 2003. Instead, there is strong evidence that the spot and futures prices responded to the same economic fundamentals.
Discussions about the role of speculation often degenerate into blanket generalizations because it is rarely clear how speculation is defined. The most general economic definition of a speculator is anyone buying crude oil not for current consumption, but for future use. What is common to all speculative purchases of oil is that the buyer is anticipating rising oil prices. Speculative buying may involve buying crude oil for physical storage leading to an accumulation of oil inventories, or it may involve buying an oil futures contract, provided an oil futures market exists. Either strategy allows one to take a position on the expected change in the price of oil. Standard theoretical models of storage imply that there is an arbitrage condition ensuring that speculation in one of these markets will be reflected in speculation in the other market (Alquist and Kilian 2010).
It is immediately clear that speculation defined in this manner need not be morally reprehensible. In fact, speculation may make perfect economic sense and indeed is an important aspect of a functioning oil market. For example, it seems entirely reasonable for oil companies to stock up on crude oil in anticipation of a disruption of oil supplies because these stocks help oil companies smooth the production of refined products such as gasoline. The resulting oil price response provides incentives for additional exploration, curbs current consumption, and helps alleviate future shortages. Hence, it would be ill-advised for policymakers to prevent such oil price increases.
In the public mind speculation has a negative connotation because it is viewed as excessive. Excessive speculation might be defined as speculation that is beneficial from a private point of view, but would not be beneficial from a social planner’s point of view.  It follows naturally that the public has an interest in preventing excessive speculation. The broad definition of speculation we discussed earlier makes no distinction between socially desirable and undesirable speculation. Indeed, determining whether speculative trading is excessive is difficult.
One strand of the literature defines speculation in terms of who is buying the oil. Traditionally, traders in oil futures markets with a commercial interest in or a physical exposure to oil have been called hedgers, while those without a physical position to offset have been called speculators. The distinction between hedging and speculation in futures markets is less clear than it may appear, however. First, the oil futures market cannot function without speculative traders providing liquidity and assisting in the price discovery. The presence of speculators defined as non-commercial traders tells us nothing about whether speculation is excessive. Second, in practice, commercial traders may take a stance on the price of a commodity or may not hedge in the futures market despite having an exposure to the commodity. Both positions could be considered speculative. Likewise, efforts to detect speculators on the basis of high ex post profits are not compelling. After all, speculators take risky positions and the return on holding oil must reflect that risk.
Another argument has been based on the relative size of the oil futures market and the physical market for oil. For example, it is often asserted that the daily trading volume in oil futures markets is several times as high as daily physical oil production, fuelling the suspicion that speculators are dominating this market. Academic research, however, shows that this ratio – after taking account of the number of days to delivery for the oil futures contract – is a fraction of about one half of daily US oil usage rather than a multiple, invalidating this argument.
An alternative approach due to Holbrook Working (1960) has been to quantify speculation as an index measuring the percentage of speculation in excess of what is minimally necessary to meet short and long hedging demand. A high Working index number, however, does not necessarily indicate excessive speculation. One benchmark in evaluating this index is the historical values of this index for other commodity markets. By that standard the index numbers for the oil market even at their peak remain in the midrange of historical experience. Moreover, there does not appear to be a simple statistical relationship between this index of speculation and the evolution of the price of oil. For example, the correlation between the Working index of speculation and daily price changes is near zero.
Sometimes excessive speculation is equated with market manipulation. For example, it has been asserted that financial traders are herding the market into positions from which they can profit, resulting in excessively high oil prices in the spot market. It is important to stress that market manipulation and speculation are economically distinct phenomena. The increased financialization of oil markets does not by itself mean that market manipulation is on the rise, and there is no widespread evidence of market manipulation in oil futures markets.
In short, there is no operational definition of excessive speculation. Indeed, existing academic studies have focused on indirect evidence of excessive speculation rather than direct evidence. The academic literature allows several conclusions:
1. There is clear evidence of the increased financialization of oil futures markets. Whether this financialization also was responsible for increased co-movement among different asset prices continues to be debated. Although there is some evidence of increased co-movement across asset classes, that co-comovement is also found in markets in which index funds do not operate and for which there are no futures exchanges, which is suggestive of an explanation based on common economic fundamentals. Indeed, there is evidence that price increases were somewhat higher for non-exchange traded commodities than for exchange-traded commodities, consistent with the view that financialization actually dampened price increases.
2. There is no compelling evidence that changes in financial traders’ positions predict changes in the price of oil futures. Conflicting results in the literature in this regard can be traced to the use of datasets in some studies that are too aggregated to be informative about these predictive relationships or otherwise inappropriate. To the extent that any evidence of predictive power from index fund holdings to oil futures prices has been found, that evidence has not been based on rigorous real-time analysis and the extent of the out-of-sample gains has yet to be quantified. Finally, evidence of predictability is not evidence of causation. This predictive power, if any, may arise simply from traders’ positions responding to the underlying fundamentals of the oil market, for example.
3. Contrary to widely held beliefs that increases in oil futures prices precede increases in the spot price of oil, there is no evidence that oil futures prices significantly improve the out-of-sample accuracy of forecasts of the spot price of oil. This result holds whether one is forecasting the nominal price or the real price of oil. In contrast, there is evidence that models based on economic fundamentals help forecast the spot price of oil out of sample.
4. The simple static models that have been used to explain how an influx of financial investors may cause an increase in the spot price of oil are inconsistent with dynamic models of storage. Economic theory tells us that both spot and futures prices are jointly and endogenously determined.
 5. The oil price–inventory relationship tells us nothing about the quantitative importance of speculation in oil markets. In particular, the absence or presence of speculative pressures in the oil market cannot be inferred from studying oil inventory data without a fully specified structural model.
6. Structural economic models of oil markets that nest alternative explanations of the evolution of the real price of oil (including speculative demand) provide strong evidence of speculation in 1979, 1986, 1990, and late 2002, but are not supportive of speculation being an important determinant of the real price of oil during 2003 and mid-2008. Instead these models imply that both spot and futures prices were driven by a common component reflecting economic fundamentals (Kilian and Murphy 2011). Alternative studies that claim to have found evidence of financial speculation suffer from identification problems and are uninformative.
7. There is no empirical evidence that the short-run price elasticity of gasoline demand is literally zero, as required by theoretical models that explain increases in the spot price based on speculation in oil futures markets without an accumulation of oil inventories. Recent oil demand elasticity estimates that take account of the identification problem in estimating demand elasticities from price and quantity data are considerably higher in magnitude than traditional estimates based on reduced form models.
8. Recently developed theoretical and empirical models of time-varying risk premia may help enhance our understanding of fluctuations in oil prices, but it is not clear how representative these models are for the global market for crude oil, and their ability to explain fluctuations in the price of oil has yet to be explored in full detail.
To conclude, one of the problems in this literature – and, more importantly, in the public debate about speculation – is that it is rarely clear how speculation is defined and why it is considered harmful to the economy. For example, the aim of recent regulatory changes in oil futures markets is to reduce price volatility, when increased oil price volatility was never the problem, but the persistent increases in the price of oil after 2003. Moreover, the literature has shown that the presence of index funds has, if anything, been associated with reduced price volatility. This view is also supported by historical analyses on the relationship between futures markets and price volatility. It is sometimes suggested that academics have failed to adequately address the issue of speculation in oil markets and that more research is needed to establish what seems obvious to many policymakers. This is not the case. Rather, extensive research has produced a near-consensus among academic experts that speculation has not been a key driver of recent oil price fluctuations. This finding has important implication for on-going policy efforts to regulate oil futures markets.
Alquist, R and L Kilian (2010), “What Do We Learn from the Price of Crude Oil Futures?”, Journal of Applied Econometrics, 25:539-573.
Calvo, Guillermo (2008), “Exploding commodity prices, lax monetary policy, and sovereign wealth funds”,, 20 June.
Fattouh, B, L Kilian, and L Mahadeva (2012), “The Role of Speculation in Oil Markets: What Have We Learned So Far?”, CEPR Discussion Paper No. 8916.
Working, H (1960). “Speculation on Hedging Markets”, Stanford University Food Research Institute Studies, 1:185-220
Kilian, L and DP Murphy (2011), “The Role of Inventories and Speculative Trading in the Global Market for Crude Oil”, University of Michigan.
Krugman, Paul (2008), “Calvo on commodities”, NY Times Blog, 21 June.
Thoma, Mark (2008), “Oil prices and economic fundamentals”, Economist’s View, 26 July.
1 On this see the debate between Guillermo Calvo (2008) and Paul Krugman (2008) as well as comments from Mark Thoma (2008). 

