I received the following question today:
Question: How can the economy get better, when every time there is a hint of recovery, oil prices go up?
Answer: High oil prices are one of the reasons that the economy slipped in the first half of 2011 and continues to struggle today. Unfortunately, we now have Europe and our own debt debate added to the many icebergs we must negotiate in the weeks and months ahead.
Moreover, oil prices are not likely to fall dramatically, short of another full-scale financial crisis like the one in 2008. One of the biggest issues is the “Arab Spring” and the subsidies that monarchies in the Middle East are paying their populations to avoid uprisings there. This has raised the floor on oil prices because those governments use oil revenues to pay for the subsidies. Losses in production from Libya are also a problem. In general, the OPEC countries are holding back on production.
Bottom Line: Oil prices are likely to remain high, and if the payroll tax cut, which helped blunt the blow from those costs to consumers, is not extended, then prices at the pump are likely to be a problem for some time to come. The reaction has been deflation and deep discounts in other areas, such as clothing prices. That brings down the overall rate of inflation, but does not cure what ails us. I wish I had a better answer.
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One Comment
The issue is as much the composition as the level of growth in China. As China shifts its reliance on growth from exports and construction to domestic demand, which it is beginning to do, China’s demand for energy will rise less rapidly. The issue is that the composition of growth is shifting from extremely inefficient and high energy parts of the economy to more energy-efficient and less energy-consuming parts of the economy. So, we could see China become less of a mover in global oil markets, even if it does not slow down demonstrably. Moreover, it is in China’s best interests to become more energy-efficient and less energy-dependent as it represents a major cost for them. This is pushing them to replace inefficient state-owned enterprises with more efficient, less state-controlled substitutes. The hurdle is the military, which still has a major hold on much of the country’s export manufacturing capacity and doesn’t want to give it up. The military would also like to regain some power with a change in leadership in China in 2012.
For the second part of your question, natural gas prices are expected to remain low relative to oil for many reasons. One is the discovery of cheap ways to extract natural gas from shale and ample domestic reserves. The other is that the price of oil is being supported by an artificial floor as a result of the “Arab Spring,” as monarchies in the Middle East are upping their subsidies to prevent their populations from rebelling against them. The revenues for those subsidies come from oil, which means that the Organization of the Petroleum Exporting Countries (OPEC) tends to resist declines in the price of oil at a much higher threshold than in the past. Some in the oil industry estimate that the clearing price for oil to meet budget (subsidy) demands has moved from about $72 per barrel to well above $80 per barrel in Saudi Arabia and is still rising. In some of the smaller oil-producing nations, they need the price of Brent North Sea Crude to clear $100 per barrel to meet their needs to pay subsidies. This could cause revolt over the longer haul, and all could unravel if we truly are forced to endure another global financial crisis (this time emanating from Europe). Short of a crisis, it will take much longer for that differential to narrow.