Sometimes a news item informs us about much more than the event in question. Recent announcements of new petrochemical projects in the US fall into that category. Both Shell and Dow Chemical are planning new ethylene crackers in the US, a market in which established ethylene facilities were being shut down only a few years ago, as part of the demand destruction necessary to balance natural gas demand with shrinking US supplies. Anyone looking for further indications of the game-changing nature of shale gas need look no further than these projects. Yet they also give us intriguing hints about two other situations of great interest: global oil prices and US economic growth.
The Shell project is of particular interest, because of its location. The company is apparently planning to locate it in Appalachia, where it will depend on the byproducts of natural gas produced from the giant Marcellus shale deposit. Considering that most of the other ethylene crackers in the US are located on or near the Gulf Coast, where gas can be supplied from numerous onshore and offshore fields, that's a remarkable endorsement of the potential of the Marcellus. You just wouldn't leave such a facility dependent on one gas field if that field weren't both very large and likely to be producing for a very long time. Anyone suggesting that shale gas is a flash in the pan should look long and hard at this project, as I'm sure Shell has done.
It's also worth pausing to recall the way Shell approaches projects like this. Shell is one of the pioneers of scenario planning, and its business plans are all based on its periodic, carefully developed views of different potential futures. I wouldn't assign some notion of infallibility to this; Shell has made its share of mistakes in the last decade, too. However, it does suggest that the company's decision to invest in this project wasn't just based on a straight-line extrapolation of current conditions. Deciding to build an ethylene cracker, a facility that turns the heavier components of natural gas into one of the basic building blocks of the petrochemical and plastics industry, in such a location is a big vote of confidence. It suggests that Shell has concluded that the current uncertainties facing shale gas development are very likely be resolved without undermining shale's capacity to produce large quantities of gas at relatively low cost, and that shale developers will find ways to resolve concerns about fracking, methane emissions, and other issues both with the affected communities and with state and national regulators.
These projects also suggest at least two other things. First, as the Reuters article noted, they represent sizable wagers on the relationship between the global price of oil and the US price of natural gas. I've commented before on the extraordinary divergence between the two, with oil bouncing around the $100 per barrel mark and US natural gas selling for the energy equivalent of $25 per barrel. A company would be unlikely to make a long-term investment like this if it thought gas and oil were likely to move back into parity any time soon. Even if gas prices eventually recover to around $6 per million BTU, as suggested by current long-dated gas futures, that's still the equivalent of less than $40/bbl--an oil price we haven't seen since the worst stretch of the global recession and financial crisis in early 2009.
And that leads to the last implication I draw from this news: these investments are bets on the health of the US economy. If the economy were headed for a protracted period of slow or no growth, adding petrochemical capacity here would be too risky, rather than putting it in the Middle East, where gas is even cheaper and the growing markets in Asia are much closer. That doesn't' mean that our problems of high unemployment, high indebtedness, and gaping federal, state and local budget deficits aren't extremely challenging, but it provides at least one modestly positive sign among the many ominous ones that are routinely amplified by the basic nature of the news media business.
Showing posts with label economic growth. Show all posts
Showing posts with label economic growth. Show all posts
Monday, June 27, 2011
Monday, February 01, 2010
Advantage China?
A spate of articles on China over the weekend, including one in the New York Times entitled, "China Leading Global Race to Make Clean Energy" got me thinking about our reaction to such reports. The Times article included some important insights about the role of relative scale and growth rates in fostering the emergence of global wind and solar power competitors from China. From a wider perspective, however, I worry that we're beginning to apply the same kind of mental inflation of competitor attributes that made "Japan, Inc." seem such an overwhelming juggernaut in the late 1970s and most of the 1980s, when it appeared that Japan would dominate every important industry and own every scrap of signature US real estate, starting with Rockefeller Center and Pebble Beach.
In the last decade or so I've watched attitudes toward China evolve from what I used to call "China Big"--an unprecedented opportunity for global companies due to the size of its emerging consumer and financial markets--to something like "China Smarter", which compares that country's growth and the policies that have sustained it to those that helped guide the mature US and European economies down the path of unsustainable asset bubbles. During this interval Chinese renewable energy firms have grown from low-cost suppliers of parts and raw materials to established EU and US equipment manufacturers, to become integrated competitors in their own right, capable of undercutting the German solar power industry in its home market--to choose just one example.
As the Times points out, China gains a big edge in renewable energy because its entire power sector must grow so rapidly to support economic growth that is expected to average 8% this year, after a decade of double-digit growth interrupted only by last year's dip to 6% or so. That means that while renewables are still more expensive than the coal power plants that have dominated the Chinese market, they don't have to compete head-to-head with them; there's enough growth for all. Contrast that to a US power market that has shrunk by an astonishing 6% since 2007, instead of continuing to grow at its formerly-dependable 1-2% per year pace. The size of China's domestic expansion and the urgency of keeping it going, together with the increasing sophistication of its low-cost manufacturing base, make it nearly inevitable that China would become a serious competitor in an industry for which the biggest factor governing market penetration--other than the degree of regulatory and subsidy support they receive--is making renewables more cost-competitive with traditional energy sources. The more that depends on experience-curve effects rather than technology breakthroughs, the more this competition will favor China, for now. Throw in concerns about access to the rare earths and metals required by much of this technology, and China's long-term advantage in renewables looks even bigger.