Wednesday, April 18, 2012

It's Not the Speculators

People are very passionate on this issue for reasons I don't fully understand, and most of you don't agree with me on this topic, but I side with Jim Hamilton on the issue of speculators in oil markets. Speculation is not the cause of high energy prices:

A ban on oil speculation?, by Jim Hamilton: Joseph P. Kennedy II, former Congressional Representative from Massachusetts, and founder, chairman, and president of Citizens Energy Corporation, has a proposal to make energy affordable for all. All we have to do, Kennedy claims, is "bar pure oil speculators entirely from commodity exchanges in the United States."

Writing in the New York Times last week, Joseph Kennedy (D-MA) explained why he believes that speculators are responsible for the high price that we currently have to pay for oil:

Today, speculators dominate the trading of oil futures. According to Congressional testimony by the commodities specialist Michael W. Masters in 2009, the oil futures markets routinely trade more than one billion barrels of oil per day. Given that the entire world produces only around 85 million actual “wet” barrels a day, this means that more than 90 percent of trading involves speculators' exchanging "paper" barrels with one another.

It's true that most buyers of futures contracts don't actually want to take physical delivery of oil. If I buy the contract at some date, I usually plan on selling the contract back to somebody else at a later date, so that I leave the market with a cash profit or loss but no physical oil. But remember that for every buyer of a futures contract, there is a seller. The person who sold the initial contract to me also likely wants to buy out of the contract at some later date. I buy and he sells at the initial contract date, he buys and I sell at a later date. One of us leaves the market with a cash profit, the other with a cash loss, and neither of us ever obtains any physical oil.

Let's take a look, for example, at NYMEX trading in the May crude oil futures contract. A single contract, if held to maturity, would require the seller to deliver 1,000 barrels of oil in Cushing, OK some time in the month of May. Last Friday, 227,000 contracts were traded corresponding to 227 million barrels of oil, which is indeed a large multiple of daily production. But it is worth noting that at the end of Friday, total open interest-- the number of contracts people actually held as of the end of the day-- was only 128,000 contracts, much smaller than the total number of trades during the day, and not much changed from the total open interest as of the end of Thursday. Many of the traders who bought a contract on Friday turned around and sold that same contract later in the day. If the purchase in the morning is argued to have driven the price up, one would think that the sale in the afternoon would bring the price back down. It is unclear by what mechanism Representative Kennedy maintains that the combined effect of a purchase and subsequent sale produces any net effect on the price. But the only way he gets big numbers like this is to count the purchase and subsequent sale of the same contract by the same person as two different trades. ...[continue reading]...

In the past, I've covered this topic in quite a bit of detail, e.g. see this subset of links:

I think that, collectively, the material in these links make a very strong case against the speculation hypothesis, but I should be careful to clarify my view. This is from the fifth link on the list, Oil Prices and Speculation (for a more technical treatment, see here and here, i.e. the first two links on the list):

We’ve heard a lot about how speculation has caused volatility in oil and other commodity prices recently, and there are calls in Congress to put constraints on speculative activity in order to stabilize prices and markets, so let's go back to the issue of whether speculative activity has been the driving force behind commodity price movements, oil prices n particular.

To begin, it's important to recognize that not all speculative activity is the same, and not all of it is bad, and as we look into how to better regulate these markets, we need to keep the types of speculative activities separate so that we don’t stifle the good type of speculation as we try to eliminate the types that cause us troubles.

First, speculative activity can arise from attempts to profit from manipulating the price of a good, and some people believe this type of manipulative activity can explain much of the volatility in oil prices we have seen recently. This, obviously, is a bad type of speculation and we should prevent it to the extent possible.

Second, moral hazard combined with easy money can lead to an undesirable type of speculation. If market participants have ready access to funds, and if they believe losses will be covered, say, through a government bailout, then they may be willing to invest far more than is optimal in speculative ventures. If they hit it big, they win. If things go sour, the government covers their losses.

A third type of speculation we’d like to avoid is speculative bubbles, and this is probably what most people have in mind when they hear the term speculation. Speculative bubbles occur due to “bandwagon effects” where rumors or some other force causes prices to deviate from their underlying fundamental values in a self-feeding frenzy that drives prices upward in a bubble, or downward in a crash.

Fourth, speculation allows us to insure against expected future changes in supply or demand, that is, anticipated changes in the price. If we expect higher demand or lower supply of a good at some point in the future, that is, if we expect a higher future price, then speculators will take some of the good off the market today, store it for the future, and then sell it after the price rises. In this way, speculation provides insurance against the future fall in supply or increase in demand by having the good available to meet those changes.

Finally, there is stabilizing speculation, for example selling short near peaks in anticipation of price declines can dampen natural market volatility, and this is generally desirable. This type of speculation - short-selling - is under considerable scrutiny right now, but in general this dampens rather than enhancing market volatility and we ought to encourage the dampening variety.

