Category Archive for: Oil [Return to Main]

Thursday, May 29, 2008

"Crude Awakening: Behind the Surge in Oil Prices"

Stephen P. A. Brown, Raghav Virmani, and Richard Alm of the Dallas Fed look at why oil prices are so high, and whether the high prices are likely to continue. It's a more optimistic view than many. Their bottom line is "Absent supply disruptions, it will be difficult to sustain oil prices above $100 (in 2008 dollars) over the next 10 years" (comments at Real Time Economics and The Big Picture):

Crude Awakening: Behind the Surge in Oil Prices, by Stephen P. A. Brown, Raghav Virmani and Richard Alm, Economic Letter, Vol. 3, No. 5, May 2008, Federal Reserve Bank of Dallas: The first few months of 2008 saw crude oil prices breach one barrier after another. They topped $100 a barrel for the first time on Feb. 19, then rose past $103.76 about two weeks later, surpassing the previous inflation-adjusted peak, established in 1980. In April and early May, oil prices pushed past $110 and then $120 a barrel and beyond.[1]

These milestones reflect a new era in oil markets. After the tumult of the early 1980s, prices remained relatively tame for two decades—in both real and nominal terms (Chart 1). This long stretch of stability ended in 2004, when oil topped $40 a barrel for the first time, then embarked on a steep climb that continued into this year.

Continue reading ""Crude Awakening: Behind the Surge in Oil Prices"" »

Two from Jeff Frankel: Whether We are Currently in a Recession and the Impact of Monetary Policy on Commodity Prices

There are two different topics to choose from, so let's start with the latest news on GDP. Today, GDP growth for the first quarter was revised upward from .6% to .9%. How does this affect the odds that we are currently in a recession? Jeff Frankel is a member of the NBER's Business Cycle Dating Committee:

Despite Positive First Quarter, Odds of 2008 Recession Are Still Above 50%, by Jeff Frankel: The Commerce Department this morning revised upward its estimate of first quarter growth in real GDP to 0.9% (precisely in line with the expectations of economic forecasters).

As a member of the Business Cycle Dating Committee of the NBER, I am asked frequently if the country is entering a recession, or if we have already done so. I cannot speak for the Committee, and I am not a professional forecaster. But I can give my views, for what they are worth.

It is hard to say that we entered a recession in the first quarter, without a single negative growth quarter, let alone two of them. Even so, three minor qualifications to that 0.9% remain: 1) The number will be revised again, and could move in either direction. 2) A bit of the measured growth consisted of an increased rate of inventory investment, which was almost certainly not desired by firms and is likely to reverse in the 2nd quarter 3) As Martin Feldstein has pointed out, the QI growth number is defined as the change for the quarter as a whole relative to QIV of 2007; within QI, the information currently available suggests that GDP fell from January to February to March.

The reason why many suspected a QI turning point in the first place is employment, which is virtually as important an indicator to the NBER BCDC as is GDP. Jobs have been lost each month since January. Total hours worked is my personal favorite, because in addition to employment it captures the length of the workweek, which firms tend to cut before they lay off workers. This indicator too has been falling.

And of course there are the longer run indicators that have been very worrisome for almost a year: depressed household balance sheets, mortgage defaults, high oil prices, low consumer confidence, etc.

The economy is a four-engine airplane flying at stall speed, skimming along the top of the waves without yet going down. ... The big question mark is the consumption engine. Is the long-spending American household taking a hard look at its diminished net worth and taking steps to raise its saving rate above the very low levels of recent years?

We are already clearly in a “growth recession.” All in all, I put the odds of an outright recession sometime this year at greater than 50%. That number is meant to add together: (1) the odds that it will turn out that we have already entered reached the turning point and (2) the odds that the sharp recent expansions in monetary and fiscal policy will succeed in postponing the recession, but only until later in the year. Come the fall, if demand starts to slow, I can’t see either the Fed delivering a second big dose of interest rate cuts (as they were able to in the 2001 recession, when the dollar was strong and inflation under control), nor the government delivering a second big dose of tax cuts (as they could in the 2001 recession, when the budget outlook was strong and debt under control).

Next, a different topic. Jeff Frankel defends his argument that high commodity prices are the result of easy monetary policy:

Monetary policy and commodity prices, by Jeffrey Frankel, Vox EU: In a speech delivered last week, Federal Reserve Vice Chairman Donald L. Kohn addressed a theory to which I am partial: the theory that low real interest rates have contributed to the continued rise in prices of agricultural and mineral commodities, including oil, over the last year. He said:

“Some observers have questioned whether the news on fundamentals affecting supply and demand in commodities markets has been sufficient to justify the sharp price increases in recent months. Some of these commentators have cited the actions of the Federal Reserve in reducing interest rates as an important consideration boosting commodity prices. To be sure, commodity prices did rise as interest rates fell. However, for many commodities, inventories have fallen to all-time lows, a development that casts doubt on the premise that speculative demand boosted by low interest rates has pushed prices above levels that would be consistent with the fundamentals of supply and demand. As interest rates in the United States fell relative to those abroad, the dollar declined, which could have boosted the prices of commodities commonly priced in dollars by reducing their cost in terms of other currencies, hence raising the amount demanded by people using those currencies. But the prices of commodities have risen substantially in terms of all currencies, not just the dollar. In sum, lower interest rates and the reduced foreign exchange value of the dollar may have played a role in the rise in the prices of oil and other commodities, but it probably has been a small one.”
(Speech at the National Conference on Public Employee Retirement Systems, New Orleans, Louisiana, May 20, 2008).

As real interest rates have come down over the last year, real commodity prices have accelerated upward despite declining economic growth, as shown in Figure 1, where the commodity price has been inverted so that one can see the correlation visually.

Continue reading "Two from Jeff Frankel: Whether We are Currently in a Recession and the Impact of Monetary Policy on Commodity Prices" »

Saturday, May 24, 2008

"The Invisible Hand Is Shaking"

I recently talked about relative prices as signaling mechanisms in the economy, and how distortions in these signals relate to Fed policy (see False Signals). Part of the discussion noted that "Market failure can also cause distorted prices, but ... this is outside the Fed's purview, so ... that's for another discussion." Conveniently, Robert Frank takes up this issue:

The Invisible Hand Is Shaking, by Robert Frank, Economic Scene, NY Times: Adam Smith's modern disciples are far more enthusiastic about his celebrated invisible-hand idea than he ever was. ...

If you believe, with Smith’s modern disciples, that unfettered pursuit of self-interest always promotes society’s interests, you probably view all taxes as a regrettable evil — necessary to pay for roads and national security, but also an unwelcome drag on economic efficiency. The problem, according to this view, is that taxes distort the price signals through which the invisible hand guides resources to their best destinations.

Smith’s more nuanced position supports a different view of taxes. When market prices convey accurate signals of cost and value, the invisible hand promotes the common good. But prices often diverge from cost and value and, in those cases, taxes can actually help steer resources toward more highly valued uses. ...

The production and consumption of many ... goods ... generate costs or benefits that fall on people besides buyers and sellers. Producing an extra gallon of gasoline, for example, generates not just additional costs to producers, but also pollution costs that fall on others. ...[M]arket forces cause production to expand until the seller’s direct cost for the last unit sold is exactly the value of that unit to the buyer. But because each gallon of gasoline also generates external pollution costs, the total cost of that last gallon produced is higher than its value to consumers.

The upshot is that gasoline consumption is inefficiently high ...[, a] classic breakdown in the invisible hand when a product’s market price doesn’t reflect all its relevant social costs and benefits. In such cases, the simplest solution is to discourage consumption by taxing it.

Doing so would not only raise revenue to pay for public services; it would also make the allocation of society’s resources more efficient...

Efficiency is important because any policy that enlarges the economic pie necessarily lets everyone have a bigger slice than before. Economists opposed suspending the gas tax because doing so would make the economic pie smaller.

Of course, when millions of voters feel the pinch of rapidly rising prices, politicians find it hard to stand idly by. But as the late economist Abba Lerner once remarked, the main problem confronting the poor is that they have too little money. The best solution is not to reduce the prices they pay, but rather to bolster their incomes — for example, by selectively reducing the payroll tax for low-income workers or increasing the Earned Income Tax Credit. Suspending the gas tax would encourage rich and poor alike to do more ... driving. It would also promote sales of fuel-intensive vehicles. Because the gas tax reduces waste, it actually makes more resources available to help low-income families.

Gasoline is one of a host of goods whose production or consumption generates costs that fall on outsiders. ... That the invisible hand often breaks down is actually good news. After all, we need to tax something to pay for public services. By taxing forms of consumption that generate negative side effects, we could not only generate enough revenue to eliminate budget deficits, but also help steer resources toward their most highly valued uses.

Because such taxes make the economy more efficient, it makes no sense to object that they impose hardships on low-income families. Again, an efficient policy is one that maximizes the size of the economic pie. And with a bigger pie, it’s always possible for everyone to get a bigger slice.

With regard to the size of the pie and who gets what, this is not the only basis for arguing for income redistribution, but I think you can base redistributive policy on a market failure argument, i.e. that distribution mechanisms have failed to reward factors of production according to their contributions to the production process. Some have received too much and others too little, and more could be done to counteract this so that we have a better chance to realize the possibility of everyone getting "a bigger slice."

Monday, May 19, 2008

Paul Krugman: Stranded in Suburbia

Paul Krugman is in Berlin:

Stranded in Suburbia, by Paul Krugman, Commentary, NY Times: I have seen the future, and it works.

O.K., I know that these days you’re supposed to see the future in China or India, not in the heart of “old Europe.”

But we’re living in a world in which oil prices keep setting records... And Europeans who have achieved a high standard of living in spite of very high energy prices — gas in Germany costs more than $8 a gallon — have a lot to teach us about how to deal with that world.

If Europe’s example is any guide, here are the two secrets of coping with expensive oil: own fuel-efficient cars, and don’t drive them too much.

Notice that I said that cars should be fuel-efficient — not that people should do without cars altogether. In Germany, as in the United States, the vast majority of families own cars... But the average German car uses about a quarter less gas per mile than the average American car. By and large, the Germans don’t drive itsy-bitsy toy cars, but they do drive modest-sized passenger vehicles rather than S.U.V.’s and pickup trucks.

In the near future I expect we’ll see Americans moving down the same path. We’ve already done it once: over the course of the 1970s and 1980s...

Can we also drive less? Yes — but getting there will be a lot harder.

There have been many news stories in recent weeks about Americans who are changing their behavior in response to expensive gasoline...

But none of it amounts to much. For example, some major public transit systems are excited about ridership gains of 5 or 10 percent. But fewer than 5 percent of Americans take public transit to work, so this surge of riders takes only a relative handful of drivers off the road.

Any serious reduction in American driving will require more than this — it will mean changing how and where many of us live.

To see what I’m talking about, consider where I am at the moment: in a pleasant, middle-class neighborhood consisting mainly of four- or five-story apartment buildings, with easy access to public transit and plenty of local shopping.

It’s the kind of neighborhood in which people don’t have to drive a lot, but it’s also a kind of neighborhood that barely exists in America, even in big metropolitan areas. Greater Atlanta has roughly the same population as Greater Berlin — but Berlin is a city of trains, buses and bikes, while Atlanta is a city of cars, cars and cars. ...

Changing the geography of American metropolitan areas will be hard. For one thing, houses last a lot longer than cars. Long after today’s S.U.V.’s have become antique collectors’ items, millions of people will still be living in subdivisions built when gas was $1.50 or less a gallon.

Infrastructure is another problem. Public transit, in particular, faces a chicken-and-egg problem: it’s hard to justify transit systems unless there’s sufficient population density, yet it’s hard to persuade people to live in denser neighborhoods unless they come with the advantage of transit access.

And there are, as always in America, the issues of race and class. Despite the gentrification that has taken place in some inner cities, and the plunge in national crime rates to levels not seen in decades, it will be hard to shake the longstanding American association of higher-density living with poverty and personal danger.

Still, if we’re heading for a prolonged era of scarce, expensive oil, Americans will face increasingly strong incentives to start living like Europeans — maybe not today, and maybe not tomorrow, but soon, and for the rest of our lives.

Monday, May 12, 2008

Paul Krugman: The Oil Nonbubble

Is the high price of oil price due to fundamentals or speculation?:

The Oil Nonbubble, by Paul Krugman, Commentary, NY Times: “The Oil Bubble: Set to Burst?” That was the headline of an October 2004 article in National Review, which argued that oil prices, then $50 a barrel, would soon collapse.

Ten months later, oil was selling for $70 a barrel. “It’s a huge bubble,” declared Steve Forbes...

All through oil’s five-year price surge, which has taken it from $25 a barrel to last week’s close above $125, there have been many voices declaring that it’s all a bubble, unsupported by the fundamentals of supply and demand.

So here are two questions: Are speculators mainly, or even largely, responsible for high oil prices? And if they aren’t, why have so many commentators insisted, year after year, that there’s an oil bubble? ...

Imagine what would happen if the oil market were humming along, with supply and demand balanced at a price of $25 a barrel, and a bunch of speculators came in and drove the price up to $100. ...

Faced with higher prices, drivers would cut back on their driving; homeowners would turn down their thermostats; owners of marginal oil wells would put them back into production.

As a result, the initial balance between supply and demand would be broken, replaced with a situation in which supply exceeded demand. This excess supply would, in turn, drive prices back down again — unless someone were willing to buy up the excess and take it off the market.

The only way speculation can have a persistent effect on oil prices, then, is if it leads to physical hoarding...But ... inventories have remained at more or less normal levels. This tells us that the rise in oil prices isn’t the result of runaway speculation; it’s the result of fundamental factors, mainly the growing difficulty of finding oil and the rapid growth of emerging economies like China. The rise in oil prices ... had to happen to keep demand growth from exceeding supply growth.

Saying that high-priced oil isn’t a bubble doesn’t mean that oil prices will never decline. ... But it does mean that speculators aren’t at the heart of the story.

Why, then, do we keep hearing assertions that they are?

Part of the answer may be ... that many people are now investing in oil futures — which feeds suspicion that speculators are running the show... But there’s also a political component.

Traditionally, denunciations of speculators come from the left of the political spectrum. In the case of oil prices, however, the most vociferous proponents of the view that it’s all the speculators’ fault have been conservatives — people who you wouldn’t normally expect to see warning about the nefarious activities of investment banks and hedge funds.

The explanation of this seeming paradox is that wishful thinking has trumped pro-market ideology.

After all, a realistic view of what’s happened over the past few years suggests that we’re heading into an era of increasingly scarce, costly oil.

The ... odds are that we’re looking at a future in which energy conservation becomes increasingly important, in which many people may even — gasp — take public transit to work.

I don’t find that vision particularly abhorrent, but a lot of people, especially on the right, do. And so they want to believe that if only Goldman Sachs would stop having such a negative attitude, we’d quickly return to the good old days of abundant oil.

Again, I wouldn’t be shocked if oil prices dip in the near future — although I also take seriously Goldman’s recent warning that the price could go to $200. But let’s drop all the talk about an oil bubble.

Tuesday, May 06, 2008

Menendez: "Thank God" Economists Don't Make Public Policy

Sen. Bob Menendez (D-NJ) is a coauthor with Clinton on the gas tax bill:

To me, the claims being made about this proposal are the same as saying tax cuts pay for themselves. Even if it has popular appeal, even if it wins votes and elections, economists are in wide agreement in saying that the proposal is misleading as stated by the campaign, and generally a bad idea. When literally all the experts around you are telling you that what you are saying is misleading (at best), yet you declare you are going to say it anyway, that’s no better than the Laffer curve stuff. Sure, it’s not much money, but what if this were attacking Iran instead and she declared she was just going to do it anyway? That’s a bigger deal, and refusing to listen to experts - dismissing them as out of touch and elitist - tells us something important.