I don't want to seem blasé about the challenge this represents, but I also think we should keep it in perspective, as we often failed to do concerning Japan in the 1980s, when its keiretsu companies seemed 10 feet tall and business bestsellers touted Japanese management techniques and warned that Japan was on the verge of overtaking the US in the global economy. Again, consider renewable energy. In 2008 the value of all wind turbines installed globally was on the order of $70 billion and for grid-connected solar power hardware around $20 billion, out of global renewable energy investments of $120 billion. That puts global wind and solar equipment sales at roughly the level of US aerospace exports for 2008, and about half the size of the total US aerospace market. That's big enough to want to retain a meaningful share of the market, but not so big that the entire economy depends on it. Or does it?
The Times article included the worrying suggestion that the US might someday be as dependent on imported Chinese renewable energy gear as it currently is on imported oil from the Middle East--never mind that the latter made up just a fifth of net US oil imports and 12% of total US oil supplies in 2008. Yet even if that analogy were correct, there's a huge difference in the economic and security implications of these two positions. We understand from experience that even a partial suspension of US oil imports would create an immediate price spike and send a shock throughout the economy. It's hard to see how the impact of even a complete embargo on sales of wind and solar equipment from China to the US could ever approach that. Although curtailed renewable energy equipment imports might disrupt the activities of companies installing them and spoil the returns of those parties financing them, existing facilities would keep turning out power. Once you've imported a wind turbine or solar module and set it up, you own it and its output until it wears out. These risks simply don't equate in the manner the Times asserts. Moreover, they are naturally limited by the significant practical challenges faced by intermittent and cyclical power generation technologies. Just read the DOE's analysis of a 20% wind power scenario to see what's necessary to achieve even that threshold.
Unfortunately, concerns about China's advances in renewable energy carry extra weight, because they align with a larger pattern of China envy exemplified by the talk of a "Beijing Consensus" that Tom Friedman apparently encountered at the World Economic Forum in Davos. China's "Confucian-Communist-Capitalist" model certainly offers speed and clarity of purpose that our own system has matched only at times of immediate national crisis. However, it's worth recalling that in the 1930s the Soviet and Italian models had their admirers here, too, for their ability to get things done, compared to the messiness of a capitalist democracy. However discredited the US economy may look after a couple of bad years, I'll take that messiness, as long as we don't manage to kill the innovative spirit--and the incentives that drive it--that enabled us to adapt the best of Japan's ideas while continuing on a trajectory that eclipsed Japan's success over the last two decades, even when you factor in the Great Recession. I'm more worried about navigating the geopolitical challenges that China's rise will create over the next few decades, and ensuring that they don't end in the kind of confrontation that resulted from Germany's rise a century ago.
In the last decade or so I've watched attitudes toward China evolve from what I used to call "China Big"--an unprecedented opportunity for global companies due to the size of its emerging consumer and financial markets--to something like "China Smarter", which compares that country's growth and the policies that have sustained it to those that helped guide the mature US and European economies down the path of unsustainable asset bubbles. During this interval Chinese renewable energy firms have grown from low-cost suppliers of parts and raw materials to established EU and US equipment manufacturers, to become integrated competitors in their own right, capable of undercutting the German solar power industry in its home market--to choose just one example.
As the Times points out, China gains a big edge in renewable energy because its entire power sector must grow so rapidly to support economic growth that is expected to average 8% this year, after a decade of double-digit growth interrupted only by last year's dip to 6% or so. That means that while renewables are still more expensive than the coal power plants that have dominated the Chinese market, they don't have to compete head-to-head with them; there's enough growth for all. Contrast that to a US power market that has shrunk by an astonishing 6% since 2007, instead of continuing to grow at its formerly-dependable 1-2% per year pace. The size of China's domestic expansion and the urgency of keeping it going, together with the increasing sophistication of its low-cost manufacturing base, make it nearly inevitable that China would become a serious competitor in an industry for which the biggest factor governing market penetration--other than the degree of regulatory and subsidy support they receive--is making renewables more cost-competitive with traditional energy sources. The more that depends on experience-curve effects rather than technology breakthroughs, the more this competition will favor China, for now. Throw in concerns about access to the rare earths and metals required by much of this technology, and China's long-term advantage in renewables looks even bigger.
I don't want to seem blasé about the challenge this represents, but I also think we should keep it in perspective, as we often failed to do concerning Japan in the 1980s, when its keiretsu companies seemed 10 feet tall and business bestsellers touted Japanese management techniques and warned that Japan was on the verge of overtaking the US in the global economy. Again, consider renewable energy. In 2008 the value of all wind turbines installed globally was on the order of $70 billion and for grid-connected solar power hardware around $20 billion, out of global renewable energy investments of $120 billion. That puts global wind and solar equipment sales at roughly the level of US aerospace exports for 2008, and about half the size of the total US aerospace market. That's big enough to want to retain a meaningful share of the market, but not so big that the entire economy depends on it. Or does it?
The Times article included the worrying suggestion that the US might someday be as dependent on imported Chinese renewable energy gear as it currently is on imported oil from the Middle East--never mind that the latter made up just a fifth of net US oil imports and 12% of total US oil supplies in 2008. Yet even if that analogy were correct, there's a huge difference in the economic and security implications of these two positions. We understand from experience that even a partial suspension of US oil imports would create an immediate price spike and send a shock throughout the economy. It's hard to see how the impact of even a complete embargo on sales of wind and solar equipment from China to the US could ever approach that. Although curtailed renewable energy equipment imports might disrupt the activities of companies installing them and spoil the returns of those parties financing them, existing facilities would keep turning out power. Once you've imported a wind turbine or solar module and set it up, you own it and its output until it wears out. These risks simply don't equate in the manner the Times asserts. Moreover, they are naturally limited by the significant practical challenges faced by intermittent and cyclical power generation technologies. Just read the DOE's analysis of a 20% wind power scenario to see what's necessary to achieve even that threshold.