So yes, by all means, limit the bad type of speculation through regulatory changes. But be sure to keep the types that help.

I've taken the stance that there is little evidence of the first and third types of speculative activity, manipulation and bubbles divorced from fundamentals, and I don't think the second type - moral hazard - made a large contribution. I've argued fundamentals are the most likely source of most of the price variation, and by fundamentals I mean any new information that causes people to change their expectations of supply and/or demand, and I've taken a lot of criticism here over that stance.

But I still think it's correct.

This will likely be successful politically -- blaming the speculators will likely ring true for many -- but I don't think the underlying economics supports the claim that speculation is the primary cause of high energy prices.

Saturday, March 31, 2012

"Why Gas Prices Are Out of Any President’s Control"

One more quick one from the airport -- Richard Thaler attempts to nudge people away from the idea that the president can control gas prices (and he calls for an increase in the gas tax):

Why Gas Prices Are Out of Any President’s Control, by Richard Thaler, Commentary, NY Times: Everyone knows it’s dangerous to ingest gasoline or to inhale its fumes. But I am starting to believe that merely thinking about the price of gasoline can damage cognitive processing. Thus I may be risking some of my precious few remaining brain cells by writing about that topic.
Here is a one-item test to see whether you are guilty of cloudy thinking about gas prices: Do you believe that they are something a president can control? Many Americans believe that the answer is yes, but any respectable economist will tell you that the answer is no.
Consider a recent poll of a panel of economists conducted by the University of Chicago Booth School of Business, where I teach. ... The 41 panel members were asked whether they agreed with the following statement: “Changes in U.S. gasoline prices over the past 10 years have predominantly been due to market factors rather than U.S. federal economic or energy policies.”
Not a single member of the panel disagreed with the statement.
Here is why: Oil is a global market in which America is a big consumer but a small supplier. ...[continue reading]...

Sunday, March 18, 2012

Strategic Petroleum Reserve to the Rescue?

Jim Hamilton:

Strategic Petroleum Reserve to the rescue, econbrowser: The United States and Britain have apparently been discussing a joint release of strategic petroleum stockpiles. ...

In fact we ran that exact experiment last year... Specifically, the IEA announced on June 23, 2011 that the OECD countries would release 60 million barrels from their joint stockpiles, half of which came from the U.S. Strategic Petroleum Reserve. There was an initial modest drop in the price of oil on the day of the announcement, though within two weeks the price was back up above where it had been before the announcement.


The price of oil did decline later in the summer, though surely this should be attributed to deteriorating news from Europe rather than the SPR release. For example, last summer's drop in WTI was mirrored by a drop in other financial indicators such as the S&P500. ...

I see no evidence that last year's SPR release accomplished anything, and would not expect the outcome of another release this year to be very different.

A far more sensible proposal would be to build the pipelines necessary to allow the oil currently in private stockpiles in the central U.S. to flow to refiners on the Gulf of Mexico. ...

Friday, March 16, 2012

Paul Krugman: Natural Born Drillers

Why are Republicans turning to "Drill, baby, drill"?:

Natural Born Drillers, by Paul Krugman, Commentary, NY Times: To be a modern Republican in good standing, you have to believe — or pretend to believe — in two miracle cures for whatever ails the economy: more tax cuts for the rich and more drilling for oil. And with prices at the pump on the rise, so is the chant of “Drill, baby, drill.” More and more, Republicans are telling us that gasoline would be cheap and jobs plentiful if only we would stop protecting the environment and let energy companies do whatever they want. ...
The irony here is that ... we’re already having a hydrocarbon boom... It’s all about the fracking... U.S. oil production has risen significantly over the past three years,... while natural gas production has exploded.
Given this expansion, it’s hard to claim that excessive regulation has crippled energy production. Indeed,... the environmental costs of fracking have been underplayed and ignored. ...
Strange to say, however, while natural gas prices have dropped, rising oil production and a sharp fall in import dependence haven’t stopped gasoline prices from rising toward $4 a gallon. Nor has the oil and gas boom given a noticeable boost to an economic recovery...
As I said, this was totally predictable.  ... Unlike natural gas, which is expensive to ship across oceans, oil is traded on a world market... Oil prices are up because of rising demand from China and other emerging economies, and more recently because of war scares in the Middle East; these forces easily outweigh any downward pressure on prices from rising U.S. production. And the same thing would happen if Republicans got their way...
Meanwhile, what about jobs? ... Put it this way: Employment in oil and gas extraction has risen more than 50 percent since the middle of the last decade, but that amounts to only 70,000 jobs, around one-twentieth of 1 percent of total U.S. employment. So the idea that drill, baby, drill can cure our jobs deficit is basically a joke.
Why, then, are Republicans pretending otherwise? Part of the answer is that the party is rewarding its benefactors: the oil and gas industry doesn’t create many jobs, but it does spend a lot of money on lobbying and campaign contributions. The rest of the answer is simply the fact that conservatives have no other job-creation ideas to offer.
And intellectual bankruptcy, I’m sorry to say, is a problem that no amount of drilling and fracking can solve.

Wednesday, March 07, 2012

"Oil Prices and the U.S. Economy"

Jim Hamilton is relatively unconcerned about oil prices:

Oil prices and the U.S. economy, by Jim Hamilton: Here's why I believe that the current high price of oil is not enough to derail the U.S. economic recovery.
Although the prices of oil and gasoline have risen significantly from their values in October, they are still not back to the levels we saw last spring or in the summer of 2008. There is a good deal of statistical evidence (for example, [1],[2]) that an oil price increase that does no more than reverse an earlier decline has a much more limited effect on the economy than if the price of oil surges to a new all-time high. ...
For example, one thing we often observe when oil prices spike up is that U.S. consumers suddenly stop buying the less fuel-efficient vehicles that tend to be manufactured in North America. That drop in income for the domestic auto sector is one factor aggravating the overall economic consequences. But if consumers have recently seen even higher prices than they're paying at the moment, their spending plans and firms' production plans are likely already to have incorporated that reality. ...
Of course, there are other channels by which higher oil prices exert a drag on the U.S. economy besides the domestic auto sector. Another series I pay close attention to is the share of total consumer spending that is eaten up by the cost of energy. But the remarkable thing here is that nominal consumer spending on energy goods and services actually declined on a seasonally adjusted basis between September and January, even as the price of gasoline was going up considerably. This represents a combination of an unusually mild winter, very low natural gas prices, and consumers finding ways to reduce their energy consumption and thereby insulate their budgets from some of the damage of higher gasoline prices.
If tensions with Iran were to escalate, then I would start to worry a good deal more. But ... I find myself in the unusual position of being less concerned about the impact of oil prices on the U.S. economy than many other analysts.

