Oil Prices – Falling into Crisis

Oil Prices – Falling into Crisis

December 11th, 2008 | Posted in Business & Economy, Environment & Energy

Every observer I know has been surprised by the historic crash in oil prices since July 2008. Many experts, including me, anticipated that the price would certainly fall, due to ending speculation and an economic slowdown, but the price has fallen off an historic cliff. How can this be explained?

A blogger who goes by the moniker of “Gail the Actuary” (whose real name is Gail Tverberg, and she is really an actuary, in the Atlanta area), has offered an explanation that is as good as any that I have seen. It is more appropriate, perhaps, to call her analysis an exploration, as she is direct in saying she does not have all the answers.

First, oil prices have historically risen and fallen in wide swings. But the current dive is vertical and fast. Gail uses this chart from the Energy Information Agency to illustrate.

Energy Information Agency spot oil prices, from The Oil Drum

Energy Information Agency spot oil prices, from The Oil Drum

This chart is something not seen before, and similar charts can be drawn for gasoline prices as well as diesel. Why? Gail explains…

I am becoming more and more convinced that the drop in gasoline prices has a huge amount to do with all of our credit problems (which in turn are related to limits on the oil supply). These credit problems are causing more and more defaults on debt and more and more bankruptcies. These defaults and bankruptcies have a double impact on oil prices–partly from reduced demand, and partly from distressed sellers disposing of futures contracts at low prices, because they are easy assets to sell.

Thus, she integrates the debt freeze with the fall in oil prices. She goes further, illustrating that almost all economic growth as measured by GDP in the U.S. since 2000 can be explained as an increase in debt. That is, while GDP grew, if you subtract all the debt added in these years, there was no real growth. She charts this here:

Debt Adjusted Real GDP, by Gail, The Oil Drum

Debt Adjusted Real GDP, by Gail, The Oil Drum

The problem shown clearly in this chart is that since 2000, growth has been a fiction. In past years, GDP growth depended on debt financing in part, but still went up in real terms. Now, the debt bubble not reflected in real growth must, she argues, inevitably unwind. While this is painful in real estate and other businesses, it impacts energy companies too. Suddenly, not only is oil too cheap to justify development of new and more expensive sources, past investments are at risk in the current financial climate. It is this issue that scares Gail, who, by the way, has studied and written on the long term oil situation for years.

Just when the industry was counting on high prices to finance new exploration and development, the prices are gone. Moreover, there is reason to suspect that prices will rebound slowly. Retarding any new exploration and development may be good news from an global warming perspective, but it is risky as the global economy attempts to transition to the next energy era.

Now, I think that economic conditions will improve faster than expected in 2009, as unfulfilled consumer demand builds, stimulus packages are passed and begin to have an effect, and a new administration engenders more confidence nationally and internationally. Still, oil will at best drift upward as economies struggle to recover.

Popular culture of course celebrates cheaper oil and gasoline. But Gail argues that not only do the debt and oil forces interact, but that the debt issue alone is so severe that a new monetary system may eventually be needed, a very radical conclusion. Bottom line Gail warns, is that we may be underestimating the consequences of the oil price crash.

Glen Hiemstra is a futurist speaker, author, consultant, blogger, internet TV show host and founder of Futurist.com. To arrange for a speech contact Futurist.com.

Glen Hiemstra

About Glen Hiemstra

Glen Hiemstra is the founder and owner of Futurist.com. An internationally respected expert on future trends, long-range planning and creating the preferred future, Glen has advised professional, business, and governmental organizations for two decades.

5 Comments

  1. Glen Hiemstra   |   Dec 12, 2008

    Good comments. I think the fall in oil prices is a real problem, rather than a good thing. I am not eager to see lots of new oil exploration which depended on the higher prices. But higher prices would lead to many benefits. I tend to agree with people like Tom Friedman that a floor ought to be established, on the order of at least $4.00 a gallon for gas, and taxes adjusted up and down to keep there for a while, with proceeds going to alternatives. Or transit.

  2. Britt Stromberg   |   Dec 12, 2008

    I agree with Brenda. Fascinating, but meaningful change requires sacrifice. I’m getting very tired of politicians saying that the economy, the middle class, etc., can’t handle higher prices (not just in oil). It’s the only way we’ll adapt.

    And on the point of no real growth since 2000…holy cow! That’s frightening.

    An excellent, eye-opening post. Thank you!

  3. Brenda Cooper   |   Dec 12, 2008

    I don’t find this heartening at all. Oil prices need to rise if we are going to be able to keep drawing money into alternative energy, into making a smarter grid, etc.

  4. Glen Hiemstra   |   Apr 16, 2009

    Thank you for the compliment. I have been writing a while, though the blog in current form is more recent of course. You might like my book, a few copies left via Amazon. I will check out Political Byline, as well as Financial News.