I have refused, for the most part, to get into Dem vs. Dem issues, and I’ve focused on McCain, but the statement she made irked me. Economics has been undermined enough, and part of it has come from people at think tanks and elsewhere who aren't economists, but pretend to be, promoting ideas like tax cuts are self-financing in op-eds, TV appearances, the NRO, and elsewhere. It has confused people, the media turns it into a he said-she said issue rather than denouncing the falsehoods and misleading statements, and people are left confused and wondering if economists know what they are talking about. When Republicans do this, it ticks me off. Economics has been undermined enough by clowns pretending to be economists, and I won’t help our side undermine the profession even further.

If they want to do public policy without talking to economists, good luck with that. I'm tired of being told I don't understand how average Americans feel. The point here is that this is a lousy way to help people. It's not that we don't care, or don't understand, it's that we do care and understand all to well and we'd like to see policies put into place that actually have a chance to help people. Promising things that aren't likely to happen - telling people they will get relief when it will likely be a pittance (the $70 figure they cite is not supported by the underlying economics) - simply leads to disappointment and disenchantment with politicians. All we are asking is that promises have a chance to be realized. Let's help the people who need help, but let's do it in a way that is effective rather than in a way that plays off their difficulties and fears, but does not really address their needs.

Sunday, May 04, 2008

"I'm not Going to Put my Lot in with Economists"

Greg Mankiw:

The Legacy of Bailouts, by Greg Mankiw: Alan Blinder makes the case for more regulation of financial institutions. The key passage:

It will, for example, substantially reduce the profitability of investment houses and, therefore, reduce their scale. But that’s the price you pay for access to a publicly financed safety net.

That is why some economists cringe when Wall Street firms are bailed out. Beyond the obvious equity issues about risking taxpayer money to help rich guys, there is the problem of efficiency. If you start bailing the firms out when they lose, you have to regulate the gambles they take. You can no longer count on the creditors to limit the firms' leverage, as the creditors are counting on Uncle Sam if things go wrong. But the more regulated these firms are, the lower their productivity will be.

The bottom line: The Bear Stearns bailout may have saved the economy from an episode of financial contagion in the short run, but in the long run it will likely leave us with a more regulated and less vibrant financial system.

I disagree. Lack of effective regulation opened the door for this crisis, and if the Fed had not intervened, there was a strong possibility that the financial system would have had a severe meltdown. Maybe not, but the chance was there and it wasn't a chance most people were willing to take.

Suppose we do nothing and there was a meltdown as feared. One need only look back at the aftermath of the Great Depression to see what happens to regulation after such an event - there was a strong regulatory response. Given the choice between a bailout and the level of regulation that comes along with it, and a crash and the much larger amount of regulation that would follow, it's hard to see why choosing the path that, in a probabilistic sense, gives a smaller likelihood of a major crash and a smaller regulatory response would be objectionable. Financial markets screwed up and they know it - that was quite evident this week at the Milken Institute Global Conference - and they accept that more regulation is needed. The choice isn't between no regulation and some regulation, there will be a regulatory response and the question is how large and effective it will be.

The chance that there would be a financial meltdown had the Fed remained passive instead of intervening is why the statement below from Hillary doesn't make a lot of sense. The equivalence she draws between the financial market bailout and lifting the gas tax is false. The Fed intervened to prevent a financial meltdown, and that helped all of us. There were costs, but the benefits - avoiding a large crash - were far larger.

There is no such necessity for a gas tax, the system won't crash and burn if we do not lift gas taxes for the summer, and the calculation is different. With the financial bailout, we had little choice but to accept some costs in order to prevent far larger costs associated with a meltdown. But given that intervention was needed, the policy that was implemented did not have obvious problems, every economist on the planet did not jump up and say there's a better way to do this! Some did, but the objection was to intervening in financial markets at all. Most agreed this was the best way to proceed if they accepted that that intervention was needed, though there were a few voices advocating variations on the policy. With the gas tax, it is just the opposite - there are no economists I know of that support the policy, not one. Even if they support the idea behind it, giving relief to lower income households, they do not support this particular means of addressing the problem:

Clinton Pushes Back on Gas Tax ‘Pushback’, by Matt Phillips:  Hillary Clinton’s sit-down with George Stephanopoulos on ABC’s “This Week,” quickly delved into her plan to suspend the federal gas tax during the peak summer driving season.

Stephanopoulos ... played a clip of Sen. Barack Obama criticizing the plan. Obama quoted New York Times columnist and Princeton economist Paul Krugman’s assessment that the idea is “pointless and disappointing,” and asked the New York senator to name “a credible economist who supports the suspension.”...

“Well I’ll tell you what, I’m not going to put my lot in with economists,” Clinton said, a response in line with some of the populist notes she’s been hitting in recent stump speeches on the gas tax.

She argued that the policy, if designed properly, could be effective. ... “But let’s step back for a minute George. You know, it’s really odd to me that arguing to give relief to the vast majority of Americans creates this incredible pushback,” she said, “When the federal government, through the Fed and the Treasury gave $30 billion in a bailout to Bear Stearns I didn’t hear anybody jump up and say, ‘That’s not going according to the market, that’s rewarding irresponsible behavior.’ We’ve got to get out of this mindset, where somehow, elite opinion is always on the side of doing things that really disadvantage the vast majority of Americans.”

First, people did complain about the bailout - see above for one, and many of the complaints hit directly on her main point, that "I didn’t hear anybody jump up and say, ‘That’s not going according to the market, that’s rewarding irresponsible behavior’." If she didn't hear that, or if none of her economic advisors did, then they aren't listening. That message was loud and clear.

The "if designed properly" part is strange too. Is she saying that as it stands, it's not a good idea, but she's pushing it anyway? Or is she saying that, as she has designed it, it is a good idea? Either way, it's bunk. She also says, "it’s really odd to me that arguing to give relief to the vast majority of Americans creates this incredible pushback." It's not giving relief that is causing the pushback, there are ways to give relief that don't give up on our environmental goals and have better efficiency properties, e.g. a lump-sum rebate to lower income households. The pushback is about the form of the policy, not the idea behind it.

I'll have to vote soon - Hillary or Obama - and mail in my ballot (we vote by mail here). I've had a bit of trouble deciding, but this will help.

Update: See also Brad Delong, Robert Reich, Richard Green, Ezra Klein, Ryan Avent, and Kevin Drum.

Wednesday, April 30, 2008

"What to Do About Gas Prices?"

Jonah Gelbach emails that he has signed on to post periodically at Economists for Obama:

What to Do About Gas Prices?, by Jonah Gelbach: As an economist, as a person who worries about climate change, and as someone who believes the Democratic Party's electoral success is very important, if only to spare us more of the damage that the GOP has done over the last quarter-century of its hammer lock on federal policy, I find political discussion of gas taxes to be extremely frustrating to watch.

Democratic politicians regularly use high gas prices as a club with which to beat Republicans. I understand that politicians use the issues they think will work. And the nexus between oil company profits and GOP officials whose policies have been awful for most people in the bottom four quintiles of the income distribution (and probably plenty in the top one) has got to be pretty tough for Democratic candidates and officials to resist.

But the fact of the matter is that gas prices should be high. They should be high for the very simple and now very obvious reason that the pressure on the world's climate needs to be reduced. Our country's foolish policy of keeping gas prices low while providing implicit (and sometimes explicit) subsidies to the vehicles that get the worst mileage should have ended many years ago. Demand-side pressure on gas prices is finally pushing gas prices into the range they should have been for many years.

But that last paragraph tells only part of the story. One effect of the low-gas price policies we've pursued for so long is that it's induced many people to buy very fuel-inefficient cars and trucks. These are the people who are getting nailed hardest in the wallets by today's high gas prices, and I don't blame them for being upset. If you drive a vehicle that gets 18 miles per gallon for 12,000 miles a year, then you use about 670 gallons of gas a year. Even a $1.00 per gallon increase in the price of gas over a period of one year alone therefore translates into more than the stimulus tax rebate that a single person with sufficient income will receive over the next month. A married couple each of whom drives such a car 12,000 miles a year will receive a smaller rebate than the one-year cost of a $1 per gallon gas price hike.

By any reasonable standard, the increase in gas prices translates into real money for a huge number of people in this country, especially under current economic conditions.

But since the reason this is true is that American consumers have been induced to buy inefficient gas guzzlers, with serious environmental consequences, policies that would reduce the price of gas should be the last thing we consider. (On this score, the gas tax holiday that Sens. McCain and Clinton have proposed at least has the virtue that it would likely do very little, leading to at most a very small change in the price of gas; McCain's proposal would add to the deficit by increasing windfall profits of oil companies, while Clinton at least has proposed a new windfall profits tax to undo her proposal's provision of windfall profits.)

So what to do?

Continue reading ""What to Do About Gas Prices?"" »

Wednesday, April 23, 2008

Commodity Prices and the Fed

Jim Hamilton answers questions about his believe that the Federal Reserve is partly responsible for recent increases in commodity prices:

Commodities and the Fed: answering the skeptics, by Jim Hamilton: Judging from some of the reactions across the blogosphere (not to mention any number of our own dear readers), maybe I should take another stab at clarifying why I see the hand of the Federal Reserve in the most recent movements in oil and commodity prices. ...

Stagnating oil production in the face of strong demand has everything to do with the broad run-up in oil prices since 2001.... My claim that the Federal Reserve has now also started to contribute to the most recent oil price increases is very specific to what we've observed since January of this year, as I clarified when I first raised this issue February 28:

Although I have been skeptical of Jeff Frankel's story that low interest rates were the primary cause of the broad movements in commodity prices over the last several years, it is very plausible to me as one explanation of what we've seen happen over the last two months.

And here's what I said on March 28:

I have long argued that the broad increase in commodity prices over the last five years has primarily been driven by strong global demand. But I am equally persuaded that the phenomenal increase ([1], [2]) in the price of virtually every storable commodity in January and February cannot be due to those same forces. This was a period when the economic news was getting bleaker by the day, eventually persuading many of us that a recession has likely started. To argue that January and February's news instead signaled booming commodity demand strains credulity.

...Some weeks back Paul [Krugman] noted that, if commodity speculation is playing a role in price moves, we should be seeing inventory accumulation. He appealed to a diagram such as the one below, which depicts the supply and demand curve in the absence of any inventory changes or speculation. Krugman noted that if speculation succeeded in driving the price above the fundamentals equilibrium price P0, it would produce a gap between supply and demand, and would have to show up as inventory accumulation.


But where, Paul asked, is the current evidence of that inventory accumulation? On Sunday, he answered his own question with [a] graph of metals inventories...

I agree with Paul and the others above that speculation was not the primary factor prior to January, and I draw the same conclusion they do from the historical graph. But in terms of interpreting the trends over the last few months, let me just note that the very short run supply and demand curves for most of these commodities are extremely steep-- there is practically no way to bring more copper to the market over the next few weeks unless you are bringing it out of storage somewhere. And if those curves are extremely steep, the magnitude of the inventory change you'd expect would be quite small. Particularly since it could show up anywhere in the chain from production to consumption, I don't think there's a strong presumption you could find evidence of it in the available data.


No matter what your favorite explanation might be-- whether speculation or fundamentals of supply or demand-- any coherent theory says these shifts should show up somewhere in quantities produced, consumed, or stored. But given the very low short-run supply and demand elasticities and the quality of available data, hoping to find confirmation or refutation of that theory on the basis of the quantity data may be asking too much. I believe we have to rely on something else to persuade us. And the main thing that makes me doubt the demand-based story is the fact that the latest surge in commodity prices-- that since January-- came at a time when every indicator of which I'm aware pointed to slower rather than faster real economic growth. ...

Free Exchange ... ends up with the following conclusion:

I predict that if the Fed did surprise by holding the rate steady, oil might crash--all the way back to $100 per barrel.

Again, that's not so different from my own views. Except that I'd add that $100 a barrel would be a welcome development at the moment. If it's within the Fed's power to achieve that, the opportunity should be seized with enthusiasm.

Tuesday, April 22, 2008

"I’m Sure Those Stupid Economists Have Never Thought of That!"

Paul Krugman explains why he is not as optimistic as as others that "human ingenuity and technological progress will solve all our problems":

Limits to growth and related stuff, by Paul Krugman: I’ve been getting some correspondence asking me where today’s resource concerns fit with the old “Limits to growth” stuff that received a lot of publicity 30+ years ago. Actually, there’s a bit of a backstory there.

In 1973-4, my junior and senior years in college, I was Bill Nordhaus’s research assistant, working on energy issues. (This is the same Bill Nordhaus who warned back in 2002 that the cost of the Iraq war would probably be a lot higher than the Bushies were letting on.) I spent much of the summer of 1973, in particular, in Yale’s wonderful geology library — though the real import of what I learned there didn’t sink in for a while, as I’ll explain in a bit.

Continue reading ""I’m Sure Those Stupid Economists Have Never Thought of That!"" »


Menzie Chinn is puzzled by a certain politician's proposal to stimulate the economy:

Puzzled, by Menzie Chinn: I have been puzzled by the proposal for a tax holiday for gasoline purchases running from Memorial to Labor day (see [0], [1], [2]), with the objective of spurring the economy. First, the Federal tax is quite low, either in real or in relative terms. Second, the benefits that would accrue to consumers are probably pretty small, under reasonable assumptions.

Going to the first point... As one can readily verify, in inflation adjusted terms, the tax has been eroded over time to levels not seen since the early 1990's. This is true regardless whether one deflates by the CPI-all or the CPI-ex. energy and food.

In relative terms, the total Federal tax has been shrinking as a share of gasoline prices, as gasoline prices have headed north (March = $3.293, all grades, inclusive of taxes). As of March 2008, the Federal tax accounted for 0.056% of that price. ...

So this is the measure to jump start the economy? I think this measure would give relief to somebody. But I also think it's a pretty blunt instrument by which to provide assistance...

Now, I'm not a microeconomist by training. Nor do I play one on TV. But it seems to me that if the supply of gasoline is price inelastic, and the demand is similarly price inelastic, then the incidence of the current Federal gas tax must be about evenly balanced. A tax holiday is then a holiday to both consumers and producers. ...

The proposed gas tax holiday was for a short duration of months. In this case, the short run price elasticity of supply is near zero, and the demand elasticity is plausibly near zero as well.

Assume both supply and demand are equally price inelastic, and this means the incidence of the Federal tax is about 50-50. Eliminating the gasoline tax for a short duration gives a windfall to both consumers and producers, of about equal proportion. (By the way, this conclusion is not true of state gasoline taxes; see Chouinard and Perloff (2004)). Now, giving a windfall to refiners and providers of feedstock for gasoline production might be a worthy goal, but I don't believe that was the stated goal. If those corporations get a windfall then either it gets stored away to be spent on investment in a new refinery or addition to an old refinery sometime in the future, or it leaks out to overseas oil producers.

Oh, and by the way, to the extent the lower price spurs gasoline consumption, this should increase the petroleum and petroleum products component of U.S. imports, and thence putting further upward pressure on the price of oil...