Monday, February 27, 2012

Fed Watch: Oil Prices - It's What Everyone is Talking About

Tim Duy:

Oil Prices - It's What Everyone is Talking About, by Tim Duy: Via Ryan Avent, Matt Yyglesias opines on the link between oil prices and monetary policy:

But it looks to me as if a demand-side oil issue is really just the same old issue of the trade deficit and the international balance of payments and not the second coming of a 1970s-style oil price shock. Perhaps it's a monetary policy issue. We send dollars abroad in exchange for oil, but then the dollars get sent back in exchange for bonds. That ought to lower interest rates and induce investment in the United States, but nominal interest rates are already at zero so the loop is cut. Even so, higher gas prices should push the price level up which pushes real interest rates down which induces investment in the United States. The chain will only be broken here if the Fed decides to ignore its own self-guidance and target headline inflation instead of core inflation.

There is a lot going on in these few sentences, but I am going to focus on the last two lines. As a point of clarification, the Fed does not target core inflation. Refer to the Fed's freshly printed statement on long-run goals and strategy:

The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate.

That's headline inflation, not core inflation. Of course, there is a near-term focus on core inflation, but not as a target, but as a guide to the path of headline inflation. Monetary policymakers should be wary about overreacting to movements in headline inflation if they are not evident in core inflation.

Consider also that the Fed is setting inflation expectations at 2 percent. Technically, expected, not current, inflation should be a determinant of investment spending. Which means that a spike in headline inflation should not stimulate investment spending via this channel assuming inflation expectations remain anchored. And, at this point, inflation expectations appear anchored:


Still below what we saw last spring. To be sure, we could see inflation expectations edge up, but anything significant would draw the attention of the Federal Reserve. I think they are pretty serious about that 2 percent target. In other words, I would be cautious about reading too much into a drop in ex-post real interest rates due to a rise in energy costs.

Note that this is a criticism of Fed policy at the zero bound, that by locking in inflation expectations at 2 percent they have effectively placed their most powerful remaining policy tool off-limits.

I could imagine that higher-gas prices induce additional investment via some other mechanism, such as increased purchases of energy efficient machinery, etc. But this would not necessarily be a sufficient offset to other, negative impacts of higher energy prices.

In any event, we are all struggling to extract a signal from the data - is this primarily a "good" shock that indicates improving global activity, or a "bad" shock due to a supply constriction? Arguably, both factors are at play - see Jim Hamilton here. Putting aside the possibility of a bad shock for the moment (I think we all agree that a supply disruption stemming from a conflict with Iran would be fairly negative, especially for Europe), I tend to see the challenge in terms similar to this from Reuters:

Looking past the near-term uncertainty surrounding Iran, Andrew Sentance, a former member of the Bank of England's Monetary Policy Committee, said high and fluctuating prices for energy were part of a "new normal" economic climate in which Asia is the main engine of global growth.

Periodic bursts of inflation would add to the volatility of what was likely to be disappointing growth in the West for quite some time, according to Sentance, a senior economic adviser to PricewaterhouseCoopers, an accounting and advisory firm.

"This strong growth in Asia and other emerging markets is putting considerable pressure on markets for energy and other commodities and that is one of the reasons why we are finding growth so difficult to achieve," he told a conference organized by the Institute of Economic Affairs, a free-market think tank in London.

"That's not just a short-term phenomenon. It's a secular issue that's going to persist through the middle of this decade," he said.

Even if higher oil prices are a symptom of improving global growth (a "good" shock) and do not trigger a US recession, they will certainly place some additional strain on US household budgets, which will in turn depress growth relative to what it would have been in the absence of the higher oil prices (consider instead the relatively low and stable prices of oil during much of the US boom during the 1990s). In effect, we could be running up against a global bottleneck that places something of a speed-limit on US (and global) growth.


As to the international finance story Yglesias tells, I think this does come back to a monetary policy story, but I think the direction might be backwards. I am still working this one out:

Yglesias is telling a story of recycling petro-dollars. In order to finance a given level of trade deficit, the dollar outflow must be recycled back into the US economy as a dollar inflow that supports some type of domestic absorption. I shy away from using the term "investment" strictly as it could support government spending or even consumption spending (think of households borrowing against home equity to buy a boat). If foreigners don't not want to recycle their dollars back into the US economy via financial inflows, the value of the dollar falls to stimulate exports and deter imports, thus improving the external deficit.

Now, to Yglesias' point, we may have something of an interesting situation whereby foreign investors find themselves holding dollar assets as cash or near-cash equivalents (low yielding Treasuries). And unless the federal government utilizes that potential via expanded borrowing (note that in the private sector, savings exceeds investment already), little additional demand is supported. Now it is interesting that foreign investors would prefer to hold relatively low-yielding assets rather than using their dollars to purchase US goods and services, but such is the outcome of so many dollars being held for central banks around the world.

As Yglesias' says, the "loop" is cut, but not necessarily because of the zero bound, but by the global demand for dollars, which arguably is the cause of the zero bound. Which then does brings us back to Yglesias' point that this is a monetary policy issue - policymakers could more actively drive down the value of the dollar by raising inflation expectations, thus making it increasingly unattractive for foreigners to hold cash or cash equivalents, and force the funds into either demand for US goods and services or investment goods. Certainly, however, policymakers would view this as a risky strategy, and thus have not gone down this road.

Wednesday, February 08, 2012

Energy Prices Caused the Recession?

Here's a new one, according to Santorum "The housing bubble was caused because of a dramatic spike in energy prices...":

The Gasoline “Bubble”?, by Ed Kilgore: ... Check out these Santorum remarks from the campaign trail in Colorado the other day:

Stressing the importance for the country to provide cheap energy to its citizens, Santorum blamed the recession not on sub-prime mortgages or the derivatives market but on spiking fuel prices.
“We went into a recession in 2008. People forget why. They thought it was a housing bubble. The housing bubble was caused because of a dramatic spike in energy prices that caused the housing bubble to burst,” Santorum told the audience. “People had to pay so much money to air condition and heat their homes or pay for gasoline that they couldn’t pay their mortgage.”


Now we are all used to Republican pols treating gasoline prices as some sort of ultimate, can’t miss issue that trumps everything else. And it is refreshing to find a GOP presidential candidate who isn’t explicitly or implicitly claiming our economic problems were caused by hordes of shiftless poor and minority folk who conspired with ACORN and Freddie and Fannie to take out mortgages that had no intention of paying. But the idea that gasoline and home heating costs caused the whole mess is a new one to me...

So the way to prevent future housing bubble problems is, of course, to deregulate the energy industry.