Unfortunately, concerns about China's advances in renewable energy carry extra weight, because they align with a larger pattern of China envy exemplified by the talk of a "Beijing Consensus" that Tom Friedman apparently encountered at the World Economic Forum in Davos. China's "Confucian-Communist-Capitalist" model certainly offers speed and clarity of purpose that our own system has matched only at times of immediate national crisis. However, it's worth recalling that in the 1930s the Soviet and Italian models had their admirers here, too, for their ability to get things done, compared to the messiness of a capitalist democracy. However discredited the US economy may look after a couple of bad years, I'll take that messiness, as long as we don't manage to kill the innovative spirit--and the incentives that drive it--that enabled us to adapt the best of Japan's ideas while continuing on a trajectory that eclipsed Japan's success over the last two decades, even when you factor in the Great Recession. I'm more worried about navigating the geopolitical challenges that China's rise will create over the next few decades, and ensuring that they don't end in the kind of confrontation that resulted from Germany's rise a century ago.
Monday, January 11, 2010
Oil Prices and the Recovery
As oil prices continue their upward trend, I'm noticing more articles and getting more comments from readers questioning whether $80-plus oil could squelch the nascent economic recovery--or for those who believe the recession isn't over, deepen it again. It's not an unreasonable question, particularly when we compare current retail fuel prices to their level of a year ago: the "gasoline stimulus" that I was tracking for much of last year. A quick glance at the chart below reveals that instead of paying a dollar or more per gallon less than twelve months earlier, as we were for much of 2009, the average US retail price for unleaded regular is now roughly a buck higher than it was the same time last year. That can't be favorable news for consumers or for businesses depending on a resurgence in consumer demand for other goods and services. But is it enough to stall economic growth?
Although I still check oil prices on a regular basis--at least every couple of days, instead of every few minutes when I was trading the stuff--sometimes I notice price trends the same way most of my readers do: by driving by neighborhood gas stations and watching the most visible price in America change day to day. The recent steady, counter-seasonal rise against the backdrop of generally slack demand and comfortably high inventories, and in the absence of any significant global supply disruptions has had me a bit perplexed. And it's really all down to oil prices, since refining margins remain fairly weak and are only as strong as they are as a result of several refineries being shut down entirely and most others running at historically low rates of throughput.
Nor does this seem to be an instance of what I've called the oil-dollar price loop. Since December 11, 2009 crude prices are up by 18%, despite the US dollar strengthening by 3% against the Euro and 5% against the Japanese Yen over the same interval, amid a general surge of commodity prices.
Most analysts seem to attribute higher oil and commodity prices to higher demand from countries like China, as the global economy responds to the impact of various stimulus packages and the stabilization of the banking system. China's growth has been particularly impressive, but even if this is boosting its demand for oil imports by 25%, as one source suggested, that hardly seems likely to swamp the substantial spare capacity that OPEC has accumulated in the last year and a half. As I noted last week, OPEC has successfully held over 3 million barrels per day off the market and maintained global oil prices at a level that wouldn't be possible based only on renewed economic growth in China and its anticipation by the market elsewhere. OPEC has attracted remarkably little flak for this policy, which a year ago probably prevented oil prices from going into free fall. That would have harmed all producers, and eventually consumers, too, by drying up future supplies.
So what's the financial impact of OPEC's self-restraint on US consumers and our economy? Even if you ignore the year-earlier comparison, current retail gas prices are around 30 cents per gallon above their average for last year. For a household driving 25,000 miles per year in typical cars, that's worth at least $25 per month. Across the entire 138 billion gallon-per-year gasoline market, that aggregates to around $40 billion/year. Applying the underlying $13/bbl oil price rise since mid-December to our net oil imports of roughly 10 million bbl/day, that figure increases to just under $50 billion/year.
As unwelcome as this additional drag on the recovery might be, at current levels it seems unlikely to further derail our $14 trillion economy, even if it contributes several billion dollars a month to our trade deficit and, along with high unemployment, depresses consumer confidence. However, near-$3 gas is one thing; widespread expectations of a return to $4 per gallon would be quite another. While higher oil prices mainly due to OPEC restraint aren't yet a cause for panic, this trend certainly bears watching.
Although I still check oil prices on a regular basis--at least every couple of days, instead of every few minutes when I was trading the stuff--sometimes I notice price trends the same way most of my readers do: by driving by neighborhood gas stations and watching the most visible price in America change day to day. The recent steady, counter-seasonal rise against the backdrop of generally slack demand and comfortably high inventories, and in the absence of any significant global supply disruptions has had me a bit perplexed. And it's really all down to oil prices, since refining margins remain fairly weak and are only as strong as they are as a result of several refineries being shut down entirely and most others running at historically low rates of throughput.
Nor does this seem to be an instance of what I've called the oil-dollar price loop. Since December 11, 2009 crude prices are up by 18%, despite the US dollar strengthening by 3% against the Euro and 5% against the Japanese Yen over the same interval, amid a general surge of commodity prices.
Most analysts seem to attribute higher oil and commodity prices to higher demand from countries like China, as the global economy responds to the impact of various stimulus packages and the stabilization of the banking system. China's growth has been particularly impressive, but even if this is boosting its demand for oil imports by 25%, as one source suggested, that hardly seems likely to swamp the substantial spare capacity that OPEC has accumulated in the last year and a half. As I noted last week, OPEC has successfully held over 3 million barrels per day off the market and maintained global oil prices at a level that wouldn't be possible based only on renewed economic growth in China and its anticipation by the market elsewhere. OPEC has attracted remarkably little flak for this policy, which a year ago probably prevented oil prices from going into free fall. That would have harmed all producers, and eventually consumers, too, by drying up future supplies.