Monday, April 21, 2008

Paul Krugman: Running Out of Planet to Exploit

Will increasing world demand for limited resource supplies pose a threat to world economic growth, or will technology keep peak oil and other such commodity peaks safely out in front of us?:

Running Out of Planet to Exploit by Paul Krugman, Commentary, NY Times: ...Last week, oil hit $117. It’s not just oil... Food prices have also soared, as have the prices of basic metals. And the global surge in commodity prices is reviving a question we haven’t heard much since the 1970s: Will limited supplies of natural resources pose an obstacle to future world economic growth?

How you answer ... depends largely on what you believe is driving the rise in resource prices. Broadly speaking, there are three competing views.

The first is that it’s mainly speculation — that investors ... at a time of low interest rates have piled into commodity futures, driving up prices. On this view, someday soon the bubble will burst and high resource prices will go the way of

The second view is that soaring resource prices do, in fact, have a basis in fundamentals — especially rapidly growing demand from newly meat-eating, car-driving Chinese — but that given time we’ll drill more wells, plant more acres, and increased supply will push prices right back down again.

The third view is that the era of cheap resources is over for good — ...we’re running out of oil, running out of land to expand food production and generally running out of planet to exploit.

I find myself somewhere between the second and third views.

There are some very smart people ... who believe that we’re in a commodities bubble... My problem with this view...: Where are the inventories? ...inventories of food and metals are at or near historic lows, while oil inventories are only normal.

The best argument for the second view, that the resource crunch is real but temporary, is the strong resemblance between ... now and ... the 1970s.

What Americans mostly remember about the 1970s are soaring oil prices... But there was also a severe global food crisis...

In retrospect, the commodity boom of 1972-75 was probably the result of rapid world economic growth that outpaced supplies,... bad weather and Middle Eastern conflict. Eventually, the bad luck came to an end, new land was placed under cultivation, new sources of oil were found..., and resources got cheap again.

But this time may be different: concerns about what happens when an ever-growing world economy pushes up against the limits of a finite planet ring truer now than they did in the 1970s.

For one thing, I don’t expect growth in China to slow sharply anytime soon. That’s a big contrast with ... the 1970s, when growth in Japan and Europe ... downshifted — and thereby took ... pressure off ... resources.

Meanwhile,... Big oil discoveries ... have become few and far between, and in the last few years oil production from new sources has ... barely ... offset declining production from established sources.

And the bad weather hitting agricultural production this time is starting to look more fundamental and permanent... Australia, in particular, is now in the 10th year of a drought that looks more and more like a long-term manifestation of climate change.

Suppose that we really are running up against global limits. What does it mean?

Even if it turns out that we’re really at or near peak world oil production, that doesn’t mean that one day we’ll say, “Oh my God! We just ran out of oil!” and watch civilization collapse into “Mad Max” anarchy.

But rich countries will face steady pressure on their economies from rising resource prices, making it harder to raise their standard of living. And some poor countries will find themselves living dangerously close to the edge — or over it.

Don’t look now, but the good times may have just stopped rolling.

Saturday, April 12, 2008

High Oil Prices and the Return of “Resource Nationalism"

When oil prices rise, why do countries tend to nationalize oil resources rather than raising taxes on oil producers which, under standard economic theory, ought to bring more revenue?

High oil prices and the return of “resource nationalism”, by Sergei Guriev, Anton Kolotilin, and Konstantin Sonin, Vox EU: As oil prices rise, global oil companies may seem to be making up for previous times when revenues barely covered production costs. However, the oil executives know all too well that high oil prices are a mixed blessing. Echoing the title of Terry Karl’s 1997 book, Eni’s CEO Paolo Scaroni called this situation “the paradox of plenty”: while high oil prices bring high cash flows, they also raise the bargaining power of oil-producing countries. Their governments resort to the policies of “a 1970's style of resource nationalism riding along the crest of high prices,” in the words of Daniel Yergin, the chairman of Cambridge Energy Research Associates (Mouawad, 2006). Governments deny private companies access to new oil fields and nationalise the fields that the private companies have started to develop.

Continue reading "High Oil Prices and the Return of “Resource Nationalism"" »

Monday, April 07, 2008

Paul Krugman: Grains Gone Wild

Can anything be done to alleviate the food crisis?:

Grains Gone Wild, by Paul Krugman, Commentary, NY Times: These days you hear a lot about the world financial crisis. But there’s another world crisis under way — and it’s hurting a lot more people.

I’m talking about the food crisis. Over the past few years the prices of wheat, corn, rice and other basic foodstuffs have doubled or tripled, with much of the increase taking place just in the last few months. High food prices dismay even relatively well-off Americans — but they’re truly devastating in poor countries, where food often accounts for more than half a family’s spending. There have already been food riots around the world...

How did this happen? The answer is a combination of long-term trends, bad luck — and bad policy.

Let’s start with the things that aren’t anyone’s fault.

First, there’s the march of the meat-eating Chinese —... the growing number of people ... who are, for the first time, rich enough to start eating like Westerners. Since it takes about 700 calories’ worth of animal feed to produce a 100-calorie piece of beef, this change in diet increases the overall demand for grains.

Second... Modern farming is highly energy-intensive... With oil persistently above $100 per barrel, energy costs have become a major factor driving up agricultural costs. High oil prices ... have a lot to do with ... China and other emerging economies ... competing ... for scarce resources..., driving up prices for raw materials...

Third, there has been a run of bad weather in key growing areas. In particular, Australia, normally the world’s second-largest wheat exporter, has been suffering from an epic drought.

O.K., I said that these factors ... aren’t anyone’s fault, but that’s not quite true. The rise of China and other emerging economies is the main force driving oil prices, but the invasion of Iraq ... has ... reduced oil supplies... And bad weather, especially the Australian drought, is probably related to climate change...

Where the effects of bad policy are clearest, however, is in the rise of demon ethanol and other biofuels. ...[E]ven on optimistic estimates, producing a gallon of ethanol from corn uses most of the energy the gallon contains. But ... even seemingly “good” biofuel policies, like Brazil’s use of ethanol from sugar cane, accelerate ... climate change by promoting deforestation.

And meanwhile, land used to grow biofuel feedstock is land not available to grow food, so subsidies to biofuels are a major factor in the food crisis. You might put it this way: people are starving in Africa so that American politicians can court votes in farm states.

Oh, and in case you’re wondering: all the remaining presidential contenders are terrible on this issue.

One more thing: Governments and private grain dealers used to hold large inventories..., just in case a bad harvest created a sudden shortage. Over the years, however, these precautionary inventories were allowed to shrink, mainly because everyone came to believe that countries ... could always import the food they needed.

This left the world food balance highly vulnerable to a crisis affecting many countries at once — in much the same way that the marketing of complex financial securities, which was supposed to diversify away risk, left world financial markets highly vulnerable to a systemwide shock.

What should be done? The most immediate need is more aid to people in distress: the U.N.’s World Food Program put out a desperate appeal for more funds.

We also need a pushback against biofuels, which turn out to have been a terrible mistake. But it’s not clear how much can be done. Cheap food, like cheap oil, may be a thing of the past.

Friday, January 04, 2008

Paul Krugman: Dealing With the Dragon

Paul Krugman says we’re having the wrong discussion about foreign policy:

Dealing With the Dragon, by Paul Krugman, Commentary, NY Times: ...Almost all the foreign policy talk in this presidential campaign has been motivated, one way or another, by 9/11 and the war in Iraq. Yet it’s a very good bet that the biggest foreign policy issues for the next president will involve the Far East rather than the Middle East. In particular, the crucial questions are likely to involve the consequences of China’s economic growth.

Turn to any of several major concerns now facing America, and in each case it’s startling how large a role China plays.

Start with the soaring price of oil. Unlike the oil crises that followed the Yom Kippur War and the overthrow of the shah of Iran, this crisis wasn’t caused by events in the Middle East that disrupted world oil supply. Instead, it had its roots in Asia.

It’s true that the global supply of oil has been growing sluggishly... But the reason oil supply hasn’t been able to keep up with demand is surging oil consumption in newly industrializing economies — above all, in China. ... China has been responsible for about a third of the growth in world oil consumption. As a result, oil at $100 a barrel is, in large part, a made-in-China phenomenon.

Speaking of made in China, that brings us to a second issue. There’s growing concern in this country about the effects of globalization on wages, largely because imports ... from low-wage countries have surged, doubling as a share of G.D.P. since 1993. And more than half of that rise reflects ... industrial imports from China...

Last, but most important, is the issue of climate change, which will eventually be recognized as the most crucial problem facing America and the world — maybe not today, and maybe not tomorrow, but soon, and for the rest of our lives.

China is already, by some estimates, the world’s largest emitter of greenhouse gases. And as with oil demand, China plays a disproportionate role in emissions growth. In fact, between 2000 and 2005 China accounted for more than half the increase in the world’s emissions of carbon dioxide.

What this means is that any attempt to mitigate global warming will be woefully inadequate unless it includes China. ...

So what does all this tell us about the presidential race?

On the Republican side, foreign policy talk is all bluster and braggadocio. To listen to the G.O.P. candidates, you’d think it was still February 2003, when the national discourse was dominated by people who thought that American military might was sufficient to shock and awe the rest of the world into doing our bidding.

Memo: China has 50 times the population of Iraq.

The Democrats in general make far more sense. But among at least some of Barack Obama’s supporters there seems to be a belief that if their candidate is elected, the world’s problems will melt away in the face of his multicultural charisma.

Memo: It won’t work on the Chinese.

The truth is that China is too big to be bullied, and the Chinese are too cynical to be charmed. But while they are our competitors in important respects, they’re not our enemies, and they can be dealt with.

A lot of Americans, when they think about the next president’s foreign-policy qualifications, seem to be looking for a hero — someone who will stand tall against terrorists, or transform the world with his optimism.

But what they should be looking for is something more prosaic — a good negotiator, someone who can bargain effectively with some very tough customers and get the deals we need on energy, currency policy and carbon credits.

Sunday, December 23, 2007

"Life after Peak Oil"

According to Gregory Clark, running out of fossil fuel may not reduce living standards by as much as you might think:

Life after peak oil, by Gregory Clark, Sacramento Bee: Oil prices have receded from their recent flirtation with $100 a barrel, but ... increased demand, high prices and the prospect of an eventual peak in oil production has caught Americans paralyzed between ... the fear that rampant consumption of oil and coal is irreversibly warming the Earth and the dread that without cheap oil our affluent lifestyles will evaporate. ...

Study of the long economic history of the world suggests two things, however. Cheap fossil fuels actually explain little of how we got rich since the Industrial Revolution. And after an initial period of painful adaptation, we can live happily, opulently and indeed more healthily, in a world of permanent $100-a-barrel oil or even $500-a-barrel oil. ...

Many people think mistakenly that modern prosperity was founded on this fossil energy revolution, and that when the oil and coal is gone, it is back to the Stone Age. If we had no fossil energy, then we would be forced to rely on an essentially unlimited amount of solar power, available at five times current energy costs. With energy five times as expensive ... we would take a substantial hit to incomes. Our living standard would decline by about 11 percent. But we would still be fantastically rich compared to the pre-industrial world. ... Our income would still be above the current living standards in Canada, Sweden or England. Oh, the suffering humanity! At current rates of economic growth we would gain back the income losses from having to convert to solar power in less than six years. ...

The ability to sustain such high energy prices at little economic cost depends on the assumption that we can cut back from using the equivalent of six gallons of gas per person per day to 1.5 gallons. Is that really possible? The answer is that we know already it is.

The economy would withstand enormous increases in energy costs with modest damage because energy is even now so extravagantly cheap that most of it is squandered in uses of little value. Recently, I drove my 13-year-old son 230 miles round-trip ... to play a 70-minute soccer game. Had every gallon of gas cost [considerably more], I am sure his team could have found opposition closer to home.

The median-sized U.S. home is now nearly 2,400 square feet, for an average family size of 2.6 people... Much of that heated, air-conditioned and lighted square footage rarely gets used. Cities ... that were developed in the world of cheap gas have sprawled across the landscape so that the only way to get to work or to shops is by car...

Some countries in Europe, such as Denmark, which have by public policy made energy much more expensive, already use only the equivalent of about three gallons of gas per person. I have been to Copenhagen, and believe me the Danes are not suffering a lot from those the daily three gallons of gas they gave up.

But can we get down to 1.5 gallons without huge pain? We can see even now communities where for reasons of land scarcity people have been forced to adopt a lifestyle that uses much less energy – places like Manhattan, London or Singapore. ... Housing space per person is much smaller, people walk or take public transit to work and to shop, and energy usage is correspondingly much lower, despite the inhabitants being very rich.

So the future after peak oil will involve living in such dense urban settings where destinations are walkable or bikeable, just as in pre-industrial cities (the city of London in 1801 had 100,000 inhabitants in one square mile). Homes will be much smaller... Nights will be darker. We will not have retail outlets lit up like the glare of the midday sun in Death Valley.

Such a lifestyle is not only possible it will be much healthier. We are not biologically adapted to the suburban lifestyle... – lots of cheap calories delivered right to your seat in the SUV that shuttles you from your sofa at home, to your chair at work, to the gym where you try and work on your weight problem. ...

So life after peak oil should hold no terror for us – unless, of course, you have invested in a lot of suburban real estate.

Wednesday, November 07, 2007

"Biofuels Can Match Oil Production"

Ricardo Hausmann with an optimistic view of the potential for biofuels as an alternative to oil:

Biofuels can match oil production, by Ricardo Hausmann, Commentary, Financial Times: Peering into the future seldom produces a clear picture. But this is not the case with bio-energy. Its long-term impacts on the global economy appear to be pretty clear, ... including the demise of the price-setting power of the Organisation of the Petroleum Exporting Countries and the end of agricultural protectionism.

First, technology is bound to deliver a biofuel that will be competitive with fossil energy at something like current prices. It probably already has. Brazil has been exporting ethanol to the US... in spite of a 54 cents a gallon tariff...

There is plenty of private venture capital money being poured into finding more efficient ways of extracting energy from biomass... New technologies will be able to extract energy from cellulose, allowing the use of pastures such as switch grass as well as the refuse of current food production. The cheque is in the mail.

Second, the world is full of under-utilised land that can grow ... biomass... Rodrigo Wagner and I have estimated that there are some 95 countries that have more than 700m hectares of good quality land that is not being cultivated. ... So the production potential of biofuels is in the same ball park as oil production today.

Third, even if only partially used, this large potential biofuels supply will cap the price of oil because its supply is much more elastic than the supply of oil. This will cause the price of oil to be set at the marginal cost of bio-energy, independently of the production decisions of Opec. ... Oil producers will still be rich, but they will not have incentives to form a cartel.

Fourth, ... This will imply a very large increase in the demand for agricultural land. Its price and that of the products that use it intensively – such as food and cotton – will go up. By how much? This will depend ... on the ... degree to which food crops will be complements or substitutes of bio-energy: they would be substitutes if switch grass were planted instead of soybeans; they will be complements if biofuels are made out of wheat stalk. My bet is that they will tend to be more substitutes than complements and the relative price of food will go up.

Fifth, the increase in the price of agricultural land and of food will relieve governments from the current political pressure to protect the agricultural sector. Governments that, as a consequence of the land glut, have been protecting and subsidising farmers will see them grow rich...

By contrast, consumers will be less enthusiastic and demand that something be done about the price of food. The obvious solution will be to cut back on protectionism and liberalise trade in agriculture.

Sixth, the countries that have the largest endowment of under-utilised lands are in the developing world, especially Africa and Latin America. Putting that land into production will require a type of infrastructure that ... usually crowds in other forms of investment by lowering transport costs in ample regions of the country. Bio-energy will make those infrastructure investments socially profitable, creating a possible stepping stone into other industries.

