Tuesday, December 16, 2014

The Oil Choke Collar: 2015 may be the acid test

 - by New Deal democrat

It's nice to be proven right.  Even more, it's nice to be proven right, for the right reason.

For the second time in two years, Oil's choke hold on the economy is asserting itself. Acceleration in recovery causes acceleration of demand, and acceleration of Oil prices - which causes the economy to stall. That choke hold won't go on forever, though. There are three forces that will combine to bring it to an end: alternate fuels, conservation, and exploration.
[T]he Oil choke hold on the economy will not last forever. I claim no clairvoyance, but a good guess is that by 2013 or 2014, the combination of alternative fuels and technology, conservation, and exploration will relieve the current situation
(emphasis added)

In 2012 and 2013, gas prices made lower seasonal peaks, and lower seasonal troughs, than in 2011.  They made a lower peak again this past spring.  Periodically during that time (e.g.,here and here) I updated the data on alternative fuels, conservation, and exploration.  Finally, a few months ago, I documented, as I consistently have since 2011, that the use of alternative fuels has been increasing - including in the vehicle fleet, that ridership on mass transit was still increasings, that demand of gas in the US was consistently declining from its 2006-07 peak, and that exploration was bringing on new supply.  I concluded:
In short, there is a very good chance that at some point in the next few months - or even weeks - we will see a new 4 year low in gas prices in the US.
Of course, by November we did see that new 4 year low, and now we have even seen a 5 year low.

In short, 3 and a half years ago I made a specific forecast about oil prices.  Not only was I right, and not only was I right about the time frame involved, but I was also right for the right reasons.  Average vehicle fleet mileage rose.  Use of mass transit rose.  Use of alternative fuels, such as in natural gas powered vehicles, and solar power, rose.  Demand for gasoline in the US fell.  New oil supplies from deep water drilling and shale oil extraction, came on line.

In simplest terms, supply rose faster than demand, ultimately creating a surplus in prodcution.  Indeed, depending on which source you read, demand is either expected to rise more slowly, or to actually fall.  And because, as Bill McBride a/k/a Calculated Risk pointed out yesterday, because supply is inelastic over the short term, a small change in demand leads to a large change in price.

Now, on November 27, Saudi Arabia refused to cut production, triggering the most recent cliff-dive in oil prices.  It is important to remember that, by that time, gas prices in the US has already fallen below $3 a gallon.  Was there a political aspect to that?  It's certainly possible, as Russia, Iran, and ISIS are among the biggest losers.

But - and somebody really needs to explain this to the Village Idiot over at Daily Kos - it is precisely because the Oil choke collar was already disengaging that such a move, if politically motivated, became possible. If demand were rising faster than supply, prices would be rising, not falling. There would be no way to "punish" players, since they would all be sharing in the profits windfall.  It is only because there was now excess supply that the issue of who would take the hit from already-lower prices became an issue.

Further, unlike the Village Idiot, somebody who actually does know what he is talking about when it comes to the oil markets, Prof. James Hamilton of Econbrowser, has estimated that "In other words, of the observed 45% decline in the price of oil, 19 percentage points– more than 2/5– might be reflecting new indications of weakness in the global economy." In other words, the fall in the price of Oil is not just about politics.

All of which means that the year 2015 could prove to be the ultimate test of my "oil choke collar" thesis.  One of my stock replies to those bemoaning relatively poor, below-trend, US GDP growth over the last few years has been, "Give me $2.50 a gallon gas instead of $3.50 a gallon gas, and I'll show you growth!"  If oil prices have been acting like a governor, choking off growth in the US economy by approaching $4 whenever the economy appears poised to obtain "escape velocity," then particularly with the present positive configuration of both the long and short leading indicators, IF oil prices remain in a new, lower range in 2015, we finally ought to see above-trend US growth.