So what's the financial impact of OPEC's self-restraint on US consumers and our economy? Even if you ignore the year-earlier comparison, current retail gas prices are around 30 cents per gallon above their average for last year. For a household driving 25,000 miles per year in typical cars, that's worth at least $25 per month. Across the entire 138 billion gallon-per-year gasoline market, that aggregates to around $40 billion/year. Applying the underlying $13/bbl oil price rise since mid-December to our net oil imports of roughly 10 million bbl/day, that figure increases to just under $50 billion/year.
As unwelcome as this additional drag on the recovery might be, at current levels it seems unlikely to further derail our $14 trillion economy, even if it contributes several billion dollars a month to our trade deficit and, along with high unemployment, depresses consumer confidence. However, near-$3 gas is one thing; widespread expectations of a return to $4 per gallon would be quite another. While higher oil prices mainly due to OPEC restraint aren't yet a cause for panic, this trend certainly bears watching.
Monday, March 09, 2009
The End of the World As We Know It?
The opinion section of the Sunday New York Times made for sobering reading this weekend. While the Times has hardly been a bastion of economic optimism of late, three op-eds stood out for their shared sense that we might be on the brink of truly wrenching change. Tom Friedman invoked an enviro-economic tipping point, citing one expert's prognosis of a "Great Disruption;" a best-selling author saw the risk of "economic cataclysm" in the bursting of Eastern Europe's foreign debt bubble; and another found parallels to the Austria-Hungary of 1913, one year before the war that ended at least three empires and mortally wounded a couple of others. But while the systemic unraveling of the past six months or so makes such possibilities likelier than they would have been just a few years ago, the odds still favor a much less drastic result than revolution or apocalypse. The enormous recent increase in the range of uncertainties we face lends added credibility to the direst scenarios. However, it's important to realize that these predictions are not certainties, unless our responses make them so. That applies to energy, as well.
When I think about the possible paths of energy supply and demand over the next few years, they depend much less on specific energy or environmental trends than on the future state of the economy. Forecasting oil prices has become meaningless without a clear view of growth, particularly in the US and China. Demand may have rebounded recently in the US, but the combination of a crippling financial crisis with a deep cyclical downturn has Americans questioning the future in ways that I haven't seen in decades, other than the immediate aftermath of 9/11. The tangible effects of what noted historian Niall Ferguson has dubbed the "Great Recession" serve to reinforce the hangover of millennial angst from the turn of the century, which manifested in the more extreme views of Y2K and more recently Peak Oil. Layer in the propensity of my own Baby Boom generation to see itself at the epicenter of great events, and the stage is set for receptiveness to the view that we stand on the brink of unprecedented, permanently life-altering change.
When I was involved in my first scenario planning project at Texaco, we came up with three remarkably insightful views of the future of the energy industry, at least two of which have remained relevant far longer than any of us could have guessed. They received wide distribution throughout the company and had the general support of many in upper management. However, that project also came up with the seeds of another scenario, a much darker view involving the rejection of globalization and a growing wave of anti-Americanism around the world. Although in some respects it was no less prescient--or challenging--than the other three scenarios, it went nowhere, because the context for exploring it didn't exist in 1997. The external consultants who guided us through the process advised us not to pursue it, or risk destroying the credibility of the entire effort. That was good advice, even in retrospect, and it served as a useful lesson about the way that assessments of the future interact with our views of the present and our experience of the past. They must also be grounded in reality.
That's certainly true for energy, today. However much we might consider our energy future to be in flux, our views of it must take into account the embedded dominance of fossil fuels in our energy systems. Given the scale of these systems, that dominance will still exist next year and the following year, no matter what policies are enacted in the US or elsewhere. This might all seem to be up for grabs, but that's really only true in the long term. I've believed for a long time that we are on the threshold of a revolution in the ways that we produce and use energy, and it has arguably already begun. But no matter what happens in the economy, short of a massive global collapse, this revolution cannot be completed overnight. It will take decades, and that is equally true of our response to man-made climate change, which took a century to create.
Whenever I watch the news or read the latest statistics about the economy, I worry about what next year might look like. The uncertainties are huge and daunting. But I also know that while the chances of a Great Depression-style collapse or a radical socio-enviro-political transformation have risen, the economic future is likelier to resemble the last few decades, minus the unsustainable levels of personal and institutional debt. In the same way, the energy transformation is likely to play out as a set of big, gradual shifts: away from coal and other carbon-intensive fuels and toward renewable energy and nuclear power, and away from liquid transportation fuels and towards the eventual electrification of most ground vehicles. These transitions will take time, and that means that, whatever their price, a decade from now there will still be electricity and natural gas for the appliances and devices you buy today, and there will still be fuel for the car you buy today. That's one set of uncertainties over which we shouldn't lose sleep.
When I think about the possible paths of energy supply and demand over the next few years, they depend much less on specific energy or environmental trends than on the future state of the economy. Forecasting oil prices has become meaningless without a clear view of growth, particularly in the US and China. Demand may have rebounded recently in the US, but the combination of a crippling financial crisis with a deep cyclical downturn has Americans questioning the future in ways that I haven't seen in decades, other than the immediate aftermath of 9/11. The tangible effects of what noted historian Niall Ferguson has dubbed the "Great Recession" serve to reinforce the hangover of millennial angst from the turn of the century, which manifested in the more extreme views of Y2K and more recently Peak Oil. Layer in the propensity of my own Baby Boom generation to see itself at the epicenter of great events, and the stage is set for receptiveness to the view that we stand on the brink of unprecedented, permanently life-altering change.