Some policy action in industrialised countries will be required to make this world possible. ... To make this scenario appealing, the impact of the expansion of the agricultural frontier on the environment and biodiversity, and the distributive effects of the rise in food prices will have to be addressed. But these problems seem solvable...

Saturday, November 03, 2007

FRB Dallas: Quarterly Energy Update

The Dallas Fed documents current conditions in energy markets, and gives forecasts of where things are headed in the future:

Soaring Oil Prices Dominate Energy Markets, Quarterly Energy Update, by Stephen P. Brown and Raghav Virmani, FRB Dallas: Oil Prices Rise Sharply Since sliding to just under $70 per barrel for West Texas Intermediate (WTI) in mid-August, oil prices have risen nearly 30 percent in two months. WTI closed at $92.91 on October 25—within $10 of the all-time inflation-adjusted high of $101.70 set in April 1980. Prices have been elevated and rising throughout 2007, climbing from $50 in mid-January to over $90 in mid-October, an astounding 86 percent gain. Oil futures prices remain in fairly sharp backwardation, which means that the market expects presently high oil prices to fall in the long term. Although this has been the case through many price spikes this year, long-term oil price expectations today have strengthened by almost 15 percent since mid-August (Chart 1).

Chart 1: Long-term oil expectations

Escalating tensions in the Middle East, slippage of the U.S. dollar (Chart 2), and an unexpected drawdown of international crude oil and product inventories account for the upward pressure on oil prices.

Continue reading "FRB Dallas: Quarterly Energy Update" »

Wednesday, September 26, 2007

Alan Greenspan versus Naomi Klein

This is part of a longer interview of Alan Greenspan and Naomi Klein:

Alan Greenspan vs. Naomi Klein on the Iraq War, Bush's Tax Cuts, Economic Populism, Crony Capitalism and More, Democracy Now [Watch 128k stream, Watch 256k stream]: AMY GOODMAN: ...We welcome you both to Democracy Now! ... You worked with six presidents, with President Reagan, with both President Bushes. You worked with President Ford, and you worked with Bill Clinton, who you have called a Republican president; why?

ALAN GREENSPAN: That was supposed to be a quasi-joke. ... I’m a libertarian Republican, which means I believe in a series of issues, such as smaller government, constraint on budget deficits, free markets, globalization, and a whole series of other things, including welfare reform. And as you may remember, Bill Clinton was ... doing much that same agenda... [H]e is a centrist Democrat. And that's not all that far from libertarian Republicanism. ...

AMY GOODMAN: Alan Greenspan, let's talk about the war in Iraq. You said what for many in your circles is the unspeakable, that the war in Iraq was for oil. Can you explain?

Continue reading "Alan Greenspan versus Naomi Klein" »

Monday, September 17, 2007

"The Iraq War is Largely about Oil"

Alan Greenspan explains his comment about oil and the Iraq war:

Greenspan Says Hussein's Removal Was 'Essential', by Bob Woodward, Washington Post: Alan Greenspan, the former Federal Reserve chairman, said in an interview that the removal of Saddam Hussein had been "essential" to secure world oil supplies, a point he emphasized to the White House in private conversations before the 2003 invasion of Iraq.

Greenspan ... made the striking comment in a new memoir out today that "the Iraq War is largely about oil." In the interview, he clarified..., saying that while securing global oil supplies was "not the administration's motive," he had presented the White House with the case for why removing Hussein was important for the global economy.

"I was not saying that that's the administration's motive," Greenspan said in an interview Saturday, "I'm just saying that if somebody asked me, 'Are we fortunate in taking out Saddam?' I would say it was essential."

He said that in his discussions with President Bush and Vice President Cheney, "I have never heard them basically say, 'We've got to protect the oil supplies of the world,' but that would have been my motive." Greenspan said that he made his economic argument to White House officials and that one lower-level official, whom he declined to identify, told him, "Well, unfortunately, we can't talk about oil." Asked if he had made his point to Cheney specifically, Greenspan said yes, then added, "I talked to everybody about that." ...

Greenspan ... added that he was not implying that the war was an oil grab. "No, no, no," he said. Getting rid of Hussein achieved the purpose of "making certain that the existing system [of oil markets] continues to work, frankly, until we find other [energy supplies], which ultimately we will."

One more person telling the administration what they wanted to hear prior to the war.

If I had questions about monetary policy, Ben Bernanke is one of the first people I would want to consult. Few, if any people are more knowledgeable about both the theory and evidence, and his recent experience enhances his understanding of how the Fed interacts with financial markets.

But if I want to know about oil markets, how removing a dictator in the Middle East will impact the region's stability, and so on, Ben Bernanke is not the first person I would think of to talk to. He might not even be in the top ten or twenty.

Greenspan was telling members of the administration what they wanted to hear, and I'm sure they used his worries about oil markets to buttress their case for going to war. But I hope Greenspan also encouraged the administration to consult with others who have more expertise on these issues than he has. I'm not sure exactly what or who Greenspan relied upon to draw his conclusions, so perhaps he consulted the experts himself, and given the cherry picking of "facts" that went on perhaps it wouldn't have mattered much in any case, but when war is involved you hope that the best and the brightest are part of the discussion.

Saturday, September 08, 2007

Olivier Blanchard and Jordi Gali: The Macroeconomic Effects of Oil Shocks. Why are the 2000s So Different from the 1970s?

Why did the economy respond differently to oil price shocks in the 2000s as compared to the 1970s?:

The Macroeconomic Effects of Oil Shocks. Why are the 2000s So Different from the 1970s?, by Olivier J. Blanchard and Jordi Gali, NBER WP 13368, September 2007 [open link]: Abstract We characterize the macroeconomic performance of a set of industrialized economies in the aftermath of the oil price shocks of the 1970s and of the last decade, focusing on the differences across episodes. We examine four different hypotheses for the mild effects on inflation and economic activity of the recent increase in the price of oil: (a) good luck (i.e. lack of concurrent adverse shocks), (b) smaller share of oil in production, (c) more flexible labor markets, and (d) improvements in monetary policy. We conclude that all four have played an important role.

Continue reading "Olivier Blanchard and Jordi Gali: The Macroeconomic Effects of Oil Shocks. Why are the 2000s So Different from the 1970s?" »

Sunday, August 12, 2007

Polarized Resource Claims

One of the consequences of anticipated global warming:

The Great Arctic Oil Rush, Editorial, NY Times: For a brief moment it seemed that Adm. Robert Peary and Dr. Frederick Cook had risen from the mists to renew their race to the North Pole.

On Aug. 2, a couple of Moscow legislators in a small submersible vessel deposited a Russian flag on the seabed two miles under the polar ice cap — backing up Russia’s claim to close to half the floor of the Arctic Ocean. Canada’s foreign minister, Peter McKay, dismissed the move, sniffing that “this isn’t the 15th century.” But just in case, Canada dispatched no less a personage than Stephen Harper, its prime minister, on a three-day tour of the region and announced plans to build two new military bases to reinforce the country’s territorial claims.

At stake is control of the Northwest Passage and, with it, what could be huge deposits of oil and natural gas in the seabed below.

In a 21st-century twist unimaginable to Cook and Peary, global warming — driven, in part, by humanity’s profligate use of those same fossil fuels — has begun to melt the polar ice, exposing potentially huge deposits of hitherto unreachable natural resources. ...[W]ith oil at $70 a barrel, the rewards of discovery could be huge.

Russia and Canada are not alone in the great Arctic oil race. Denmark, Finland, Norway, Iceland and the United States also have a deep interest in the matter.

One thing is clear. To the extent that ownership can be determined, it will not be decided by photo-ops or even by planting flags.... It will be decided by geologists, lawyers and diplomats.

Under international law, nations have rights to resources that lie up to 200 miles off their shores. The rest is regarded as international waters, subject to negotiation under the Law of the Sea. A nation can claim territory beyond the 200-mile limit, but only if it can prove that the seabed is a physical extension of its continental shelf.

The Russians are claiming that the huge Lomonosov Ridge underneath the pole is in fact an extension of their continental shelf. And to show just how crazy this could get, the Danes are spending a fortune trying to prove that their end of the same ridge — though now detached — was once part of Greenland, which belongs to Denmark.

The United States does not find itself in a strong position. Misplaced fears among right-wing senators about losing “sovereignty” has kept the Senate from ratifying the Law of the Sea even though the United Nations approved it 25 years ago. This, in turn, means that the United States, with 1,000 miles of coastline in the Arctic, has no seat at the negotiating table.

President Bush and moderate Republicans like Senator Richard Lugar ... will try to remedy this blunder when Congress reconvenes. This would at least enable Washington to stake its claims to the continental shelf extending northward from Alaska. We may never need a share of that oil, but it seems foolish not to keep it in reserve.

Friday, July 27, 2007

Paul Krugman: The Sum of Some Fears

Paul Krugman discusses three fears about the economy:

The Sum of Some Fears, by Paul Krugman, Commentary, NY Times: Yesterday’s scary ride in the markets wasn’t a full-fledged panic. The interest rate on 10-year U.S. government bonds — a much better indicator than stock prices of what investors think will happen to the economy — fell sharply, but ... ended the day ... well above its levels earlier in the year. This tells us that investors still consider a recession ... fairly unlikely.

So it wasn’t the sum of all fears. But it was the sum of some fears — three, in particular.

The first is fear of bad credit. Back in March, ... I spun a fantasy about how a global financial meltdown could take place: people would suddenly remember that bad stuff sometimes happens, risk premiums ... would soar, and credit would dry up.

Well, some of that happened yesterday. “The risk premium on corporate bonds soared...,” reported Bloomberg... “And debt sales faltered...” Mark Zandi of Moody’s ... said ... another major hedge fund stumble..., “...could elicit a crisis of confidence and a global shock.”...

But what’s really striking is ... the current angst ... over two things that I thought had been obvious for a long time: the magnitude of the housing slump and the persistence of high oil prices.

I’ve written a lot about housing..., so let me just repeat the basics. Back in 2002 and 2003, low interest rates made buying a house look like a very good deal. As people piled into housing, ... prices rose ... and ... the boom fed on itself...

Eventually the bubble had to burst, and ... it did... And ... past boom-and-bust cycles in housing tells us that it should be several years ... before things return to normal.

I’ve written less about oil prices, so let me emphasize ... we’re now in our third year of very high oil prices..., even though there hasn’t been any major disruption in world oil supply.

It’s pretty clear what’s happening: ...finding new oil is getting a lot harder. Meanwhile, emerging economies, especially in Asia, are burning ever more oil... With demand soaring and supply growth sluggish at best, high prices are what you get.

So why did people seem so shocked by a few more bad housing and oil numbers? What I guess I didn’t realize was how deep the denial still runs.

Over the last couple of years a peculiar conviction emerged among some analysts — mainly, for some reason, among those with right-wing political leanings — that the housing bubble was a myth and that the real bubble was in oil prices.

Each new peak in oil prices was met with declarations that it was all speculation — like the 2005 prediction by Steve Forbes that oil was in a “huge bubble” and that its price would be down to $35 or $40 a barrel within a year. And on the other side, as recently as this January, National Review’s Buzzcharts column declared that we were having a “pop-free” housing slowdown.

I didn’t think many people believed this stuff, but the market’s sudden freakout over housing and oil suggests that I was wrong.

Anyway, now reality is settling in. And there’s one more thing worth mentioning: the economic expansion that began in 2001, while it has been great for corporate profits, has yet to produce any significant gains for ordinary working Americans. And now it looks as if it never will.

Previous (7/23) column: Paul Krugman: The French Connections
Next (7/30) column: Paul Krugman: An Immoral Philosophy

Thursday, July 26, 2007

"I Find It Hard to Take Them Seriously"

Rudy Giuliani thinks he has a great idea - energy independence - and he's going to lead the way:

Leading America Toward Energy Independence, by Rudy Giuliani, Real Clear Politics: America needs to become energy independent. We should have started to move toward energy independence back in the 1970s... Presidents Nixon and Carter talked about energy independence, but not a lot got done. The next President of the United States is going to have to make it a major goal... Most people will say it's impossible... I'm running for president because I know how to get things done.

I will move America toward energy independence... In the long-run, energy independence can become a great industry for America. We can sell our advances to countries like China and India. They need energy independence even more than we do... The government has to approach energy independence the way we put a man on the moon. ...

I'm going to turn this over to Jim Hamilton:

Finally, it is worth pointing out that, even if the U.S. somehow were to achieve energy self-sufficiency, that would not be the same thing as energy independence. It is hard to envision an arrangement that could effectively decouple the price of oil in the U.S. from that elsewhere in the world, even if our imports were zero. As a result, even if we were importing no oil from Saudi Arabia, I would expect a disruption in Saudi production to still have a very dramatic effect on the price that consumers pay in the U.S.

For these reasons, I am open to discussion about the extent to which it might be desirable to try to reduce the amount of oil that the U.S. imports, and strategies for achieving that goal. But when someone talks about "energy independence", I find it hard to take them seriously.

It's hard to take Giuliani seriously in any case.

Update: Free Exchange at The Economist follows up with "how vacuous such ideas really are."

Wednesday, July 11, 2007

James Hamilton: IEA Becomes More Pessimistic

A recent IEA report paints a pessimistic picture of oil markets in the near future. I'm going to turn the microphone over to Jim Hamilton and let him explain what this means. Here's a condensed version of his remarks on the issue:

IEA becomes more pessimistic, by James Hamilton on energy: The International Energy Agency's latest Medium-Term Oil Market Report is significantly more pessimistic about global surplus oil capacity over the next half-decade.

The IEA Report (hat tip to Tim Iacono and The Oil Drum for the link) sees a tighter oil market ahead than it had been predicting just last February. The IEA's methodology has to make an economist wince-- they extrapolate demand trends, separately calculate supply prospects, and, when the two numbers aren't equal to each other, issue a hand-wringing report like the present one.

Source: IEA.

The forecast now calls for demand growth to exceed supply, presumably putting upward pressure on prices... The increased strain comes from a number of different sources. The IEA is now anticipating world oil demand in 2010 ...[to be] 0.6 mb/d higher than their February forecast-- as Tim notes, a good recession could fix that problem. They also are anticipating a 0.9 mb/d smaller increase in non-OPEC crude supply and 0.8 mb/d smaller increase in OPEC crude capacity relative to their February projections. A big factor in the latter adjustments is "slippage"-- projects always seem to take longer than originally anticipated. In addition, the IEA is now subtracting 0.4 mb/d in a new category for unplanned production outages-- it's a safe bet that somewhere in the world we'll see hurricanes or other unscheduled disruptions.

The IEA report stresses that the adjustments are not coming from changes in assumptions about depletion rates... The IEA also makes clear they are not signing on to peak oil...

But conspicuous by its absence is a discussion of the production decline in Saudi Arabia. The report lists 2007 Saudi production capacity at 10.8 mb/d, but does not offer a theory as to why Saudi production is currently only 8.6 mb/d and has dropped by 2 mb/d over the last two years.

Continue reading "James Hamilton: IEA Becomes More Pessimistic" »

Tuesday, May 29, 2007

Lumps of Coal

Is liquefied coal the answer? It depends upon the question being asked. Here's Brad Plumer:

How Energy Independence Threatens the Environment, by Bradford Plumer, TNR: ...When environmentalists talk about energy policy, they usually focus ... on global warming. Many Democrats, however, prefer to frame the discussion in terms of "energy security." And who can blame them? Even people who shrug at the thought of rising temperatures agree that the country should wean itself off foreign oil. It's a hugely popular idea. And, since many of the policies that would free the United States from ... Opec would also curb carbon emissions, who would begrudge the Democrats this bit of clever framing?