Monday, November 07, 2011

Paul Krugman: Here Comes the Sun

Who doesn't like solar energy?:

Here Comes the Sun, by Paul Krugman, Commentary, NY Times: ...We are, or at least we should be, on the cusp of an energy transformation, driven by the rapidly falling cost of solar power. That’s right, solar power. If that surprises you,... blame our fossilized political system, in which fossil fuel producers have both powerful political allies and a powerful propaganda machine that denigrates alternatives.
Speaking of propaganda..., let’s talk briefly about hydraulic fracturing, aka fracking.
Fracking — injecting high-pressure fluid into rocks deep underground, inducing the release of fossil fuels — is an impressive technology. But it’s also a technology that ... contaminates drinking water; there is reason to suspect ... that it also contaminates groundwater; and the heavy trucking ... inflicts major damage on roads.
Economics 101 tells us that an industry ... should be required to “internalize” those costs... Yet ... the industry and its defenders demand ... that it be let off the hook... Why? Because we need that energy! ...
So it’s worth pointing out that special treatment for fracking makes a mockery of free-market principles. Pro-fracking politicians claim to be against subsidies, yet letting an industry impose costs without paying compensation is in effect a huge subsidy. ...
And now for ... the success story you haven’t heard about.
These days, mention solar power and you’ll probably hear cries of “Solyndra!” Republicans have tried to make the failed solar panel company ... a symbol of government waste — although claims of a major scandal are nonsense...
But Solyndra’s failure was actually caused by technological success: the price of solar panels is dropping fast, and Solyndra couldn’t keep up with the competition. ... If the downward trend continues — and if anything it seems to be accelerating — we’re just a few years from the point at which electricity from solar panels becomes cheaper than electricity generated by burning coal. ...
But will our political system delay the energy transformation now within reach?
Let’s face it: a large part of our political class, including essentially the entire G.O.P., is deeply invested in an energy sector dominated by fossil fuels, and actively hostile to alternatives. This political class will do everything it can to ensure subsidies for the extraction and use of fossil fuels, directly with taxpayers’ money and indirectly by letting the industry off the hook for environmental costs, while ridiculing technologies like solar.
So what you need to know is that nothing you hear from these people is true. Fracking is not a dream come true; solar is now cost-effective. Here comes the sun, if we’re willing to let it in.

Saturday, October 15, 2011

Did Speculation Drive Oil Prices?

Reviving an old debate (see here too):

Did Speculation Drive Oil Prices? Market Fundamentals Suggest Otherwise, by Michael D. Plante and Mine K. Yücel, Economic Letter, FRB Dallas: Oil market speculation became an especially popular topic when the price of crude tripled over 18 months to a record high $145 per barrel in July 2008. Of particular interest to many is whether speculators drove oil prices beyond what fundamentals would have otherwise justified. We explore this issue over two Economic Letters. In this article, we look at evidence from the physical market for oil and conclude that fundamentals, and not speculation, were behind the dramatic rise and fall in oil prices. In our companion Economic Letter, we examine the futures market.
Oil prices began their climb in 2002, reaching a record high in mid-2008, and then collapsed at the end of ’08 amid the global recession. As world economic growth picked up, so did oil prices. Overall, the year-over-year change in oil prices has fairly closely tracked world gross domestic product (GDP) growth (Chart 1).

Chart 1: World GDP Mirrors Oil Price Growth

Energy consumption increases as GDP rises; but energy consumption in developing countries increases almost twice as fast as in developed countries. GDP expansion in emerging economies was particularly strong between 2005 and 2007, averaging 8 percent per year. Real GDP in China, for example, grew by an average 12.7 percent annually between 2005 and 2007, while the nation’s oil consumption increased 5.1 percent annually during the period.
From the beginning of 2007 to mid-2008, weekly prices for West Texas Intermediate (WTI) crude oil jumped 152 percent, from $57 to $143 per barrel. It’s possible that growing demand for crude oil might not be the reason for the rise. However, if the increase was due to other factors, oil consumption should have begun falling in response to the higher prices. Instead, there was almost no consumption decline during the period, implying that oil prices were driven by growing world income and demand.

Continue reading "Did Speculation Drive Oil Prices?" »

Monday, June 27, 2011

"The Strategic Petroleum Reserve Drawdown"

Jim Hamilton analyzes the effects of the International Energy Agency's plans to release 60 million barrels of oil from the strategic reserves held by 28 member countries (the US will contribute about half of this total). I think it would be fair to say he's not impressed with this plan:

The Strategic Petroleum Reserve drawdown, econbrowser

I share his assessment:

...the deed is now done, and the IEA has run an interesting experiment for us in how oil markets function. I would recommend against further SPR sales, regardless of the final outcome of the current effort. The reason is that I see the long-run challenge of meeting the growing demand from the emerging economies as very daunting, and in my mind is the number one reason we're talking about an oil price above $100/barrel in the first place.
A one-time release from the SPR, or even a series of releases until the SPR runs dry, does nothing whatever to address those basic challenges.

It's not clear how much impact this will have on prices, but if prices do drop as a result of the release, some countries may take advantage of the opportunity:

the Chinese might see a temporary drop in prices as an opportunity to add to their own SPR. To the extent that happens, we're getting back to the no-effect scenario

If we had a Strategic Job Reserve to draw upon, or something similar, e.g. an infrastructure bank, that might make a difference. But I don't think this will do much to help.

My guess is that the president is trying to signal that the administration cares about the struggles middle and lower income households face due to the recession and lack of job opportunities. But if that's the goal, there are better ways to go about it. Presently, with the focus on deficit reduction, it's not at all clear that job creation is anywhere near the top of the administration's to do list. Introducing job creation legislation, even if only to force the Republicans to vote it down, would be a much better approach to convincing middle and lower income voters that Democrats do, in fact, care about their troubles and are doing their best to help.

Sunday, May 15, 2011

"Shale Gas Environmental Concerns"

When I was at the Milken Global Conference, several people who had been to a session on shale-gas extraction were very excited about the possibilities. One person insisted that we'd be a net exporter of energy within a decade or so (I was skeptical). I kept asking about environmental concerns, but they were generally brushed away, or, as one person told me, the need is large enough that politicians will make sure this moves forward despite any environmental problems. However, Jim Hamilton notes that recent evidence suggests the environmental problems are larger than we thought:

Shale gas environmental concerns, by Jim Hamilton: Technological breakthroughs in methods for drilling for natural gas have opened up the possibility of vast new supplies. However, environmental concerns may turn out to be significant.
Stuart Staniford has taken a look at a study of the effects of shale-gas extraction on drinking water recently published in the Proceedings of the National Academy of Sciences. The scatter diagram below summarizes 60 drinking water wells in Pennsylvania, with distance from a natural gas well on the horizontal axis and methane concentration in the water on the vertical axis. All of the water wells with concentrations above 28 milligrams of methane per liter of water were within one kilometer of active drilling.