When I was involved in my first scenario planning project at Texaco, we came up with three remarkably insightful views of the future of the energy industry, at least two of which have remained relevant far longer than any of us could have guessed. They received wide distribution throughout the company and had the general support of many in upper management. However, that project also came up with the seeds of another scenario, a much darker view involving the rejection of globalization and a growing wave of anti-Americanism around the world. Although in some respects it was no less prescient--or challenging--than the other three scenarios, it went nowhere, because the context for exploring it didn't exist in 1997. The external consultants who guided us through the process advised us not to pursue it, or risk destroying the credibility of the entire effort. That was good advice, even in retrospect, and it served as a useful lesson about the way that assessments of the future interact with our views of the present and our experience of the past. They must also be grounded in reality.
That's certainly true for energy, today. However much we might consider our energy future to be in flux, our views of it must take into account the embedded dominance of fossil fuels in our energy systems. Given the scale of these systems, that dominance will still exist next year and the following year, no matter what policies are enacted in the US or elsewhere. This might all seem to be up for grabs, but that's really only true in the long term. I've believed for a long time that we are on the threshold of a revolution in the ways that we produce and use energy, and it has arguably already begun. But no matter what happens in the economy, short of a massive global collapse, this revolution cannot be completed overnight. It will take decades, and that is equally true of our response to man-made climate change, which took a century to create.
Whenever I watch the news or read the latest statistics about the economy, I worry about what next year might look like. The uncertainties are huge and daunting. But I also know that while the chances of a Great Depression-style collapse or a radical socio-enviro-political transformation have risen, the economic future is likelier to resemble the last few decades, minus the unsustainable levels of personal and institutional debt. In the same way, the energy transformation is likely to play out as a set of big, gradual shifts: away from coal and other carbon-intensive fuels and toward renewable energy and nuclear power, and away from liquid transportation fuels and towards the eventual electrification of most ground vehicles. These transitions will take time, and that means that, whatever their price, a decade from now there will still be electricity and natural gas for the appliances and devices you buy today, and there will still be fuel for the car you buy today. That's one set of uncertainties over which we shouldn't lose sleep.
Friday, January 23, 2009
A Painful Adjustment
A quick read through the morning paper reminded me just how much the future path of energy prices and energy sector investment depend on the economy, and on the measures intended to speed its recovery. It doesn't seem like so long ago that the situation was exactly reversed, with the economy faltering in part due to a massive oil price shock. Now, the very things that energy strategists and planners most took for granted--the steady pace of demand growth driven by an expanding global economy and unimpeded access to financing for projects large and small--have become the biggest uncertainties affecting the industry. A random selection of articles and op-eds in today's Wall Street Journal seems to confirm that these uncertainties won't be resolved quickly. Indeed, they cannot be, until the recession has done its unpleasant work of re-directing employment and investment away from sectors that grew unsustainably large during the parallel housing and consumer debt bubbles, and towards new and better uses.
In the Money & Investing section we read, "Oil Rallies on Stimulus Hopes." With the volatile expiration of the February crude oil contract behind us, March West Texas Intermediate settled at $43.67 yesterday. But the rally in question, of four days duration, doesn't change the fact that this same March contract has declined by about 70% since its high last July, and by 10% since last December 31. No one expects a return to last year's peaks, but the hopes for a quick agreement on an economic stimulus package ought to be tempered by the enormity of the task that package is intended to accomplish, and by our questionable ability to sustain the requisite deficits long enough to see its programs through.
The challenge is illustrated by an article that provides the kind of good news/bad news mix typical of a deep recession: "Home Construction at Record Slow Pace." At December's seasonally-adjusted annual rate of 550,000 units, new home construction is apparently at the lowest level since at least 1959, and half its rate of a year earlier. This is clearly bad news for anyone working in home construction and all the businesses that supply it. However, it's good news for current homeowners, since less supply will eventually lead to higher prices. It also reflects the reality that the home construction sector cannot be maintained at the scale it reached during the housing bubble. Too many of the country's resources were devoted to building new and bigger homes, fueled by unrealistically high levels of debt. Finding more productive and sustainable employment for the people and businesses affected is just one task of the stimulus, and of the recession itself. The same is true for a consumer-goods sector, including retail, that also grew unsustainably large, driven by massive home-equity and credit card debt.
For all the hopes pinned on the stimulus, its Achilles heel is the scale of the deficits involved, on top of a preexisting budget deficit and the enormous loans made to the banking sector. While the projected US deficits in 2009 and 2010 might look manageable as a share of GDP, their absolute magnitude raises serious, unanswered questions about funding. "The World Won't Buy Unlimited U.S. Debt," points out one op-ed in the Opinion section. I understand the risks of doing too little and the worries about a liquidity trap, in which monetary policy loses its effectiveness, or entering a deflationary spiral; however, the stimulus carries risks of its own. Nor can we forget that ours is not the only government taking on more debt to fund an urgent stimulus. "Expect the World Economy to Suffer Through 2009," conclude Ian Bremmer and Nouriel Roubini, of the Eurasia Group and NYU, respectively.