But the strategy comes with a downside: ...Big Coal is teaming up with an array of Republicans and Democrats to tout liquefied coal as a substitute for gasoline... The country is sitting on vast coal reserves, they reason, so why not use those instead of tossing money at the House of Saud? There's just one catch: Liquefied coal would do little to reduce carbon emissions and, in all likelihood, would make things worse. Nevertheless, the idea continues to gain currency in Congress, in part because "energy security" is a sales pitch few politicians can resist.

The ... coal industry ... has fallen on hard times. .... Moreover, ... if Congress passes a strong emissions-reduction bill to deal with climate change, coal production could decline sharply... As a result, investors have been increasingly wary of financing new coal-related projects.

Liquefied coal could be just the life raft Big Coal needs. ... Unfortunately..., the Energy Department found that coal-to-liquid fuel could generate roughly twice the carbon emissions that regular gasoline does. Coal backers counter that, if the carbon released during liquefication could be captured and permanently stored underground, the fuel would be comparable in carbon impact to gasoline--that is, the status quo. But the technology for storing carbon underground remains unproved, and, even if it works, cost pressures may prevent it from being adopted on a large scale...

Yet, despite these problems with liquid coal, Democrats are hopping aboard. ... For their part, Republicans seem to have few qualms about coal. ...

Ironically, for all the hype, liquefied coal is hardly the cheapest or easiest way to achieve energy security. According to the National Coal Council, ... a tremendous coal-to-liquid push--involving $211 billion in investments over the next 20 years and a 40 percent increase in mining--would allow the United States to replace just 10 percent of its oil supply. By contrast, using that coal to generate electricity for plug-in hybrids would displace twice the oil and emit a fraction of the carbon.

Still, the Coal-to-Liquids Coalition insists that liquid coal is "among the most practical, promising answers to greater energy security." And, so long as official Washington continues to treat this dubious assertion as fact, Democrats who prefer to talk about energy independence first and global warming second will be playing right into Big Coal's hands.

See also Lawmakers Push for Big Subsidies for Coal Process for an example of the push to liquefy coal and more discussion of these issues.

Friday, May 11, 2007

FRB Dallas: Economic Outlook and Quarterly Energy Update

Here are two outlooks from the Dallas Fed, one for the national economy and one for energy prices.

First, the national economic outlook. The first paragraph is interesting - it says that first quarter GDP estimates probably overstate the extent of the slowing in the economy. Chart 3 showing the depth and duration of the current housing downturn compared to past housing downturns is also interesting - it shows that, as of now, the depth and duration of the current cycle is very close to the average over all cycles:

Growth Slows in First Quarter 2007, by Jim Dolmas, FRB Dallas: Real GDP growth slowed to a 1.3 percent annual rate in first quarter 2007 from a 2.5 percent rate in fourth quarter 2006, according to the Bureau of Economic Analysis’s advance estimate. While the pace of economic activity certainly cooled in the first quarter, the 1.2 percentage point drop in the GDP growth rate probably overstates the extent of the underlying slowing. Unusual declines in exports and federal government defense outlays combined to subtract about 0.4 percentage point from first-quarter growth.

Continue reading "FRB Dallas: Economic Outlook and Quarterly Energy Update" »

Saturday, February 17, 2007

Jim Hamilton: Saudi Oil Production Cuts

Jim Hamilton says there's potentially a big story concerning the reasons for Saudi Arabia's cuts in oil production that the press hasn't noticed:

Saudi oil production cuts, by Jim Hamilton: This is a potentially huge story that is not being adequately investigated by the financial press...

Update: A follow-up:

Study sees harmful hunt for extra oil, by Carola Hoyos, Financial Times: All the world’s extra oil supply is likely to come from expensive and environmentally damaging unconventional sources within 15 years, according to a detailed study.

This will mean increasing reliance on hard-to-develop sources of energy such as the Canadian oil sands and Venezuela’s Orinoco tar belt.

A report ... calculates that the world holds 3,600bn barrels of unconventional oil and gas that need a lot of energy to extract. ...

Only 15 per cent of the 3,600bn is heavy and extra-heavy oil, with the rest being even more challenging.

The study makes clear the shift could come sooner than many people in the industry had expected, even though some major conventional oil fields will still be increasing their production in 2020. Those increases will not be enough to offset the decline at other fields.

“It becomes unclear beyond 2020 that conventional oil will be able to meet any of the demand growth,” ... The report added that natural gas products such as liquids and condensate would also become important sources of growth.

The increasing reliance on unconventional oil will require a substantial reshaping of the energy industry. ...

[T]he challenge is huge, said Matthew Simmons, an industry banker who sent shock waves through the oil world when he questioned whether Saudi Arabia, the most important oil source, would be able to continue to expand production.

“The ability to extract this heavy oil in significant volumes is still non-existent,” he said in a recent speech.

“Worse, it takes vast quantities of scarce and valuable potable water and natural gas to turn unusable oil into heavy low-quality oil.” ...

Saturday, February 03, 2007

Thomas Friedman: Iran's Great Weakness May Be Its Oil

The San Diego Union-Tribune has Thomas Friedman's latest column from Times Select:

Iran's great weakness may be its oil, by Thomas Friedman, Commentary,Union-Tribune: There may be only one thing dumber than getting addicted to consuming oil as a country – and that is getting addicted to selling it. ... Economists have long studied this phenomenon, but I got focused on it here in Moscow after chatting with Vladimir Mau, the president of Russia's Academy of National Economy. ...

Here's the story: The inefficient Soviet economy survived in its early decades ... thanks to cheap agriculture, from peasants forced into collective farms, and cheap prison labor... Beginning in the 1960s, however, even these cheap inputs weren't enough, and the Kremlin had to start importing ... grain. Things could have come unstuck then. But the 1973 Arab oil embargo and the sharp upsurge in oil prices – Russia was the world's second-largest producer after Saudi Arabia – gave the Soviet Union a 15-year lease on life from a third source of cheap resources: “oil and gas,” Mau said.

The oil windfall gave the Brezhnev government “money to buy the support of different interest groups ..., import some goods and buy off the military-industrial complex,” he said. “The share of oil in total exports went from 10-to-15 percent to 40 percent.” ...

By the early 1980s, though, oil prices had started to sink... “One alternative for the Soviets was to decrease consumption, but the Kremlin couldn't do that – it had been buying off all these constituencies,” Mau explained. ... Oil prices and production kept falling as Gorbachev tried reforming communism, but by then it was too late.

The parallel with Iran, Mau said, is that the shah used Iran's oil windfall after 1973 to push major modernization onto a still traditional Iranian society. The social backlash produced the ayatollahs of 1979. The ayatollahs used Iran's oil windfall to lock themselves into power.

In 2005, ... Iran's government earned $44.6 billion from oil and spent $25 billion on subsidies – for housing, jobs, food and 34-cents-a-gallon gasoline – to buy off interest groups. Iran's current populist president has further increased the goods and services being subsidized.

So if oil prices fall sharply again, Iran's regime would have to take away many benefits from many Iranians... For a regime already unpopular with many of its people, that could cause all kinds of problems and give rise to an Ayatollah Gorbachev. We know how that ends...

In short, the best tool we have for curbing Iran's influence is not containment or engagement, but getting the price of oil down in the long term with conservation and an alternative-energy strategy. Let's exploit Iran's oil addiction by ending ours.

Monday, January 29, 2007

The Price of Gas and Fuel Consumption

Paul Krugman saw the "Five Myths?" about gas consumption and conservation and sends along this graph. It's from his favorite textbook. He says:


Saw your "five myths" post. The thing is that the big issue isn't how much you drive, but mileage. And there's a strong effect of prices on consumption, mainly through that channel.

Oh, you do have to be careful, though: Europe uses a lot more diesel, so you don't want to just look at gasoline.

Here's the figure for use in the 2nd edition of the Krugman/Wells text showing that higher fuel prices are associated with lower fuel consumption:


Wednesday, January 24, 2007

Robert Samuelson: Biofuels

Robert Samuelson is wary of the strong push toward biofuels because it might divert us from taking other, more effective paths to reducing our dependence on foreign energy sources:

Blindness on Biofuels, by Robert J. Samuelson, Commentary, Washington Post: President Bush joined the biofuels enthusiasm in his State of the Union address, and no one can doubt the powerful allure. Farmers, scientists and venture capitalists will liberate us from insecure foreign oil by converting corn, prairie grass and much more into gasoline substitutes. Biofuels will even curb greenhouse gases. Already, production of ethanol from corn has surged from 1.6 billion gallons in 2000 to 5 billion in 2006. Bush set an interim target of 35 billion gallons in 2017 on the way to the administration's ultimate goal of 60 billion in 2030. Sounds great, but be wary. ...

The great danger of the biofuels craze is that it will divert us from stronger steps to limit dependence on foreign oil: higher fuel taxes ... and tougher federal fuel economy standards to force auto companies to produce them. ...

Until now, most ethanol has been made from corn. ... Ethanol receives heavy federal subsidies. ... Naturally, corn farmers love this. They've been the program's main beneficiaries. Although ethanol displaces only tiny amounts of oil (slightly more than 1 percent), it's had a big effect on corn prices. ... They could go higher. ... Higher prices for corn (which is fed to poultry, hogs and cattle) raise retail meat prices. Ironically, fuel subsidies may boost food costs.

But corn harvests won't be large enough to meet either the 35 billion- or 60 billion-gallon targets. Large amounts of "cellulosic" ethanol would also be needed... Prime candidates are farm wastes, including wheat straw and cornstalks. Unfortunately, the chemistry for doing this is far more costly than it is for corn kernels. Without technological advances, cellulosic ethanol won't be economically viable. It could be supported only with massive federal subsidies or direct requirements forcing refiners to use the fuel, regardless of cost. Then the high costs would be passed on to consumers. ...

Biofuels are certainly worth pursuing. Up to some point, they're even worth subsidizing. Government can nurture new technologies, and breakthroughs for cellulosic ethanol -- hardly inconceivable -- would make a meaningful difference in the U.S. fuel balance. But there's also a real threat that the infatuation with biofuels is a political expediency that will turn into a classic government boondoggle, benefiting selected constituencies and providing few genuine public benefits. That has already happened with corn.

Our primary need is to curb reliance on foreign oil. If imports were dependable, they would not be dangerous, but they come from unstable or hostile suppliers. Although our dependence can't be eliminated, it can be reduced. The most obvious way is to improve the efficiency of vehicles by 30 to 50 percent over the next few decades. Americans need more hybrids and more small vehicles. Biofuels might be a complement, but if they blind us to this larger reality, they will be a step backward.

Thursday, January 04, 2007

The Sensitivity of the Economy to Rising Oil Prices

In this Economic Scene, Austan Goolsbee looks at how the sensitivity of the economy to increases in the price of oil has changed since the 1970s:

A Country Less Dependent on Oil Is Free to Make Other New Year’s Resolutions, by Austan Goolsbee, Economic Scene, NY Times: Well, another New Year’s Day has ..., no doubt, started another wave of resolutions to ... go on a diet. But after seeing gas prices pass $3 a gallon last year, hearing all the talk about global warming and having a bad feeling about all the bluster coming from the Iranian president, Mahmoud Ahmadinejad, a great many folks wish the economy would go on a diet, too, and stop using so much energy.

Some of the fear over energy and the economy ... resides in people old enough to remember some grimmer New Year’s Days. In 1973, OPEC imposed an oil embargo against the United States and Western Europe... New Year’s Day 1974 came in the middle of the first great energy crisis. Oil prices shot up with the embargo and the American economy collapsed into recession ..., our first stagflation.

New Year’s 1980 was even worse: the Iranian revolution, American hostages and oil prices pushing $40 a barrel. The second great energy crisis once again plunged the American economy into a recession coupled with high inflation.

Our past seems to show that when oil prices rise too much, our economy cannot grow. These lessons have been taken to heart by Mr. Ahmadinejad and Osama bin Laden as each has contemplated ways to cripple the American economy.

But ... much has changed since the wrenching days of the 1970s... The energy used for each dollar of gross domestic product in 1980 was almost 70 percent greater than it is today. While we have collectively wrung our hands over the decline of manufacturing in the country, it has also reduced the relationship between energy prices and growth.

Manufacturing industries consume about 25,000 B.T.U.’s of energy for each dollar of gross domestic product they generate. The most energy-intensive sectors, like the steel, iron ore and aluminum industries, consume about 70,000 B.T.U.’s. Outside of manufacturing, the economy uses less than 6,000. ...

So now when the price of oil goes up, ... it does not automatically mean recession. Indeed, it caused only a ripple this last year. Unemployment and inflation both stayed quite low. ... OPEC’s ability to impose an oil embargo on the West ... and bring the economy into recession is highly limited today.

Paradoxically, although the economy seems somewhat less prone to disruption from energy crises, there remains one enormous group that suffers from high prices: us, the car drivers. Industry has become less and less dependent on energy over time, but the average American commuter is now more dependent.

From 1980 to 1990, rising Corporate Average Fuel Efficiency standards forced automakers to improve car mileage significantly. .... That ended in 1990... Our regulations are now much less stringent than those in Europe, Japan and even China. We also shifted to driving trucks and sport utility vehicles. We moved farther from our places of work and drove a lot more. Since 1990, the number of gallons we use, even on a per vehicle basis, rose substantially.

So as the price of oil neared $80 a barrel last year and gasoline exceeded $3 a gallon, it did not bring the economy to its knees, the way previous oil crises did. It just hit all of us driving our cars. Mr. Ahmadinejad may not have the ability to terrorize the economy, but he can certainly aggravate soccer moms in their minivans or commuters stuck in traffic by making them pay more...

It is New Year’s so ...[f]orget about New Year’s resolutions for the economy and stick to your own. Next time you need to get somewhere, toss the keys and walk.

Wednesday, December 20, 2006

What About Iraq's Oil?

Christopher Hayes wants to know why "the word oil never crossed the lips of any of the reporters at today’s press conference" with president Bush, and why reporters don't ask about the establishment of permanent bases once the war has ended:

Oil Law, by Christopher Hayes: Listening to the President’s press conference..., something caught my ear. ... Bush mentioned that a key to unifying the country would be getting Iraq’s new oil law passed. The idea is, I imagine, that once Iraq’s new government has figured out how to equitably share oil revenues among various factions, everyone’s going to get along just fine. Of course, along with bringing Iraqis together, the new law might just also provide a boon to American energy companies A win-win!

As Antonia Juhasz shows in a new cover story for In These Times (not yet on line), and argued in the LA Times earlier this month, access to oil continues to drive US policy in Iraq:

The Bush administration hired the consultancy firm BearingPoint more than a year ago to advise the Iraqi Oil Ministry on drafting and passing a new national oil law. Plans for this new law were first made public at a news conference in late 2004 in Washington. Flanked by State Department officials, Iraqi Finance Minister Adel Abdul Mahdi (who is now vice president) explained how this law would open Iraq’s oil industry to private foreign investment. This, in turn, would be “very promising to the American investors and to American enterprise, certainly to oil companies.” The law would implement production-sharing agreements. ...

In July, U.S. Energy Secretary Samuel Bodman announced in Baghdad that oil executives told him that their companies would not enter Iraq without passage of the new oil law. Petroleum Economist magazine later reported that U.S. oil companies considered passage of the new oil law more important than increased security when deciding whether to go into business in Iraq.

