Sunday, November 25, 2012

Stock Markets and Oil Part V: Conclusion

Budgeting: Sudden Expenses
Oil is the primary transport fuel of all industrial nations - whether by land, air or sea.  So what percent of GDP does the US spend on oil?  Below I have a chart showing the average nominal and 2011-dollar price of oil for each year from 1965 to 2011.  Also included is the percent consumption of oil as a % of GDP - I used annual consumption multiplied by the nominal annual average oil price of the same year to calculate a rough idea of consumption.

Relationship of oil prices and oil consumption as a percent of GDP. The late-1990s had similar numbers as the pre-embargo era.  For the world in 2011, oil consumption accounted for 4.5% of gross world product (purchasing power parity).
The Other Fossil Fuels: Coal and Natural Gas
Coal consumption has declined in the past 5 years - much like oil; and it has received negative publicity for its harmful pollutants.  Natural gas has historically been coupled with oil: both in production and pricing.  Demand for natural gas has increased in the past 15 years as new generating capacity was added starting in the late-1990s.  Almost 90% of coal is used for generating electricity and almost a third of natural gas is used for generating electricity; however oil remains the dominant transportation fuel.

Both coal and oil consumption were hit by the financial crisis of 2007.  The vast majority of coal is now used for generating electricity - though it was once used almost entirely for industrial (rail) and residential use (home heating). 

Electricity generation is becoming a greater share of natural gas use.

Natural gas pricing and production has historically been coupled with oil, but in the past few years has shown a gradual decoupling. How long this decoupling will last is likely controlled by both demand and supply from unconventional reservoirs (tight stratigraphic trap source rocks).
Demand Growth: China
From the above graphs, you can see US oil consumption is on the decline.  Most demand growth is coming from China, and there appears to be a correlation between oil prices and the Chinese currency - the renminbi.  The correlation is recent - since the financial crisis - as the Chinese have only begun to depeg their currency in the past ten years and have done a lousy job at that.

In 2005 China depegged its currency. It started concave down until oil prices peaked in 2008 when again the renminbi was pegged. For the next two years oil prices recovered and the Chinese kept the renminbi pegged. In 2010 China depegged the renminbi. It began moving concave up as oil prices regained and plateaued.
Resource Depletion: Peak Oil
The biggest oilfields in the world have been discovered, produced and marketed the world over.  The large, salt-sealed anticlinal-trapped oil fields of Saudi Arabia have been suspected of having peaked.  Matthew Simmons stated such in his book Twilight in the Desert (2005) - anticipating what the likely outcome would be.  Rumors have abounded that other reputable oilfields such as the Burgan, in Kuwait, have peaked or are very near.

Many of the largest oilfields were discovered by geologist and engineers using surface geology to locate subsurface structural traps, and because oftentimes the oil seeped to the surface. Seismic exploration opened up the exploration possibilities but meant the technological and human capital would take away from the return on investment.

Boom and doom predictions about oil are nothing new.  Peak oil concerns have been around for over a hundred years but have only been rigorously studied over the past 60 years.  On the otherside, predictions about abundant supplies of oil due to some new type of technology have also circulated.

Herman Kahn in his book The Coming Boom (1982) argued that predictions about chronically high oil prices were too pessimistic.  He stated that the predictions did not take into account technological factors which would lead to increased oil production.  Increased oil production would have the benefit of greatly reducing the run-away inflation of the late-1970s and early-1980s.

Economically speaking, more people are bidding up the price of a diminishing resource.  This is true for all resources but oil's depletion, I believe, is happening at a much quicker pace (and with a greater magnitude) than other resources like limestone and iron.  More money will generate more production, but the increasing costs of technological and human capital means return on investment will continue to dwindle.  Exploration and production is being pushed toward the most marginal and most inaccessible oilfields.

As the global economy improves (or not), people take pleasure in being able to move around freely: either to shop, dine out, watch movies or whatever.  Because people (and the goods they purchase) move around using oil combustion engines, oil is necessarily at the root of inflation.

What then could justify a decoupling of the US stock markets and the price of oil in these credit-tight times; what would justify a return to the pre-embargo-like year of 1998?  Although the S&P 500 has been slightly gaining on oil for the year, I wonder how long it can continue.  My ultimate question therefore is what is the energy constraint on an economy?


  1. Luke,

    You might find this interesting.

    Energy, Production and Entropy

    I think Steve Keen is on the cutting edge of economics and blazing new trails out of the old equilibrium models.

    1. I like the 'heat death of the universe' comment he made. Years ago I heard about this: that eventually, entropy pushes out the useful energy and you can't use any of the energy. At that point the universe reaches some sort of equilibrium.

      An undergraduate professor of mine once worked out the problem based on certain assumptions and came to a point so far in the future that there was no way humans would be able to witness it - according to his theory on humanity.