We need to keep all of this in mind, as we assess the stimulus package that the Congress and new administration are designing. Every assertion that it should be as big as possible should be balanced by a reminder that, because we will go deep into debt to fund it--with unpredictable consequences--it should not be one dollar larger than truly necessary. In particular, that means that provisions that can't be shown to have a high likelihood of putting people and businesses to work productively in the next 18 months should be deferred until we have a clearer sense of the receptiveness of global lenders for the mountain of Treasury bonds and T-bills the government must issue to pay for them. I'm glad I don't have to make those choices, and I wish our elected leaders the greatest success in this endeavor. Much more than just energy markets hinges on it.
In the Money & Investing section we read, "Oil Rallies on Stimulus Hopes." With the volatile expiration of the February crude oil contract behind us, March West Texas Intermediate settled at $43.67 yesterday. But the rally in question, of four days duration, doesn't change the fact that this same March contract has declined by about 70% since its high last July, and by 10% since last December 31. No one expects a return to last year's peaks, but the hopes for a quick agreement on an economic stimulus package ought to be tempered by the enormity of the task that package is intended to accomplish, and by our questionable ability to sustain the requisite deficits long enough to see its programs through.
The challenge is illustrated by an article that provides the kind of good news/bad news mix typical of a deep recession: "Home Construction at Record Slow Pace." At December's seasonally-adjusted annual rate of 550,000 units, new home construction is apparently at the lowest level since at least 1959, and half its rate of a year earlier. This is clearly bad news for anyone working in home construction and all the businesses that supply it. However, it's good news for current homeowners, since less supply will eventually lead to higher prices. It also reflects the reality that the home construction sector cannot be maintained at the scale it reached during the housing bubble. Too many of the country's resources were devoted to building new and bigger homes, fueled by unrealistically high levels of debt. Finding more productive and sustainable employment for the people and businesses affected is just one task of the stimulus, and of the recession itself. The same is true for a consumer-goods sector, including retail, that also grew unsustainably large, driven by massive home-equity and credit card debt.
For all the hopes pinned on the stimulus, its Achilles heel is the scale of the deficits involved, on top of a preexisting budget deficit and the enormous loans made to the banking sector. While the projected US deficits in 2009 and 2010 might look manageable as a share of GDP, their absolute magnitude raises serious, unanswered questions about funding. "The World Won't Buy Unlimited U.S. Debt," points out one op-ed in the Opinion section. I understand the risks of doing too little and the worries about a liquidity trap, in which monetary policy loses its effectiveness, or entering a deflationary spiral; however, the stimulus carries risks of its own. Nor can we forget that ours is not the only government taking on more debt to fund an urgent stimulus. "Expect the World Economy to Suffer Through 2009," conclude Ian Bremmer and Nouriel Roubini, of the Eurasia Group and NYU, respectively.
We need to keep all of this in mind, as we assess the stimulus package that the Congress and new administration are designing. Every assertion that it should be as big as possible should be balanced by a reminder that, because we will go deep into debt to fund it--with unpredictable consequences--it should not be one dollar larger than truly necessary. In particular, that means that provisions that can't be shown to have a high likelihood of putting people and businesses to work productively in the next 18 months should be deferred until we have a clearer sense of the receptiveness of global lenders for the mountain of Treasury bonds and T-bills the government must issue to pay for them. I'm glad I don't have to make those choices, and I wish our elected leaders the greatest success in this endeavor. Much more than just energy markets hinges on it.
Monday, September 22, 2008
The Low-Growth Scenario
Who would have guessed as recently as two years ago that the story that finally pushed the energy crisis off the front page would turn out to be a major global financial crisis? Of course, energy--specifically its environmental consequences, along with high oil prices--remains just as important as it was, but it must now be viewed in an entirely different economic context, the ultimate shape of which remains to be seen. The slowing of global economic growth has already resulted in lower oil prices. But if that slowdown becomes a recession, particularly one triggered by a significant tightening of credit, the expansion of both conventional and alternative energy supplies could be affected, along with investments in improved energy efficiency, including more fuel-efficient automobiles.
I've led a number of scenario projects in the last decade, many of them examining various aspects of the future of energy. One of the key steps in developing scenarios involves the identification and ranking of the main uncertainties affecting the outcome of the proposition in question. Participants will often highlight economic conditions such as growth rates and inflation, but in my experience, these have usually been trumped by other factors, including environmental regulations, energy prices, and technology. As fundamental as economic growth is to demand for energy and the capital to invest in new forms of energy, the prospect of a protracted period of low growth and tight capital simply didn't seem credible to most people, even though the last major slowdown in energy investment followed the collapse of oil prices in the late 1990s, which was triggered in part by the Asian Economic Crisis.
There are numerous ways in which a credit crunch would affect energy investment, though the notion that I keep hearing, that it would enforce an either/or choice between investing in traditional energy sources--oil, gas and coal--versus renewables is almost certainly wrong. If oil investment slows, it likely won't be because oil companies can't borrow for projects, but because falling demand and resulting lower prices make marginal projects unattractive. Particularly for the largest oil companies, who after several years of high prices have lots of cash and little remaining debt, decisions will boil down to hurdle rates and forecasts of future oil, natural gas, and refined product prices--and to their effective tax rate on profits, which is already around 40%. Most alternative energy companies are in a very different position, with large recent investments and much smaller cash flows, a significant fraction of which depend on government subsidies and mandates. A credit crunch could slow their expansion dramatically.