There are two elephants in the room when it comes to Iraq, and for some reason the establishment press can never quite bring itself to broach the subjects: permanent bases and access to oil. It’s fairly clear that Bush is not going to withdraw from Iraq no matter what happens. Part of this is due to the fact that he has decided that as long as we stay in Iraq we can’t lose the war, and he doesn’t want to lose. But there’s also the not-so-minor fact that if we withdraw from Iraq we’ll have a hard time establishing permanent bases and may not have any secure access to the country’s oil.

So why is it the word oil never crossed the lips of any of the reporters at today’s press conference?

Update: In response to comments, let me add that I think the form of the contracts/law matters. Access is different from control/property rights and that's where people may be talking past each other.

If, for example, the law gives U.S. companies the right to some of the oil in return for developing the infrastructure destroyed in the war, preferential treatment about who gets the development contracts, etc. - the kind of cronyism we've seen again and again - that's one issue, and one that merits raising. It's this phrase:

The law would implement production-sharing agreements.

that caught my eye in that regard.

If it's just access, the so long as the oil hits world markets, then that's another issue, and I agree that it won't affect price, etc.

Update: Angy Bears follow up - see PGL, then Steven Kyle.

Thursday, November 30, 2006

The Advantages of Pay-As-You-Drive Insurance

In a recent Economic Scene article for The New York Times posted here, Hal Varian explains the benefits of per-mile auto insurance. He also *patiently* answers many of the questions that come up in comments to the post (his answers are here and there are more rounds of questions and answers in the comments to that post complete with supporting models).

In the article, Hal Varian discusses work by Aaron S. Edlin and Pinar Karaca-Mandic from their paper, “The Accident Cost From Driving.” In this article from Economist's Voice, Aaron Edlin summarizes work in this area with a focus on the political advantages of using per-mile auto insurance to reduce gasoline consumption:

If Voters Won’t Go for Taxing Oil to Conserve Energy, How Do We Do It?, by Aaron S. Edlin, Economist's Voice, November, 2006: ...Lowering our dependence on oil would give the United States considerably more flexibility in Middle East policy. It would also help us to fight global climate change. Yet precious little has been done. The obvious solution of European-size taxes on gasoline and other uses of oil is just too unpopular in the United States to become law. ...

What can be done to decrease America’s energy dependence, given the public’s apparently well entrenched fear of increases in the cost of driving? One way forward may be a simple reform to auto insurance: Pay as You Drive.

Pay-as-you drive-insurance: how it would work

Currently, auto insurance is largely, but not entirely, independent of the amount of driving a person does. If an individual drives 5,000 miles per year, instead of 25,000, then her insurance rate is reduced only slightly: often, by 15% or less. ...

Suppose that, instead, ... that auto insurers were required to quote premiums on a per-mile driven basis instead of a per-year basis.

Consider a given class of drivers ... whom insurance companies currently charge $1000 per year, and who currently drive 10,000 miles per year on average. Instead of charging these drivers $1000 per year, insurers might charge 10 cents per mile driven.

The average driver ... would continue to pay the same amount—$1000 per year— assuming no change in driving behavior. However, suppose this driver chooses to cut her driving in half, to 5,000 miles per year... Then she would save $500/year, much more than under the current pricing system. Moreover, if the same driver were to double her driving, she would double her insurance cost... Such a pricing system would give her a significant incentive to reduce her driving. Elsewhere, I have estimated that such pay-as-you-drive insurance could reduce driving and gasoline consumption by 10–15%.

The political advantage of pay-as-you-drive insurance over a gas tax is that it doesn’t increase the total cost of driving, at least on average. ... Prices at the pump, of course, stay the same—making the measure much more palatable... And rather than voters simply fearing negative consequences, they can enjoy some positive ones: lowered insurance prices as a reward for changes in behavior. ...

The change won’t be painless for everyone, of course. Those who drive twice the average will pay twice as much. But that’s only fair: They also cause more accidents, and burden the environment, and worsen our dependence issue, twice as much. And charging high mileage drivers more is exactly what will give people an incentive to drive less.

The peculiar all-you-can-drive way that auto insurance is currently priced

The late Nobel Laureate William Vickrey wrote almost forty years ago that “the manner in which [auto insurance] premiums are computed and paid fails miserably to bring home to the automobile user the costs he imposes in a manner that will appropriately influence his decisions.”

The costs to which Vickrey referred were accident costs, not terrorism, climate, and national security costs. The great thing, though, is that by switching our insurance system to pay-as-you-drive insurance, we can reduce accident costs with more efficient accident pricing, and reduce these other costs as a bonus. ...

Vickrey’s point is that with each mile we drive, there is a cost in the form of accident risk. When we don’t pay the costs we impose, the incentives are obvious: we drive more than is economically efficient, causing accidents as we go. If we paid as we drove, and were charged a per-mile premium we would choose to drive less and there would be fewer accidents. And that would be fair: we would simply be forced to pay for the externalities of our conduct. ...

If Americans are successfully incentivized to drive less by pay-as-you-drive insurance, [accident] costs will fall appreciably... Several insurance carriers have begun to experiment with pay as you drive insurance, but they have not rushed to charge per-mile premiums on their own. Too many of the gains would not be captured by the company changing the policies. They need some encouragement.

The political salability of mandating pay-as-you-drive

...Per-mile premiums ... could lower the cost of driving for most people because most people drive less than the average. (Because driving quantities follow a skewed distribution, the median is considerably lower than the mean). Moreover, such premiums give drivers additional control over their costs, so they can choose to lower them still further.

There would, of course, be opposition. Although more than 50% of people drive less than the arithmetic average, many obviously drive more ... and would tend to oppose the change, at least if they vote their pocket books. Moreover, oil companies, the highway lobby and gas stations can be expected to oppose any change that leads to less driving. ...

[A] full-scale national shift to pay-as-you-drive insurance is too much to hope for. Still, a shift could be made in stages: if each insurance carrier had to issue 5% of its policies at per-mile rates, no carrier would be at a competitive disadvantage. ...

There are many pieces to a sound national energy policy, but per-mile premiums should be high on the list. What is needed is a jump start.

Tuesday, November 28, 2006

Political Price Cycles in Gasoline Markets?

Are oil prices manipulated prior to elections? This paper provides evidence that they are based upon a sample of legislative elections for 32 countries over 27 years:

Do Politicians Manipulate Gasoline Prices?, by David Wessel WSJ Washington Wire: Before the recent U.S. congressional election, there were widespread, unsubstantiated assertions that the Bush administration somehow had manipulated gasoline prices so they’d fall before the November congressional elections. Economists pooh-poohed them. Now a couple of International Monetary Fund economists, looking through data on gas prices and legislative elections from 1978 to 2004 in 32 countries from Australia to the U.S., say there may be something to this conspiracy theory.

“Focusing on real” – inflation-adjusted – “gasoline prices alone, we observed that they declined 0.3%, on average, during ‘normal’ quarters and about 0.7% during quarters of electoral campaign. Moreover, in 15 countries of the sample, this difference exceeded 2 percentage points, whereas it exceeded 6 percentage points in seven countries,” economists Claudio Paiva and Rodriga Moita write in new IMF working paper. ...

Though the paper appears to be carefully done, I'm skeptical. In particular, though there is a theoretical model in the paper, how the price manipulation is carried out isn't completely clear. The paper says:

[A]nother assumption we make in using the gasoline market in the empirical part of our paper [is] that governments either determine gasoline prices directly through price regulation or exert strong influence on them through regulatory stocks, importation, taxes, subsidies, and when setting environment and safety standards.

Thus, the connection between government action prior to elections and gas price changes is assumed, not established empirically. I'm not saying the connection is or isn't there for the countries in the sample, just that it hasn't been shown to exist for the U.S.

Update: Here are the countries:

Australia, Austria, Belgium, Brazil, Canada, Switzerland, Denmark, Finland, France, Germany, Greece, India, Indonesia, Ireland, Italy, Japan, Korea, Mexico, Netherlands, New Zealand, Norway, Poland, Portugal, Romania, Slovak Republic, South Africa, Spain, Sweden, Thailand, Turkey, United Kingdom, United States

Sunday, October 15, 2006

Who Should Reduce Their Energy Consumption?

As a follow-up to the post below this one on the politics of promoting increased energy independence, this is from the CEO of Eni:

To extend the age of oil, we must save fuel now, by Paolo Scaroni, Commentary, Financial Times: One of the most common explanations advanced in the west for the current squeeze on energy supplies – and for why prices are still so high ... is ... China...

But... In spite of China’s rapid expansion, it still accounts for only 8 per cent of global oil demand. Meanwhile, the US and Europe account for 25 per cent and 18 per cent of global oil demand respectively. Each Chinese individual uses fewer than two barrels of oil a year. This compares with the 12 barrels used by their European counterparts and with the massive 26 barrels used by each US citizen every year.

It is the west’s consumption, along with sustained under-investment in energy infrastructure during the 1990s, that has really pushed prices up. The paradox is that, while on the one hand we complain about high oil prices, on the other we pursue energy policies that are wholly irrational. ... Look at the US, where oil demand keeps rising. Indeed, one out of every two cars sold there in the past five years was an SUV or a light truck...

Continue reading "Who Should Reduce Their Energy Consumption?" »

Is It Energy Independence, Stupid?

Thomas Friedman thinks energy policy, energy independence in particular, is the key to winning the election:

The Energy Mandate, by Thomas Friedman, Commentary, NY Times: James Carville, the legendary Clinton campaign adviser who coined the slogan, “It’s the economy, stupid,” knows a gut issue when he sees one. So when Mr. Carville contacted me the other day to tell me about the newest gut issue his polling was turning up for candidates in the 2006 elections, I was all ears.

“Energy independence,” he said. “It’s now the No. 1 national security issue. ... It’s become kind of a joke with us, because no matter how we ask the question, that’s what comes up.” ...

Clinton pollster Stan Greenberg, ...[said] “When we lay out different plans for how to deal with Iraq, any plan that also includes energy independence tops any other plan that doesn’t”... Mr. Greenberg ... added that people are not expressing this view because they are worried about price, but because they are starting to understand that our oil dependence is fueling a host of really bad national security problems. “There is frustration that leaders have not taken it up,” he added...

What this means for Democratic Party candidates, argues Mr. Carville, is that it’s no longer enough to have “energy security” as part of a 12-step plan for American renewal. No, it needs to become a defining issue of what Democrats are all about.

It should “not be part of an expanding litany, but rather a contracting narrative,” explained Mr. Carville. “It can’t just be that we are for a woman’s right to choose, and education and energy independence. This is the thing we need to get done above and beyond everything else.” People should associate “energy security” with Democrats the way they associate “tax cuts” with Republicans, he argued. “This is not something to add to the stew — this is the stock.”

The best way for a party that is often viewed as weak on national security to overcome that deficit is to be for energy independence, he noted. ...

So does this mean the public would accept a gasoline or B.T.U. tax? No, said Mr. Greenberg. The public wants government to impose much higher auto mileage standards on Detroit and much more stringent energy codes on buildings and appliances. People want a tough regulatory response, à la California.

Remember, Mr. Carville and Mr. Greenberg are professional campaign advisers. They get paid to get people elected — not to offer feel-good nostrums. So when they tell you that their polling and focus groups around the country show that “reducing dependence on foreign oil” is voters’ top national security priority, you know that this issue has finally arrived. The party that captures it most credibly will be rewarded.

Hello? Anybody listening?

I've been listening since this column came out a few days ago. I hear Bush and other Republicans making this point repeatedly, they even have plans on how to get there (ethanol production, Alaskan and offshore drilling, etc.), but I didn't hear much from Democrats. I'm not as sure as Carville is that this should be the signature issue, but Democrats could surely be more aggressive on this point.

Monday, October 02, 2006

The Saudi Pledge?

Via email, something for the conspiracy theorists from the Financial Times:

White House ‘ignored’ Iraq warning, by Caroline Daniel, Financial Times (free): The Bush administration was shaken on Friday by revelations from a new book by Bob Woodward, the veteran investigative reporter... In a claim that could fuel conspiracy theories about the recent oil price decline ... Mr Woodward described a conversation between Prince Bandar bin Sultan and Mr Bush in which the former Saudi ambassador said he could ease oil prices ahead of the elections. “They could go down very quickly. That’s the Saudi pledge. Certainly over the summer, or as we get closer to the election, they could increase production several million barrels a day,”

Jim Hamilton discusses, and dismisses, another conspiracy theory here. I'm not much of a conspiracy theory type, and I haven't heard anything indicating the Saudis are increasing supplies, only that they aren't cutting production like Nigeria and Venezuela plan to do, e.g. see "Oil falls 3 percent, healthy inventories weigh" from Reuters:

Some traders said the planned cutbacks by Nigeria and Venezuela would have little impact on prices unless larger producers in the Organization of the Petroleum Exporting Countries also said they would join the move. "The only significant thing would be if Saudi Arabia announced they were going to cut output, which they haven't," said Christopher Bellew...

I'm not quite sure what, if anything, to make of Woodward's report so I'll turn it over to you.

Sunday, October 01, 2006

Vintage Varian: Raise Gasoline Taxes

Hal Varian from October, 2000 on the need for higher gasoline taxes:

Tax cutting may be in fashion, but it's a good time to raise gasoline taxes, by Hal R, Varian, New York Times, Oct 19, 2000: With all the talk of tax cuts, this may be an inopportune time to propose a tax increase. But it is easier to put tax reforms in place when times are good than when they are bad, and United States policy on gasoline taxation could be much improved.

Gasoline taxes are an emotional issue... But there are several good reasons that increasing the gasoline tax in the United States makes economic sense.

First, it is a good idea to tax the consumption of goods that impose costs on other people. One person's consumption of gasoline increases emissions of carbon dioxide and other pollutants, and this imposes environmental costs on everyone. And even those who do not care much about the environment have to acknowledge that driving contributes to traffic congestion. Increased taxes on gasoline would reduce consumption, cutting both pollution and congestion.

But, you might argue, we already have taxes on gasoline: federal, state and local taxes average about 41 cents a gallon, or 28 percent of the price of gasoline. Isn't this enough? The problem is that the tax is used mostly to pay for road construction and maintenance. True, the gasoline tax decreases the use of gasoline, but the road subsidy increases its use.

If we subtract the subsidy from the tax, we end up with a net tax rate on gasoline in the United States of about 2 percent, which is much, much lower than net gasoline taxes in the rest of the world.

There is another, quite different reason to tax oil products.

Economists like to tax things that are in fixed supply because the same amount is available whether or not the tax is imposed. ...[I]n the long run, there is only so much oil. Taxing petroleum products will not reduce the total amount of oil in the ground, it will just slow the rate at which it is discovered and extracted.

Taxes on gasoline reduce the demand for oil, thereby reducing the price received by the suppliers of oil. And most of those suppliers are foreign: the United States now imports 56 percent of its oil... Taxing foreigners is popular both economically and politically -- they do not vote. Of course, domestic oil producers not only vote, they contribute to campaigns, and a tax on gasoline would be unpopular with them. But deals can be made -- taxes can be traded for depletion allowances and other accounting goodies to make such a plan politically viable.

A gasoline tax in a small country falls mostly on the residents of that country. The world price of oil is essentially independent of the taxing policies of most countries, since most countries consume only a small fraction of the amount of oil sold.

But the United States consumes a lot of oil -- almost a quarter of the world's production. That means it has considerable market power: its tax policies have a major impact on the world price of oil, and economic analysis suggests that in the long run, a significant part of a gasoline tax increase would end up being paid by the producers of oil, not the consumers.