[click to enlarge]

Methane concentrations as a function of distance to the nearest gas well for active (closed circles, defined as within 1 km) and nonactive (open triangles, defined as grater than 1 km away) drilling areas. Source: Osborn, et. al. (2011).
Stuart also tracked down the relevance of a 28 mg/l concentration:

A dissolved methane concentration greater than 28 mg/L indicates that potentially explosive or flammable quantities of the gas are being liberated in the well and/or may be liberated in confined areas of the home.

There are potential huge investments to be contemplated to try to take advantage of the new natural gas resources, for purposes such as electrical generation by utilities, gas-powered cars and trucks, and refueling stations. But uncertainties about potential future regulation and litigation must make anyone cautious. I think it's in the interests of everyone involved to identify right away where the contamination documented above is coming from and develop regulations to minimize it. ...

Wednesday, March 23, 2011

The Cost of Food and Energy across Consumers

Spending on food and energy is 44.1% of after-tax income for households in the lowest 20 percent of the income distribution:

The Cost of Food and Energy across Consumers, by Daniel Carroll, Economic Trends, FRB Cleveland: Rising food and energy prices have been getting considerable attention recently. The latest report from the Bureau of Labor Statistics shows that ... [e]nergy rose by 2.1 percent (7.3 percent year-over-year), which is consistent with its longer trend over the past six months. Curiously, given the focus it has received, the rise in food prices has been ... modest, just ... 1.8 percent year-over-year... In fact, food at home is up only 2.7 percent from its lowest point in the past two years. ...
The importance of food and energy prices to households’ bottom lines is not evenly distributed across the income distribution... For the median household, food and energy are roughly 17 percent of both expenditures and after-tax income. Households in the top 20 percent of the income distribution spend 11.6 percent of total expenditures on food and energy, which adds up to 7.9 percent of disposable income. For the bottom 20 percent these shares rise to 20.4 percent of expenditures and a whopping 44.1 percent of after-tax income!



For those astutely wondering why food and energy expenditures are a larger fraction of total expenditures than of total income for the bottom 20 percent, there is a much higher fraction of households in this quintile which may be using savings and credit markets to consume above their annual income. Likely categories are the unemployed, business owners with temporary losses, students living on loans, and retirees drawing down their nest eggs.

Monday, March 07, 2011

Speculators Gone Wild?

One more from Tim:

Speculators Gone Wild?, by Tim Duy: At the risk of becoming involved in the ongoing Paul Krugman/Yves Smith debate regarding the influence of speculators on commodity prices, I direct readers to Colin Barr at CNN Money:

The surge of speculative money into the oil futures pits shows that big financial players are expecting the price of WTI crude to surge well above the recent $105 or so seen last week. If they are right, it will bring $4 gasoline a step closer….

…"It does not get any clearer which way Wall Street is trying to take oil," says Stephen Schork, who writes the Schork Report energy markets newsletter in Villanova, Pa.

Schork notes that speculators now own nearly six times as many barrels of oil – 268,622 futures contracts representing nearly 269 million barrels – as can be stored at the WTI trading hub in Cushing, Okla. And since the CFTC numbers released Friday only go through last Tuesday, they likely underestimate the degree of speculative fervor building in the energy markets.

Money appears to be flooding into energy markets to chase a sure thing, with potentially severe consequences for a global economy still on the mend. The article continues:

The speculative fervor is so remarkable that the big trading firms now have nearly twice as many long contracts open as they did in 2008, when oil spiked to $147 in the summer, a development that either foreshadowed or caused the global economic meltdown, depending on how you look at it.

I think this suggests that the recent oil price gains are driven more by speculation that in 2008. And note that we know how quickly oil prices collapsed when the global recession knocked down energy demand. So if oil prices are being driven by even more extreme speculative activity today, the possibility for a sharp reversal also exists – the question is whether that reversal comes before or after oil prices bring the global economy to its knees.

Presumably, growing tranquility in the Middle East would cause speculators to run for the exits. This, however, seems unlikely. Instead, it might be an interesting time for a large, surprise release from the Strategic Petroleum Reserve. This is not something I expect or would really argue for given I don’t think that $100 oil qualifies as a national emergency. But I would like to understand more about the importance of speculative activity in driving oil prices, and perhaps this is something best understood only by catching a lot of traders on the wrong side of a “sure thing.”

Monday, January 10, 2011

Fed Watch: Are Oil Prices About to Undermine the Recovery?

Tim Duy:

Calculated Risk directs us to an LA Times story identifying the possibility that rising gasoline prices will undermine the recovery. He also reminds us that James Hamilton recently wrote on the subject as well, concluding:

I could certainly imagine that an abrupt move up in gasoline prices from here could hurt the struggling recovery of the domestic auto sector and dampen overall consumer spending. I do not think it would be enough to give us a second economic downturn, but it could easily be a factor reducing the growth rate.

I would add that the current price appears inline with the general upward trend since the beginning of last decade. Here I extrapolated on the 2000-2006 trend:

New Picture
The sudden rise in oil in 2007, a clear deviation from the trend in the first half of the decade, led to substantial demand destruction, a severe blow to the US economy which at the time was struggling under the weight of the housing meltdown and the financial crisis (and arguably still is). The recent rise in oil appears different, more a reestablishment of the previous trend.

From this point on, I tend to think the issue is less of will oil continue to rise, but at what speed will it rise. The trend over the last decade appears to make a lie of recent claims that we have entered into a period of plentiful energy (see also James Hamilton), and while higher oil prices will tend to crimp growth, a gradual price increase should allow for non-disruptive adaptation on the part of economic agents.

What I more concerned with is the possibility of another sharp spike in prices, such as occurred in 2007-08. A repeat of that incident would once again cripple households, who, after 18 months of recovery, are just barely starting to see the light. The most obvious channel to trigger such a spike is monetary, that the Federal Reserve's large scale asset purchases trigger a disruptive decline in the Dollar. Federal Reserve Chairman Ben Bernanke was not buying that story last week. From the Wall Street Journal:

Mr. Bernanke says his quantitative easing policy is not to blame for the sharp increase in the price of oil. Instead, oil’s rise is the result of strong demand from emerging markets. The dollar, he notes, has been “quite stable” in the past few months. One worry in the run up to the Fed’s $600 billion bond-buying announcement in November was that it was going to cause the dollar to fall sharply, which would in turn put upward pressure on commodities like oil priced in dollars. The stable dollar, which has risen since the program’s announcement, implies the Fed isn’t the problem in commodities markets, Mr. Bernanke notes.