Nor would this effect be confined to companies and large alternative energy projects. If consumers can't obtain attractive financing for more efficient appliances, heating systems, or rooftop solar power installations, the markets for those products will languish, and their aggregate impact on energy consumption and greenhouse gas emissions will be less than hoped, at least for the next few years. That also applies to more efficient cars, especially those involving technologies that add significant up-front costs. Lavish tax credits for plug-ins and other hybrids might not help their sales much, if buyers can't qualify for the loans to buy them. Getting up to $5,000 off your taxes the following April--assuming that doesn't exceed your net tax liability--may seem very attractive, but only if you can float that amount in the interim, or reduce your withholding accordingly. (Based on recent effective average federal income tax rates, anyone earning less than about $80,000 per year might not qualify for the full credit.) As US new car sales fall, it will take longer for the fleet to turn over, and for overall fuel economy to improve.
It's still not certain that we'll be living the low-growth scenario. Much depends on the success of the emergency measures developed by the Treasury and Federal Reserve Bank and now under urgent consideration by the Congress. But even if a $700 billion "bailout" shores up the value of weak assets, the deterioration of which has sickened both the firms that lent against them and the other firms that entered into derivative contracts tied to them--the formerly-obscure but now infamous Credit Default Obligations (CDOs)--it is unlikely that everything will rapidly revert to the status quo ante normal. Confidence may be restored, but our financial sector will end up smaller, and that will mean less availability of easy credit. Unless energy prices spike much higher, again, that would work against measures to overturn the energy status quo. I think we're going to hear a lot more about this in the weeks and months ahead.
I've led a number of scenario projects in the last decade, many of them examining various aspects of the future of energy. One of the key steps in developing scenarios involves the identification and ranking of the main uncertainties affecting the outcome of the proposition in question. Participants will often highlight economic conditions such as growth rates and inflation, but in my experience, these have usually been trumped by other factors, including environmental regulations, energy prices, and technology. As fundamental as economic growth is to demand for energy and the capital to invest in new forms of energy, the prospect of a protracted period of low growth and tight capital simply didn't seem credible to most people, even though the last major slowdown in energy investment followed the collapse of oil prices in the late 1990s, which was triggered in part by the Asian Economic Crisis.
There are numerous ways in which a credit crunch would affect energy investment, though the notion that I keep hearing, that it would enforce an either/or choice between investing in traditional energy sources--oil, gas and coal--versus renewables is almost certainly wrong. If oil investment slows, it likely won't be because oil companies can't borrow for projects, but because falling demand and resulting lower prices make marginal projects unattractive. Particularly for the largest oil companies, who after several years of high prices have lots of cash and little remaining debt, decisions will boil down to hurdle rates and forecasts of future oil, natural gas, and refined product prices--and to their effective tax rate on profits, which is already around 40%. Most alternative energy companies are in a very different position, with large recent investments and much smaller cash flows, a significant fraction of which depend on government subsidies and mandates. A credit crunch could slow their expansion dramatically.
Nor would this effect be confined to companies and large alternative energy projects. If consumers can't obtain attractive financing for more efficient appliances, heating systems, or rooftop solar power installations, the markets for those products will languish, and their aggregate impact on energy consumption and greenhouse gas emissions will be less than hoped, at least for the next few years. That also applies to more efficient cars, especially those involving technologies that add significant up-front costs. Lavish tax credits for plug-ins and other hybrids might not help their sales much, if buyers can't qualify for the loans to buy them. Getting up to $5,000 off your taxes the following April--assuming that doesn't exceed your net tax liability--may seem very attractive, but only if you can float that amount in the interim, or reduce your withholding accordingly. (Based on recent effective average federal income tax rates, anyone earning less than about $80,000 per year might not qualify for the full credit.) As US new car sales fall, it will take longer for the fleet to turn over, and for overall fuel economy to improve.
It's still not certain that we'll be living the low-growth scenario. Much depends on the success of the emergency measures developed by the Treasury and Federal Reserve Bank and now under urgent consideration by the Congress. But even if a $700 billion "bailout" shores up the value of weak assets, the deterioration of which has sickened both the firms that lent against them and the other firms that entered into derivative contracts tied to them--the formerly-obscure but now infamous Credit Default Obligations (CDOs)--it is unlikely that everything will rapidly revert to the status quo ante normal. Confidence may be restored, but our financial sector will end up smaller, and that will mean less availability of easy credit. Unless energy prices spike much higher, again, that would work against measures to overturn the energy status quo. I think we're going to hear a lot more about this in the weeks and months ahead.
Tuesday, January 22, 2008
Energy and the Economy
We're currently being provided with an uncomfortable reminder that the economy trumps all other issues, when it's doing badly. Energy has been a big part of this story, at least in terms of perception. However, in part because weak refining margins have sheltered consumers from the full impact of $90 oil, and because natural gas has temporarily uncoupled from oil prices, on average Americans still pay less for energy than we did during most of the 1960s, 1970s and into the 1980s. Of course, that's cold comfort for those who have seen their fuel outlays double in the last four years. The important question now is how energy will affect a weakening economy, and vice versa. In lieu of a comprehensive answer that would tie up a team of economists for weeks, here are a few thoughts on the subject.
Energy and the economy are deeply intertwined. Economic growth pushes up energy demand, though at a much slower rate than in the past. Energy prices rise in turn, and that stimulates supply, albeit with a significant lag. In this cycle we've seen the impact of supply constraints from infrastructure, resource nationalism, and the availability of equipment and experienced technical staff. Now throw in the rapid economic transformation of China, India and the rest of Asia, along with the undetermined effects of unprecedented levels of financial speculation in oil. Prices haven't self-corrected as we might have expected, and the result has been dramatic energy price inflation of a type very different from the energy crisis of the 1970s. The financial flows this has created are enormous: a billion dollars per day, from the US alone.