Nearly 20 years ago, Theodore Bergstrom, an economist who is now at the University of California at Santa Barbara, compared the actual petroleum tax policies of various countries with policies those countries would adopt if they wanted to transfer more OPEC profits to themselves.

He found that if ... the United States, Europe and Japan all coordinated their oil-tax policies, they would collectively want to impose net tax rates of roughly 100 to 200 percent. This is not as scary as it sounds since such a coordinated tax increase would mostly affect oil producers; the price at the pump would increase much less.

Mr. Bergstrom's analysis was focused entirely on transferring profits from oil-producing to oil-consuming nations. If we factor in the pollution and congestion effects mentioned earlier, the optimal petroleum taxes would be even higher.

In the past, Al Gore has advocated increasing gasoline taxes for environmental reasons, though he has been pretty quiet about this proposal lately. George W. Bush does not think much of oil taxes, but he likes the idea of a tax cut.

Let me propose a bipartisan plan: raise the tax on gasoline, but give the revenue back to taxpayers in the form of an income tax credit.

Average consumers would be about as well off as they are now, but the higher price of gasoline would tend to discourage consumption -- giving us environmental, congestion and tax-the-foreigner benefits. It would make sense to phase the tax in over several years, so that the next time drivers trade in their sport utility vehicles, they would have an incentive to buy those fuel-efficient cars that Detroit has promised to produce.

Increasing the net tax on gasoline by, say, 2 percent a year for the next 10 years would be pretty painless for most people. Oil prices would almost certainly drop back down in the next few years, tending to reduce the price of gasoline back toward historical levels. A higher gasoline tax would just mean prices would not drop quite as far as they would otherwise.

If something must be taxed, it makes a lot of sense to tax something that is costly to the environment, costly to the users and mostly controlled by foreigners. The United States is passing up a big opportunity by not taxing gasoline at a higher rate.

I haven't strongly supported these proposals, perhaps because I hate the idea of paying more for gas. But that's the point of raising the tax, I'm supposed to dislike it and reduce my consumption, and I can't deny that an increase in gas taxes is needed. Robert Frank has a similar proposal (analyzed graphically here), while Martin Feldstein has called for tradeable gas rights.

Friday, September 29, 2006

Bush on Energy Policy

The Wall Street Journal interviews George Bush on energy issues:

Interview With President Bush, Wall Street Journal:

Office of the Press Secretary
(Birmingham, Alabama)

Internal Transcript
September 28, 2006


Q: I think I would like to just start on the topic that you were on just now -- energy. Obviously, it's a huge priority for you and I wonder if you can just talk about where it goes from here.

THE PRESIDENT: I think energy diversification is a priority for the nation. And by energy diversification, I mean that a policy that promotes technological change so that we become less dependent on crude oil from overseas.

The best way to become less dependent on crude oil from overseas is to change the driving habits of the country. My vision is that, ultimately, we'll be using hydrogen-powered automobiles; in the meantime, we'll be diversifying our fuel mix from gasoline to more ethanol. Conservation will be achieved by new technologies, such as batteries that enable a car to go for the first 40 miles on electricity and your car doesn't have to look like a golf cart.

It's interesting, this diversification has required federal involvement -- federal involvement through tax credits for ethanol, as well as research dollars. But those research dollars are being complemented by research dollars in the private sector. And one reason why the research dollars in the private sector are coming is because the price of crude oil, the rise in the price of crude oil has made it clear that there is profitability for private dollars when they invest...

Q: Do you envision more policy down the road?

THE PRESIDENT: I envision more money being spent to accelerate that which is possible. You heard a full discussion today about the possibility of switch grass and two types -- using switch grass as a raw material and two types of manufacturing processes.

The market for ethanol will evolve differently than the market for gasoline, because transportation is part of the bottleneck of finished product, and therefore in order to get ethanol penetration throughout the country, there are going to have to be locally-built plants so as to reduce transportation costs. And, therefore, there's going to be the need for locally-grown raw materials for those plants. And some places just aren't that good for growing corn or sugar, therefore, we're going to have to develop alternatives to be able to use to make ethanol. ...

Q: And do you envision the money being spent in that area, in particular?

THE PRESIDENT: Well, we're spending, since I've been President, about $29 billion on dealing with alternative forms of energy, which it affects the warming issue. In other words, as you diversify away and/or improve the capacity to burn certain fuels, you're developing environmentally friendly technologies.

And so our effort is multifaceted. You know, for example, you heard me mention the need to deal with nuclear waste. And I believe we ought to reprocess, as well as have fast burner reactors that can deal with that fuel, which reduces the amount of waste substantially, which then makes it easier to store, which then makes it easier to convince people that nuclear power is the way to go. Nuclear power is renewable. Nuclear power is going to be necessary for the production of hydrogen, which is the new kind of -- which will be the new source of powering automobiles, plus it's clean. It deals with the warming issue.

Q: So that's another area, is it fair to say, where you envision some new policy?

Continue reading "Bush on Energy Policy" »

Friday, September 22, 2006

Oil Prices and the U.S. Trade Deficit

This Economic Letter from the San Francisco Fed looks at the relationship between oil prices and the trade deficit:

Oil Prices and the U.S. Trade Deficit, by Michele Cavallo, Economic Letter, FRBSF: With the price of oil ... having nearly quadrupled over the last four years, it is little surprise that U.S. import prices have soared. One concern about these higher import prices relates to their implications for the U.S. trade balance... This Economic Letter explores the relation between the surge in oil prices and the trade deficit...

Continue reading "Oil Prices and the U.S. Trade Deficit" »

Thursday, August 10, 2006

Econoblog: Will Oil History Repeat Itself?

James Hamilton and Stephen Brown on how oil prices impact the economy:

Will Oil History Repeat Itself?, Econoblog, WSJ Online (free): ...Economic forecasters keep a close eye on gushing fuel prices, which preceded recessions in 1974, 1979 and 1990. But so far, the global economy has seemed to shrug off recent spikes in the price of a barrel of oil, which has more than doubled over the past three years.

The Online Journal asked energy economists James Hamilton, of the University of California, San Diego, and Stephen Brown, of the Federal Reserve Bank of Dallas, to discuss why high oil prices haven't choked off economic growth.

Here's some of the discussion, but there's a lot more if you click through to the (free) original:

James Hamilton writes: The price of oil has more than doubled in the last three years, going from $30 a barrel to now above $75. On previous occasions when we saw oil price moves of this magnitude, such as 1974, 1979 and 1990, the world economy went into a recession. What's different this time?

In my view, part of the answer has to do with the cause and timing of the oil shocks. In each of the previous episodes, oil prices made their move within the space of a few months and were caused by war-related cuts in oil production. By contrast, the current run-up has been a more gradual process...

The answer seems to be that, in those previous episodes, consumers and businesses didn't go about things as before but instead made some pretty abrupt changes in their spending patterns. ... A rapid drop in consumer confidence ... led to significant drops in spending for key sectors. Because workers and capital cannot immediately relocate, the result was unemployment and idle capacity, which greatly magnified the economic losses associated with the energy bill itself.

For the most part, those sudden shifts in spending haven't been seen this time around. ...

Stephen writes: I think James and I are mostly on the same page. Three things have me concerned about the economy's ability to continue to out distance the oil price increases.

1) Until recently, consumers continued to spend even as energy prices and energy bill rose. Much of that seems to have been financed by borrowing against home equity... With housing prices no longer as strong and interest rates rising, we are seeing anecdotal reports that overall consumer spending has become sensitive to rising fuel costs. ...

2) We are also beginning to see reallocation effects in the economy that are the result of higher energy prices -- not just globalization. For instance, sales of big vehicles are down while Toyota's profitability is at a record high. Shippers are shifting away from trucking to more fuel-efficient rail.

3) And as James notes, rising productivity pushing oil prices upward explains the situation very well for 2003-2004. The price increases in 2005 and 2006 seem to be better described as supply shocks, or at least, developments outside the U.S.

Some of these increases seem to be driven by fears of disruptions in a very tight market, as well as by actual disruptions, such as have resulted from civil strife in Nigeria, continuing production issues in Venezuela, conflict in Iraq, and pipeline problems in Alaska....

James writes: ... Stephen's point about home-equity borrowing raises another very important issue, which is the interaction between oil prices and other strains that may be hitting the economy. The oil price spike of the first Persian Gulf War in 1990 came at the same time that construction employment was already falling due to a weak housing market. Given that backdrop, crashing auto sales proved enough to tip the economy into a recession.

By contrast, the price spike associated with Katrina last fall came at a time when the housing market and construction employment were still booming. That strikes me as a very important reason why all we saw that time was slower but still positive GDP growth.

The situation at the moment is clearly quite different from where we were last fall. ... It wouldn't take much of a shock from any source to become a lot more pessimistic about that forecast.

And then there's the critical role of consumer psychology. ...

Stephen writes: ...Back-of-the-envelope calculations based on previous research suggests that the gains in oil prices that have occurred likely only shaved 0.5-0.8% off of annual GDP growth in 2005 and will have similar effects in 2006 and 2007. So, higher energy prices probably aren't the only factor driving the current slowdown. ...

Wednesday, July 05, 2006

Stiglitz: Nationalization of Bolivia's Energy Resources Driven by Commendable Democratic Progress

Joseph Stiglitz defends nationalization of oil and gas fields in Bolivia as a way to renegotiate unfair and perhaps illegal contracts put into place under previous administrations:

Who Owns Bolivia?, by Joseph E. Stiglitz, Project Syndicate: A few months ago, Evo Morales became Bolivia‘s first democratically elected indigenous head of state. Indigenous groups constitute 62% of Bolivia’s population, and those with mixed blood another 30%, but for 500 years Bolivians had been ruled by colonial powers and their descendants. Well into the twentieth century, indigenous groups were effectively deprived of a vote and a voice. ... So Morales’ election was historic, and the excitement in Bolivia is palpable.

But Morales’ nationalization of Bolivia’s oil and gas fields sent shock waves through the international community.  ... Genuinely concerned about raising the incomes of his desperately poor people, he recognized that Bolivia needs foreigners’ expertise to achieve growth, and that this entails paying fairly for their services. But are foreign owners getting more than a fair rate of return?

Morales’ actions are widely supported by Bolivians, who see the so-called privatizations (or “capitalizations”) under former President Gonzalo “Goni” Sanchez de Lozada as a rip-off: Bolivia received only 18% of the proceeds! Bolivians wonder why investments of some $3 billion should entitle foreign investors to 82% of the country’s vast gas reserves, now estimated to be worth $250 billion. ...

No wonder that Bolivians thought they were being cheated and demanded a new deal. On May 2, Morales simply reversed the percentages, pending renegotiation of the contracts: the companies operating in the two largest fields would get 18% of the production for themselves. As part of this new deal, Bolivia should also get a larger share when prices increase. (Bolivia may, of course, not want to bear the risk of a fall in the price, so it may strike a deal to transfer some of the downside risk to foreign companies, giving them in exchange more of the upside potential.)

To most Bolivians, what is at stake is a matter of fairness: Should foreign oil and gas companies get a fair return on their capital, or a supernormal return? Should Bolivia be paid a fair value for its resources? And should Bolivia, or foreign companies, reap most of the windfall gains from increases in energy prices?

Moreover, many deals were apparently done in secret by previous governments – and apparently without the approval of Congress. Indeed, because Bolivia’s Constitution requires the approval of Congress for such sales, it isn’t clear that Morales is nationalizing anything: the assets were never properly sold. ...

As with many privatizations elsewhere, there are questions as to whether the foreign investors have kept their side of the bargain. ... The foreign companies’ contribution was supposed to be further investment. But did they fully live up to their commitments? Are accounting gimmicks being used...? Bolivia’s government has, so far, simply raised questions, and set in motion a process for ascertaining the answer.

The problem in Bolivia is a lack of transparency, both when contracts are signed and afterwards. Without transparency, it is easy for citizens to feel that they are being cheated – and they often are. ... Around the world, oil and gas companies have themselves to blame: too often, they have resisted calls for greater transparency. In the future, companies and countries should agree on a simple principle: there should be, to paraphrase President Woodrow Wilson’s memorable words, “open contracts, openly and transparently arrived at.”

If the Bolivians do not get fair value for their country’s natural wealth, their prospects are bleak. Even if they do, they will need assistance, not only to extract their resources, but also to improve the health and education of all Bolivians – to ensure long-term economic growth and social welfare. For now, the world should celebrate the fact that Bolivia has a democratically elected leader attempting to represent the interests of the poor people of his country. It is a historic moment.

Tuesday, July 04, 2006

Old King Coal

Martin Wolf on energy security:

The best hope for energy security, by Martin Wolf, Financial Times: ...Thomas Malthus, the early 19th century forefather of environmental doomsayers, ... remark[ed] that: “The power of population is so superior to the power of the earth to produce subsistence for man, that premature death must in some shape or other visit the human race.” Malthus was wrong: the world’s population has risen six-fold since his day, while life expectancy has doubled. So will contemporary Malthusians prove right about energy?

The answer is: no. Moreover, ... the future lies with oil, gas and, above all, “old king coal”, the fuel with which the industrial revolution began. This must concern another group of Malthusians – those concerned with global warming. That, however, is a subject for next week. The theme of today is how humanity might meet its demand for commercial energy. A recent survey from the Organisation for Economic Co-operation and Development suggests that demand for commercial energy might double by 2050. If anything, this is a conservative assumption...

Now consider whence – and at what prices – this additional energy might come. ... Taken together, fossil fuels now provide 86 per cent of the world’s commercial energy. Is the world about to run out of these fuels? “No” is the answer or at least not in the next half century and almost certainly far longer.

Published oil reserves do, it is true, cover only about 40 years of current consumption. If consumption rises, as seems inevitable, that does not seem to provide much of a cushion. Moreover, believers in the theory of “peak oil” argue that the world has already reached peak production. ... Their analysis is based on ... the pattern of discovery. Peakists argue that the world has used up about half the available supply and global production is in irreversible decline.

Against this, most analysts argue that reserves tell one little about available supplies, that higher prices and innovation generate greater extraction from existing fields, that discovery of new (if smaller) fields is continuing and, most important, that unconventional oil resources are still to be exploited ... So even if production of conventional oil were to peak, the oil era would not be over. The question is rather one of price. The potential at a price of $70 a barrel seems huge. Many argue that the price needed to bring forward additional supply is much lower.

Nor does the end of oil mean the end of fossil fuels. Gas and, above all, coal are even more plentiful. Some would counter that petroleum is a unique source of high quality energy for transportation... But it is possible to convert coal and natural gas into “syngas” (synthesis gas) and then into liquid fuels. The question is one of cost. The answer is that this would be more expensive than conventional oil, but not prohibitively so.

What role then might be played by nuclear and renewables in such a “business as usual” scenario? “Marginal” seems to be the answer. The big points are that renewable energy is expensive, nuclear energy is controversial...

Renewables have problems of usability, scalability or cost. To generate half of all current energy consumption we would need 100m windmills.... Use of large proportions of the earth’s surface for bio-mass runs into the constraints imposed by alternative uses (food production and natural habitat). In principle, solar energy should be more than adequate: the quantity falling on the earth’s surface is more than 6,000 times current commercial energy consumption. The hurdle is the difficulty and cost of collecting solar energy...

