Posted on 01/06/2015 12:08:44 PM PST by Kaslin
The sudden fall in the price of oil provides a unique opportunity to examine the widely held belief that deflation is economic poison. As many governments and central banks have vowed to fight deflation at all costs in 2015, the question could hardly be more significant.
While falling prices may strike the layman as cause for celebration, economists believe that it can kick off a nasty, and often inescapable, negative cycle, which many believe leads inevitably to a prolonged recession, or even a depression. However, these same economists acknowledge that falling energy prices may offer a stimulus, equivalent to an enormous "tax cut," particularly for lower and middle income consumers for whom energy costs represent a major portion of disposable income. They suggest that the money consumers and businesses no longer spend on gasoline and heating oil could be spent on other goods and services thereby creating demand in other areas of the economy. Even Fed Chair Janet Yellen, a staunch advocate of the economic benefits of rising consumer prices, has extolled the benefits of falling oil prices.
After considering these competing tensions, most economists agree that falling energy prices are a net positive for an economy (except for oil exporting countries like Russia and Venezuela). But the fact that there is even a debate is shocking. It should be clear to anyone that consumers individually, and an economy collectively, benefit from lower energy prices. As I mentioned in a column late last month, no one buys energy for energy's sake. We simply use it to do or get the things that we want. The lower the cost of energy, the cheaper and more abundant the things we want become.
But if we all can agree that lower energy prices offer a benefit, why can't we make the same conclusion about food prices? Wouldn't consumers get a huge "tax cut" if their grocery bills fell as dramatically? How about health care? Wouldn't we all be better off if our hospital and insurance bills fell dramatically from their currently insane levels? Come to think of it, why wouldn't we be better off if the price of everything fell? When does too much of a good thing become too much?
Modern economists tell us that while it's okay for one or two sectors to see price dips, the danger comes when prices decline across the board. Their theory is that if consumers believe that prices will fall over time that they will curtail their purchases to get better deals down the road. Even if the overall dip is relatively small, just 1% annually for example, they believe any amount of deflation will eviscerate demand and kick off a cycle where depressed demand leads to weak sales, which leads to business contraction, layoffs, and further depression in demand thereby renewing the downward cycle.
But the truth is that deflation is not the menace to consumers and businesses that governments would like us to believe. Common sense and basic economics tell us that prices fall for two reasons: Either an excess of supply or a lack of demand. In both cases falling prices are helpful, not harmful
For much of our history, increased productivity increased the supply of goods and forced prices lower. Falling prices made former luxuries affordable to the masses, and in so doing made possible the American middle class. Based on data from the Historical Statistics of the United States, the many periods of sustained deflation did not halt American economic growth in the first 150 years of the Republic. (Sustained inflation did not become the normal state of affairs until 1913, when the Federal Reserve was created).
Prices can also drop when demand falls due to economic contraction. Any store owner will tell you that if customers stop buying and inventories get too high, the best way to create new demand is to mark down prices. This is basic supply and demand. Demand rises as prices fall. In this sense, falling prices are not the cause of economic contraction, but the market solution to depressed demand.
But today's economists are rewriting this fundamental law. In their eyes, demand rises as prices rise. This is the equivalent of a physicist suggesting that the law of gravity forces objects to repel from one another, and that a stone dropped from a rooftop will fall upward. They further stand logic on its head by concluding that falling prices are the cause of the reduced demand. (It's like blaming rain on wet sidewalks, and concluding that the showers will stop if the sidewalks can be dried.)
Economists also argue that falling prices will harm business and lead to unemployment. They forget that falling prices also mean falling costs and increased sales, which lead to higher profits, more capital investment, greater production, and higher real wages. Henry Ford succeeded, and his workers prospered, not because he raised prices, but because he lowered them. Cheaper Model T's did not impose a burden on the public or compel Ford to lower wages. More recently, the tech industry has prospered, and has paid its workers well, by consistently lowering prices.
As a result of these ideas, economists advocate for policies that push up prices. But all this does is kill off more demand and prolong the slump they are trying to cure.
Since Janet Yellen acknowledged the beneficial effects of falling gas prices to consumers, I wonder if she could name even a single category of goods that would impose a burden on consumers if it were to fall in price? My guess is that she can't. If a decline in the price of any individual product is good, then a decline in the price of all products simultaneously is even better. Am I the only one who notices the inconsistency in this logic?
Perhaps this disconnect can shed some light on a topic that central bankers are desperately trying to keep hidden in the shadows: Falling consumer prices are good for the consumer and the economy, but they are bad for central banks looking to maintain asset bubbles and for governments looking for a graceful way to renege on their debts.
If we continue to insist that falling prices are the cause of economic malaise, we will continue to produce economies where malaise is the only possible outcome.
And what’s the life span of the newly frack’d deposits? 18mo, 24mo.? At $60 are they seriously going to gamble on moving the pipes around when so many people who entered at $100/barrel have just gone bust? Who’s going to lend to them at that point (seen all the articles about the the amount of leverage out there in oil plays?).