Movements in commodity prices have not been sufficiently disruptive to suggest a Fed-induced cause is at hand, and have tended to be more consistent with indications of general economic improvement.

In short: Energy prices are yet another thing to keep an eye on. Still, recognize the increase to date appears to be more of a return to the recent trends than a disruptive price spike. Not that rising prices won't have consequences, but the trend of the past decade may simply be something we need to learn to live with. Rather than watching the trend itself, be watching for upward spikes from that trend - those would almost certainly translate into something nasty for the still struggling US economy.

Monday, December 27, 2010

Paul Krugman: The Finite World

It's not always about us:

The Finite World, by Paul Krugman. Commentary, NY Times: Oil is back above $90 a barrel. Copper and cotton have hit record highs. Wheat and corn prices are way up. Over all, world commodity prices have risen by a quarter in the past six months. So what’s the meaning of this surge?
Is it speculation run amok? Is it the result of excessive money creation, a harbinger of runaway inflation just around the corner? No and no.
What the commodity markets are telling us is that we’re living in a finite world,... the rapid growth of emerging economies is placing pressure on limited supplies of raw materials, pushing up their prices. And America is, for the most part, just a bystander in this story. ...
This doesn’t necessarily ... reject the notion that speculation is playing some role... But the fact that world economic recovery has also brought a recovery in commodity prices strongly suggests that recent price fluctuations mainly reflect fundamental factors.
What about commodity prices as a harbinger of inflation? Many commentators on the right have been predicting for years that the Federal Reserve ... is setting us up for severe inflation. ... Yet inflation has remained low. What’s an inflation worrier to do?
One response has been a proliferation of conspiracy theories, of claims that the government is suppressing the truth about rising prices. But lately many on the right have seized on rising commodity prices as proof that they were right all along, as a sign of high overall inflation just around the corner.
You do have to wonder what these people were thinking two years ago, when raw material prices were plunging. If the commodity-price rise of the past six months heralds runaway inflation, why didn’t the 50 percent decline in the second half of 2008 herald runaway deflation?
Inconsistency aside, however, the big problem with those blaming the Fed ... is that ... commodity prices are set globally, and what America does just isn’t that important a factor.
In particular,... the primary driving force behind rising commodity prices isn’t demand from the United States. It’s demand from China and other emerging economies. As more and more people in formerly poor nations are entering the global middle class, they’re beginning to drive cars and eat meat, placing growing pressure on world oil and food supplies.
And those supplies aren’t keeping pace. Conventional oil production has been flat for four years; in that sense, at least, peak oil has arrived. ... Also, over the past year, extreme weather ... played an important role in driving up food prices. And, yes, there’s every reason to believe that climate change is making such weather episodes more common.
So what are the implications of the recent rise in commodity prices? It is, as I said, a sign that we’re living in a finite world, one in which resource constraints are becoming increasingly binding. This won’t bring an end to economic growth, let alone a descent into Mad Max-style collapse. It will require that we gradually change the way we live, adapting our economy and our lifestyles to the reality of more expensive resources.
But that’s for the future. Right now, rising commodity prices are basically the result of global recovery. They have no bearing, one way or another, on U.S. monetary policy. For this is a global story; at a fundamental level, it’s not about us.

Thursday, July 29, 2010

Placing the 2006/08 Commodity Price Boom into Perspective

This was controversial at the time, particularly the role of speculation: What caused the 2006-2008 commodity price boom?:

Placing the 2006/08 Commodity Price Boom into Perspective, by John Baffes: The 2006-08 commodity price boom was one of the longest and broadest of the post-WWII period. The price boom emerged in the mid-2000s after nearly three decades of low and declining commodity prices (see figure). The long-term decline in real prices had been especially marked in food and agriculture. Between 1975-76 and 2000-01, world food prices declined by 53 percent in real US-dollar terms. Such price declines raised concerns, especially with regard to the welfare of poor agricultural producers. ... Starting in the mid-2000s, however, most commodity prices reversed their downward course, eventually leading to an unprecedented commodity price boom.

Source: World Bank, Development Prospects Group

Between 2003 and 2008, nominal prices of energy and metals increased by 230 percent, those of food and precious metals doubled, and those of fertilizers increased fourfold. The boom reached its zenith in July 2008, when crude oil prices averaged US$ 133/barrel, up 94 percent from a year earlier. Rice prices doubled within just five months of 2008... The price surge led to a various heated debates on its causes and its consequences, including the role of biofuels, speculation, policy reactions, and, most importantly, whether high agricultural prices are beneficial or harmful to the poor. A paper we just published revisits the causes of the boom...

Apart from strong and sustained economic growth, the price boom was fueled by numerous factors including low past investment in extractive commodities, weak dollar, fiscal expansion and lax monetary policy in many countries, and investment fund activity. On the other hand, the combination of adverse weather conditions, the diversion of some food commodities to the production of biofuels, and government policies (including export bans and prohibitive taxes) brought global stocks of many food commodities down to levels not seen since the early 1970s, created a "perfect storm" further accelerating the price increases that eventually led to the 2008 rally. The weakening and/or reversal of these factors coupled with the financial crisis that erupted in September 2008 and the subsequent global economic downturn induced sharp price declines across most commodity sectors. Yet, the main price indices are still twice as high compared to their 2000 real levels, begging once more the question about the real factors affecting them.

The paper concludes that a stronger link between energy and non-energy commodity prices has been the dominant factor in the boom of agricultural and food prices, and is likely to be the dominant influence on developments in commodity, and especially food, markets. The analysis shows that demand by emerging economies, often cited as a key factor behind the food price surge of 2008, in fact it was much less of a factor than is often sited. The paper also argues that the effect of biofuels on food prices has not been as large as originally thought. On the other hand, the use of commodities by financial investors (the so-called ‘financialization of commodities’) may have been partly responsible for the 2007/08 spike. Finally, econometric analysis of the long-term evolution of commodity prices supports the view that price variability overwhelms price trends. This conclusion implies that suggested policy actions essentially aiming to alleviate the impacts of price spikes on developing countries through reliance on some level of buffer stocks ... risk reproducing the failure of previous collective measures designed to prevent the decline or reduce the variability of prices.

Friday, July 02, 2010

Rogoff: Can Good Emerge From the BP Oil Spill?