Does this scenario – of a world in which fossil fuels generate the bulk of commercial energy over the next half century – generate worrying security problems? If one focuses on oil or gas alone, the answer might be yes. In both these cases, the reserves are not located where most of the consumption takes place. The gap is particularly large for conventional oil... But coal is widely distributed, with much of it in the large consuming regions. The best solutions then for governments concerned with security are diversity of sources and open and flexible world markets. Attempts by any power to seize valuable resources for exclusive use would create serious global insecurity and even war...

Remember that this argument ignores the question of climate change. It asks whether the Malthusians who argue that the world will soon run out of fossil fuels allow the Malthusians who worry about the damage to the atmosphere to cheer up. The answer is an unambiguous no. It will be perfectly possible to run a fossil fuel economy for many decades at prices that are likely to be substantially lower than those of recent times. Even if they remain at current levels, the world economy will almost certainly cope, as its recent performance suggests. The world can afford quite expensive energy. The big question is, instead, whether the environment on which our lives depend can cope with the results.

Update: This is from The New York Times, It examines the coversion of coal to either diesel or natural gas:

Search for New Oil Sources Leads to Processed Coal, by Matthew L. Wald, NY Times: The coal in the ground in Illinois alone has more energy than all the oil in Saudi Arabia. The technology to turn that coal into fuel for cars, homes and factories is proven. And at current prices, that process could be at the vanguard of a big, new industry. ...

But there is a big catch. Producing fuels from coal generates far more carbon dioxide, which contributes to global warming, than producing vehicle fuel from oil or using ordinary natural gas. And the projects now moving forward have no incentive to capture carbon dioxide beyond the limited amount that they can sell for industrial use.

Here in East Dubuque, Rentech Inc., a research-and-development company ... recently bought a plant that has been turning natural gas into fertilizer for forty years. ... In an important test case for those in the industry, it will take a plunge and revive a technology that exploits America's cheap, abundant coal and converts it to expensive truck fuel. ...

There are drawbacks; the technology requires a large capital investment, and a plant could be rendered useless by a collapse in oil prices. ... Lately ... the price of diesel fuel, which determines the value of this coal-based fuel, also called synfuel, has soared, as has the price of natural gas, which made plants like the one at East Dubuque ripe for change.

Most of the interest is in making diesel using a technology known as Fischer-Tropsch, for the German chemists who demonstrated it in the 1920's. ... The technology was used during World War II in Germany and then during the 1980's by South Africa when the world shunned the apartheid regime there. Now Rentech is preparing to use an updated version. ...

Other projects are in various stages of planning in this country... But people who think this technology will find wide use presume some kind of environmental controls, which the Rentech plant, thus far, does not have. Some environment and energy experts doubt that the method is compatible with a world worried about global warming. Unless the factory captures the carbon dioxide created during the process of turning coal into diesel fuel, the global warming impact of driving a mile would double. ...

But the Energy Department sees potential. In March, the Energy Secretary, Samuel K. Bodman, said ... that making diesel fuel or jet fuel from coal was "one of the most exciting areas" of research and could be crucial to the President's goal of cutting oil imports. He said that loan guarantees enacted in last summer's energy bill might be used for Fischer-Tropsch diesel fuel.

In Des Plaines, Ill., near Chicago, a new company called GreatPoint Energy has developed, on a laboratory scale, a vastly improved process for turning coal into natural gas.

The promise and the pitfalls are similar for both GreatPoint and Rentech. ... [T]urning coal into natural gas or diesel fuel means ... carbon emissions, which causes concern to environmentalists. Carbon is released in converting coal into an energy-rich gas made up of carbon monoxide and hydrogen, and then converting the gas into something more useful. Rentech wants to turn it into liquid fuel. GreatPoint wants to rearrange the molecules into natural gas. ...

Robert Williams, a senior research scientist at Princeton, said "it's a step backward" to operate a plant like Rentech's without capturing the carbon. "It almost doubles the emission rate," he said.

Mr. Ramsbottom also sees the carbon dioxide problem. "The worldwide production of Fischer-Tropsch fuels is going to ramp up dramatically, and carbon sequestration is on everybody's mind," he said. But the geology of this part of Illinois is not suitable for sequestering the carbon dioxide from these plants. Building a pipeline would be expensive and difficult to justify while carbon emissions are not taxed, experts say.

GreatPoint has a different plan: move the plant where it can sell the carbon.

Andrew Perlman, the company's chief executive, thinks it has value. "Not only is it capturable, one of biggest advantages of the system is, we can locate our plant near a natural gas pipeline, in places where we can sell that carbon dioxide for a profit, using existing technology," he said. Oil producers inject carbon dioxide into old oil fields, to force oil to the surface.

Backers also hope that methanization, the process GreatPoint uses, will succeed in part because it fits in with existing energy infrastructures, like gas pipelines and coal mines. If it did, it could have a profound impact on the balance of natural gas imports... Like Fischer-Tropsch diesel, methanization is not a new idea; one plant in North Dakota does it now... But GreatPoint is going about it in a new way, in which far less energy is lost in the transition. ...

Robert Williams, a senior research scientist at Princeton University, points out that crop wastes and wood chips can also be gasified, producing carbon monoxide and hydrogen. Normally, biomass is thought of as carbon-neutral, because for each plant cut down for gasification, another grows and absorbs carbon from the atmosphere. But if biomass is gasified and the carbon dioxide sequestered by being pumped into the ground in the expectation that it will stay there, then atmospheric carbon actually declines for every gallon produced.

From a greenhouse perspective, that is more attractive than what Rentech does now with the carbon dioxide from its plant here. It is sold to soft-drink bottlers. That keeps the gas sequestered until someone burps.

Wednesday, June 28, 2006

Wheels for Mini-Me

Here's the story: Daimler Hopes Americans Are Finally Ready for the Minicar:


The article says it will fit on a regulation pool table and that "Fortwo is the only car in the world less than 3 meters (roughly 10 feet) long."

This and a Hummer side by side at a stop light would make an interesting contrast.

Monday, June 26, 2006

Ahmadinejad is a Destabilizing Influence; Bernanke is Not

What is the explanation for the recent large stock market losses in the U.S. and around the world generally? Was it U.S. monetary policy as many claim, or something else?

What News Is Moving the Markets?, by Robert J. Shiller, Commentary, Project Syndicate:  Stock markets in much of the world have shown sharp cumulative declines since around May 10, with most of the drop occurring in the two-week period to around May 23, but with prices continuing to fall on average since then. Does trouble in the world’s stock markets mean trouble for the world economy? ...

Continue reading "Ahmadinejad is a Destabilizing Influence; Bernanke is Not" »

Saturday, June 17, 2006

Trapping Carbon from Coal-Fire Plants

News on the technology front:

Trapping Carbon, Freeing Coal, SciAm blog:  There is a lot of carbon in the ground. For eons, life forms ranging from microbes to Homo sapiens have trapped the element as part of their fundamental molecular makeup... Some of that carbon has been recycled into descendant organisms and soil, and some has been transformed by temperature, pressure and time into coal, natural gas and oil--the fuels of our modern economy. Keeping that carbon safely underground to fend off climate change is one of the current goals of modern industry and has given rise to a seeming oxymoron: clean coal. The idea is to burn the coal but capture the carbon that the burning produces and pump it back underground.

It sounds simple. But millions of dollars have been spent--with the promise of billions more--in the thus far vain pursuit of a technology that can capture a diffuse gas (carbon dioxide), concentrate it and render it suitable for transport. Now the R.E. Burger Plant in Shadyside, Ohio, stands on the threshold of becoming the first coal-fired power plant to test both the capture and storage of the leading greenhouse gas...

[T]his would be the first time the CO2 was pumped underground simply to store it--as much as 7,000 feet beneath the surface and safely away from the atmosphere and oceans. Powerspan plans to have its capture and compression technology in place by next year; Batelle will drill a test well shortly thereafter if all goes well. Then, if the geology and technology work, pumping could begin by the end of the decade. Because there is no cheap, reliable and easy to build alternative to coal-fired power plants--particularly in the U.S., China and India, where it is most needed--such carbon capture and storage represents a critical technology fix for the pollution that is warming our world. ...

Sunday, June 11, 2006

A Gas Tax with a Rebate

Recently, there have been several proposals to encourage conservation of oil. One proposal from Robert Frank increases the tax on gasoline, then rebates the tax revenue to consumers through a payroll tax reduction or some other means. As he states:

In my Feb. 16 column, I suggested an additional gasoline tax of $2 a gallon. All revenue would ... be returned on an approximately equal per capita basis

To look at the economics of this proposal, I decided to examine a fairly standard textbook treatment of the topic where a tax on each gallon of gas consumed is imposed along with a lump-sum tax rebate to consumers on an equal per capita basis. (I hope the microeconomists won't mind a macro guy stumbling around in their territory. This proposal is discussed in Pindyck and Rubinfeld 5th ed., pgs. 114-115.)

Here's a graph of what happens before and after the tax, and after both the tax and the rebate.

Click on figure to enlarge

The consumer starts out at point A consuming QA gallons of gasoline and has a utility level of U2. After the tax, which rotates the budget line downward as shown by the dashed budget constraint, the consumer moves to point B which is on a lower indifference curve U1, and consumption falls to QB. Finally, after the rebate which shifts the budget line outward, the consumer moves to point C and consumption increases to QC (the tangent indifference curve at point C is omitted for clarity).

Overall, the consumption of gasoline has fallen, as intended, and the consumer is worse off because the level of utility attainable at point C is below the level U2 at point A. Even though the money comes back to consumers in the form of a rebate, the reason consumption falls from A to C is because the income elasticity of demand for gasoline is relatively low (around .3 by some estimates) so that the substitution effect dominates the income effect.

In this example, a low-income household would be made worse off by the tax and rebate proposal (because indifference curve U2 is no longer attainable), but it's still possible for some low-income individuals, those who consume less gas than the value of the lump-sum rebate, to benefit. However, the substitution effect induced by the tax makes the average household worse off. To aid low income individuals, other proposals such as linking the size of the rebate to income could be examined as well.

Finally, this highlights the costs to households, but there are also potential benefits. To assess the proposal, the costs must be compared to the benefits from reduced dependence on foreign oil and the additional security that brings about, and the environmental and other benefits from lower consumption of gasoline.

Thursday, June 08, 2006

Discouraging Energy Use

Once again, Robert Frank calls for a $2 a gallon tax on gasoline with the revenue from the tax used to offset payroll taxes, but this time there are refinements designed to overcome objections to the initial proposal:

Energy Policy Is Far Too Complicated to Be Left to the Politicians, by Robert H. Frank, Economic Scene, NY Times: ...[T]he recent spike in gasoline prices has prompted a wave of proposals that if enacted would do far more harm than good. Senator John Thune, Republican of South Dakota, among others, has advocated suspension of the federal gasoline tax of 18.4 cents a gallon. Similar proposals to suspend state taxes have been advanced in New York and at least 12 other states. These proposals make no economic sense...

An immediate problem is that a tax cut would be offset in part by OPEC's response to it. ... Dealing with OPEC is ... like dealing with a rational kidnapper... A visible transfer of money to the victim's family (like an inheritance) would serve only to increase the kidnapper's ransom demand. Similarly, since OPEC now realizes that motorists are able to pay $3 a gallon, its best response to a gasoline tax cut would be to raise the price of oil by enough to keep gasoline prices at $3. ...

Gasoline prices are rising because the world's appetite for oil has been outstripping dwindling supplies. Legislatures cannot repeal the law of supply and demand. To escape the burden of widespread energy shortages, we must consume less energy. And to achieve that goal, gasoline prices need to be higher, not lower...

In my Feb. 16 column, I suggested an additional gasoline tax of $2 a gallon. All revenue would ... be returned on an approximately equal per capita basis by reducing payroll taxes. Because rebates for individual consumers would be independent of the amount of gasoline tax they paid, the higher post-tax gasoline prices would strongly encourage conservation. ... And just as a gasoline tax cut would encourage future OPEC price increases, a tax increase would discourage them.

As with all such proposals, the devil is in the details. Because the losers from any policy change cry more loudly than the winners sing, a tax increase would be palatable only if the resulting economic gains were distributed equitably. Readers were quick to identify deficiencies in my proposed payroll tax rebate. It would not help retirees, for example, because they no longer pay this tax. The rebate for retirees could instead take the form of an augmented Social Security payment...

Businesses could also receive rebates... To promote efficiency, the critical design feature is that the rebate for each business be independent of its current gasoline consumption.

Would a steep gasoline tax jeopardize automakers like Ford and General Motors, whose current product lines emphasize light trucks and sport utility vehicles? ... The transition could be smoothed by announcing a start date well in the future — say, Jan. 1, 2009 — and then phasing in the tax gradually, say, by 10-cent monthly increments.

What about low-income motorists who could not afford to buy new fuel-efficient cars? A gradual phase-in would also provide valuable transition time for these drivers. They could retire their current vehicles within a few years in favor of more recent used models with better fuel economy. Rebates could also be made progressive...

An academic economist clearly runs less risk than a politician in proposing higher gasoline taxes. But how much political risk would such a proposal really entail? According to a recent New York Times/CBS News poll, 55 percent of Americans would be willing to support a higher gasoline tax if it reduced dependence on foreign oil... It may be naïve to expect our current crop of leaders to take affirmative steps to alleviate the energy crisis. But ... surely we can demand that politicians do no further harm.

Robert Frank: Impose a tax per gallon, the revenue is given back as a rebate of some type, one option is a payroll tax reduction. The tax can be adjusted to reach conservation goals.

Martin Feldstein: Issue tradeable gas rights with the cap on the number of available credits set by the government. The revenue from the tax can be used to reduce the budget deficit or to finance equally large cuts in personal taxes. The cap can be set according to conservation goals.

CAFE standards: These standards specify the miles per gallon a particular class of cars or trucks must achieve. Evidence for the effectiveness of CAFE standards is not very strong, and the standards are not as efficient as taxes or tradeable gas rights. This is because when fuel economy standards are raised it lowers the cost per mile driven, and people have an incentive to drive more.

If these are my only three choices, I choose the tax. But I would prefer a broader array of options for using the revenue from the tax beyond just reducing payroll taxes, including spending on transportation infrastructure that helps to achieve conservation goals and improves economic efficiency.


Alan Greenspan testifies before the Senate Foreign Relations Committee about U.S. oil dependence:

Greenspan sounds alarm on oil supply,  Reuters/IHT: Alan Greenspan ... offered a grim view on Wednesday of the world's rising vulnerability to high crude oil prices, saying he was skeptical that oil producers could pump enough crude to meet future demand... "The United States ... has been able to absorb the huge implicit tax of rising oil prices so far," Greenspan told the Senate Foreign Relations Committee... "However, recent data indicate we may finally be experiencing some impact." ... Greenspan warned that a big oil price increase could spur "a significant contraction in the economy."

Greenspan said that few of the world's dominant producers, aside from Saudi Arabia, see the danger that rising crude oil prices pose to the economy, and to their sustained ability to sell oil. ... Greenspan said while U.S. businesses had so far been able to improve productivity to compensate for costly energy, households were suffering from higher gasoline prices.

"Current oil prices over time should lower to some extent our worrisome dependence on petroleum," said Greenspan... "Still higher oil prices will inevitably move vehicle transportation to hybrids, and despite the inconvenience, plug-in hybrids." Greenspan warned that... "The balance of world oil supply and demand has become so precarious that even small acts of sabotage or local insurrection have a significant impact on oil prices," he said, adding that global refining capacity was still too limited.

A few months ago, a Greenspan warning that a large increase in oil prices could cause "a significant contraction in the economy" and his worry that high oil prices are beginning to place a drag on output would have had a much larger impact. I wonder if he misses the power to move markets.