Thanks. You’re a real gem.
Typical well will flow for several decades. Not at the same rate as initially, but 30~40 years easy.
I don't think you understand the production side very well.
I probably overstated the life span.
Say 25 years easy, 40 years or more maybe.
Which all gets away from my original point: the recent surge in fracking as an extraction method is a result of $100 oil, general deflation (aside from oil) actually is another driver to delay new exploration or new areas of production - delay means lower prices for the fixed equipment and the likelihood that temporarily reduced production will help raise oil prices. Almost no-one alive today has experience of deflation in a major economy, it will have the most peculiar effects on business decision making in general, and make businesses resistant to investment given that they will be very unsure on their returns.
Do you understand, the drilling rig count, went significantly high before we reached those prices?
Overall therefore, I'd argue that the fracking/horizontal implementation was NOT a productivity enhancement, it meant spending more effort/money to get the same output (regardless of the fact that the output would have been impossible without the tech). Getting more widgets/dollar of cost is productivity growth, that is the opposite of what the oil patch has been doing.
No doubt that the higher the price of oil, the more folks invest money trying to drill for it. More rigs always get put in service when prices stay high for years.
better utilization of fracking+horizontal drilling being deployed.
That would explain a decline in rigs for the same oil price, not an increase.
I'd argue that the fracking/horizontal implementation was NOT a productivity enhancement,
Bad argument. Productivity per rig continued to increase in this time period.
Drilling Productivity Report, December 2014
http://www.eia.gov/petroleum/drilling/pdf/dpr-full.pdf
None of that supports any claim that hydraulic fracturing needs $100 to be profitable.
If your primary source of income is to skim the wealth that others create, then you benefit from high prices and the mindless consumption of others. If you’re actually productive, then lower prices and frugal spending raise your standard of living.
Guess I’ll agree to disagree. Just try telling the bankruptcy courts that all is fine at today’s oil prices, looks like they’ll need a lot of expert witnesses in the near future.
I’ll share with you then number of well completed below $100 dollars.
I haven’t claimed all is fine. Several companies took on too much debt and depended on high prices that won’t happen at this time.
But that is far different than trying to claim hydraulic fracturing needed $100 to be profitable. Hundreds of thousands of wells were stimulated this way for decades when prices were under $100. It isn’t an opinion, it is history.
I'll try another approach: USA onshore discovery and extraction of oil has been getting more expensive in terms of effort and raw materials, not less. Of course, engineers regularly improve productivity at the margins, but in the big picture the cost/barrel curve point up. That is the very definition of declining productivity. I'm not a peak oil person, but surely we all know that US production is more expensive than say, Saudi, and over a timeframe of years that is not improving.
You need to understand that Saudi and the others don’t have an abundance of cheap oil either. They don’t have the production capability to replace all the recent oil growth the US has had over the past 7 years. Total OPEC surplus production capabilities, which is nearly all in Saudi, is a little over 2 MMBPD.
As an example of what Saudi Arabia spends to produce its next barrel of oil, look at what they spent recently.
$17-billion (significant overruns from estimates) on the Manifa project for 900,000 barrels a day.
Offshore in shallow waters, they built 27 man-made drilling islands, 13 platforms, and 15 onshore drillsites. The project includes 41 km of causeways and 3 km of bridges designed to maintain natural water flow in Manifa Bay. They have worked for over half a century trying to figure out a way to economically produce this lower value, high sulfur heavy oil with high metal content.
They don’t have the capacity to supply the world with “cheap” oil. They don’t have cheap untapped fields, they have expensive stuff like us. The old massive fields that built their empire are well aged and they spend significant dollars on Enhanced Oil Recovery methods like water flood to keep the production from them dropping to fast, but they are dropping. That is why they spend $17 billion to develop a new field with low quality oil.
https://www.saudiaramcoworld.com/issue/196006/manifa-oil.field.under.the.sea.htm
http://www.theoildrum.com/node/9056
http://www.oilandgasnewsonline.com/Article/33782/No_plans_to_raise_output_capacity
The price is not going to immediate jump back up to $100. But it will climb, because nobody has sufficient supply at the cheap prices those outside the industry dream of.
I’m not sure we disagree here. The stuff is getting more expensive all over, not less. That is declining productivity (if you measure output in Bbl not USD).
If you still think we need $100 oil for hydraulic fracturing to be a profitable stimulation method, we don't agree.
I hate making predictions. The oil price has already dropped farther than I thought it could in the past 6 months. But I do not see a long term (multiple years) with prices staying ~$50. They will climb over the next few years. $70? $80??, $90???
Unless something else greatly changes, like a really bad global economy where the demand actually falls for several quarters in a row. Or a dozen different things that greatly impact global price.
But in either case, hydraulic fracturing is not over in the US or the rest of the world.
Cheers!
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