Kenneth Rogoff says anger among twenty somethings might "be the ticket to rekindling interest in a carbon tax":

Can Good Emerge From the BP Oil Spill?, by Kenneth Rogoff, Commentary, Project Syndicate: Perhaps it is a pipe dream, but it is just possible that the ongoing BP oil-spill catastrophe in the Gulf of Mexico will finally catalyze support for an American environmental policy with teeth. ...
The fact is, the BP oil spill is on the cusp of becoming a political game-changer of historic proportions. If summer hurricanes push huge quantities of oil onto Florida’s beaches and up the Eastern seaboard, the resulting political explosion will make the reaction to the financial crisis seem muted.
Anger is especially rife among young people. Already stressed by extraordinarily high rates of unemployment, twenty-somethings are now awakening to the fact that their country’s growth model – the one they are dreaming to be a part of – is, in fact, completely unsustainable, whatever their political leaders tell them. ...
Might a reawakening of voter anger be the ticket to rekindling interest in a carbon tax? ... Why might a carbon tax be viable now, when it never has been before? The point is that, when people can visualize a problem, they are far less able to discount or ignore it. Gradual global warming is hard enough to notice, much less get worked up about. But, as high-definition images of oil spewing from the bottom of the ocean are matched up with those of blackened coastline and devastated wildlife, a very different story could emerge.
Some say that young people in the rich countries are just too well off to mobilize politically, at least en masse. But they might be radicalized by the prospect of inheriting a badly damaged ecosystem. Indeed, there is volatility just beneath the surface. Modern-day record unemployment and extreme inequality may seem far less tolerable as young people realize that some of the most cherished “free” things in life – palatable weather, clean air, and nice beaches, for example – cannot be taken for granted.
Of course, I may be far too optimistic in thinking that the tragedy in the Gulf will spur a more sensible energy policy... A great deal of the US political reaction has centered on demonizing BP and its leaders, rather than thinking of better ways to balance regulation and innovation.
Politicians understandably want to deflect attention from their own misguided policies. But it would be far better if they made an effort to fix them. A prolonged moratorium on offshore and other out-of-bounds energy exploration makes sense, but the real tragedy of the BP oil spill will be if the changes stop there. How many wake-up calls do we need?

The response to the financial crisis from Congress has been disappointing, and it's hard not to let that color thoughts about climate change legislation. I'm not optimistic. But if there is action, I doubt it will be through a carbon tax. People may be angry, but the anger is at specific targets, e.g. BP. There are attempts to say "you, the American public caused this by your insatiable demand for energy," but I think that will backfire. especially if it can be linked to PR from BP. People don't think it's individually their fault that the oil spill happened, and while they are more than willing to make other people pay for it -- those who are responsible -- I'm not so sure they are ready to place the burden on themselves. The same goes for climate change policies more generally. I just don't see a carbon tax in the cards.

Update: Richard Green:

Ken Rogoff thinks the BP spill might produce a groundswell for a carbon tax...: ...but Mark Thoma is not so sure [Rogoff's take is here].

I am actually more inclined to agree with Rogoff on this one. When environmental problems are easily visible, they seem to generate political consensus for action. The air quality in Los Angeles, which was obviously awful 30 years ago, if much better currently--the vast majority of days are quite clear now(although we still have the problem of invisible small particulates). The 1952 smog disaster led to major policy changes in the UK. The BP disaster could similarly mobilize policy.

Mark could still be right about this--I just hope he is not.

Friday, June 25, 2010

"Will This Well End Well?"

The definition of "onshore" changes when you are a regulator captured by the industry you are supposed to monitor:

Will this well end well?, by Eric Rauchway: There oughta be an axiom of regulation, that if you’re changing the rules in such a way that will make you sound grossly culpable when something goes wrong, you shouldn’t do it.

The future of BP’s offshore oil operations in the Gulf of Mexico has been thrown into doubt by the recent drilling disaster and court wrangling over a moratorium.

But about three miles off the coast of Alaska, BP is moving ahead with a controversial and potentially record-setting project to drill two miles under the sea and then six to eight miles horizontally to reach what is believed to be a 100-million-barrel reservoir of oil under federal waters.

All other new projects in the Arctic have been halted by the Obama administration’s moratorium on offshore drilling, including more traditional projects like Shell Oil’s plans to drill three wells in the Chukchi Sea and two in the Beaufort.

But BP’s project, called Liberty, has been exempted as regulators have granted it status as an “onshore” project even though it is about three miles off the coast in the Beaufort Sea. The reason: it sits on an artificial island — a 31-acre pile of gravel in about 22 feet of water — built by BP.

Then the article quotes some scientists saying this doesn’t sound like such a hot idea. So wait, why is it okay? “BP has defended the project in its proposal, saying it is safe and environmentally friendly.” Well, okay then.

I hope very much I have no future interest in returning to this link.

More from the article linked above:

Rather than conducting their own independent analysis, federal regulators, in a break from usual practice, allowed BP in 2007 to write its own environmental review for the project as well as its own consultation documents relating to the Endangered Species Act... The environmental assessment was taken away from the agency’s unit that typically handles such reviews, and put in the hands of a different division that was more pro-drilling, said ... scientists, who discussed the process because they remained opposed to how it was handled. “The whole process for approving Liberty was bizarre,” one of the federal scientists said.

Friday, June 11, 2010

Too Big to Exist?

pgl at EconoSpeak:
...While the “drill baby drill” proponents of offshore drilling used to tell us that we had the technology to keep oil spills from happening or once they did happen from becoming environmental nightmares - as we have recently learned, technology has not advanced that much. If oil companies are shielded from paying more than pennies on the dollar for such potential problems, it is no wonder they under-invest in this technology. The stock market seems to be signaling that BP shareholders may indeed pay much more than pennies on the dollar. If that does happen, bravo! ...
John Boehner voices a very different view than mine:
In response to a question from TPMDC, House Minority Leader John Boehner said he believes taxpayers should help pick up the tab for the clean up. "I think the people responsible in the oil spill--BP and the federal government--should take full responsibility for what's happening there," Boehner said at his weekly press conference this morning. Boehner's statement followed comments last Friday by US Chamber of Commerce CEO Tom Donohue who said he opposes efforts to stick BP, a member of the Chamber, with the bill. "It is generally not the practice of this country to change the laws after the game," he said. "Everybody is going to contribute to this clean up. We are all going to have to do it. We are going to have to get the money from the government and from the companies and we will figure out a way to do that." So today I asked Boehner, "Do you agree with Tom Donohue of the Chamber that the government and taxpayers should pitch in to clean up the oil spill?" The shorter answer is yes.
This sounds like the Congressman wants us to subsidize negative externalities.

Essentially, the well was too big too fail, but it failed anyway. Technology has given us the ability to create things whose individual or collective failure can cause tremendous damage, from oil wells to complicated financial assets, more so than ever before.

It is evident that we need to do a much better job of evaluating and regulating these types of risks. If the answer to the question "what if there's a problem and all of our safeguards fail" is "there will be a huge disaster," and if we really can't quantify the true risks due to black swans, etc., or be absolutely certain we can handle or even think of every possible contingency, then perhaps these technologies are too big to safely exist.