So what happens next? That depends on how much influence the US market has on an increasingly globalized energy market. Even with the economy still growing, we've seen total US oil consumption has plateau for three years, now, and our imports of oil and petroleum products have been essentially flat since 2005. We're responsible for less than 15% of the 5 million barrel per day spurt of demand since 2003 that has used up most of the world's spare production capacity. If our consumption fell this year, that might not affect oil prices much, unless the US economic slowdown triggered a global economic contraction. Consider China, where rapidly increasing oil consumption has been led by domestic consumers, who are insulated from world oil price changes by regulated petroleum product prices, and by export industries that supply developed countries, including the US. Because China uses much more energy per unit of GDP than we do, a slowdown there would have a more dramatic impact on oil prices.
But if $90 oil represents a significant drag on the US economy, how much would oil prices have to fall in order to stimulate economic growth? That's hard to say, because during most of the run-up from $30 per barrel to $70 or so, our economy appeared to be immune to the consequences of higher oil prices. Right now analysts and markets seem most concerned about consumers, for whom the increase in gasoline prices since last January has added an average of about $65 per month in cost per household. Reversing that would require getting oil back to the mid-$50s, barring a big increase in refining margins, as refiners cut back on output that is losing them money.
How might oil revert to $50 per barrel this year? We can rule out the influence of alternative energy, in the short run. Biofuels output can't grow fast enough to make that kind of dent in demand. I also doubt we can convince OPEC to open their taps wide; they are unlikely to see that as being in their best interest, unless they thought it was the only option for preventing a global collapse that would shrink their revenues even more. That leaves speculation and demand. There's no consensus on how much of the current oil price is attributable to speculation. As the yields on other asset classes drop, are speculators more or less likely to invest in oil commodities? And how many of them will need to liquidate commodity holdings to cover losses on other positions? Even if the contribution of speculation dropped by $10 per barrel, we're still only talking about roughly $20 per month per household.
That leaves demand, though this is an example of the worm eating its tail. Demand growth is widely viewed as the biggest contributor to the increase in oil prices since 2003, so a global drop in oil demand of a couple of million barrels per day would probably deflate oil prices sharply. But in the short term, we can't create that big a fall in demand through higher efficiency alone. The scenario that comes closest to being able to deliver that looks similar to what we experienced in the Asian Economic Crisis of the late 1990s, when the combination of falling regional demand and rising global production cut oil prices in half. However, the global economy has become much more inter-dependent in the last ten years, and this kind of cure would almost certainly be worse than the disease.
Although oil prices have contributed to the current crisis, they didn't cause it. While oil prices will likely fall, if the US goes into recession and the global economy contracts, that by itself won't do much to restore the economy to sound health. Oil looks like a lagging, rather than leading indicator, here, and we need to turn elsewhere to solve the financial mess that has resulted from the popping of the US housing bubble and the debt problem that has created. Later this week I'll take a look at what this might mean for alternative energy.
Energy and the economy are deeply intertwined. Economic growth pushes up energy demand, though at a much slower rate than in the past. Energy prices rise in turn, and that stimulates supply, albeit with a significant lag. In this cycle we've seen the impact of supply constraints from infrastructure, resource nationalism, and the availability of equipment and experienced technical staff. Now throw in the rapid economic transformation of China, India and the rest of Asia, along with the undetermined effects of unprecedented levels of financial speculation in oil. Prices haven't self-corrected as we might have expected, and the result has been dramatic energy price inflation of a type very different from the energy crisis of the 1970s. The financial flows this has created are enormous: a billion dollars per day, from the US alone.
So what happens next? That depends on how much influence the US market has on an increasingly globalized energy market. Even with the economy still growing, we've seen total US oil consumption has plateau for three years, now, and our imports of oil and petroleum products have been essentially flat since 2005. We're responsible for less than 15% of the 5 million barrel per day spurt of demand since 2003 that has used up most of the world's spare production capacity. If our consumption fell this year, that might not affect oil prices much, unless the US economic slowdown triggered a global economic contraction. Consider China, where rapidly increasing oil consumption has been led by domestic consumers, who are insulated from world oil price changes by regulated petroleum product prices, and by export industries that supply developed countries, including the US. Because China uses much more energy per unit of GDP than we do, a slowdown there would have a more dramatic impact on oil prices.
But if $90 oil represents a significant drag on the US economy, how much would oil prices have to fall in order to stimulate economic growth? That's hard to say, because during most of the run-up from $30 per barrel to $70 or so, our economy appeared to be immune to the consequences of higher oil prices. Right now analysts and markets seem most concerned about consumers, for whom the increase in gasoline prices since last January has added an average of about $65 per month in cost per household. Reversing that would require getting oil back to the mid-$50s, barring a big increase in refining margins, as refiners cut back on output that is losing them money.
How might oil revert to $50 per barrel this year? We can rule out the influence of alternative energy, in the short run. Biofuels output can't grow fast enough to make that kind of dent in demand. I also doubt we can convince OPEC to open their taps wide; they are unlikely to see that as being in their best interest, unless they thought it was the only option for preventing a global collapse that would shrink their revenues even more. That leaves speculation and demand. There's no consensus on how much of the current oil price is attributable to speculation. As the yields on other asset classes drop, are speculators more or less likely to invest in oil commodities? And how many of them will need to liquidate commodity holdings to cover losses on other positions? Even if the contribution of speculation dropped by $10 per barrel, we're still only talking about roughly $20 per month per household.
That leaves demand, though this is an example of the worm eating its tail. Demand growth is widely viewed as the biggest contributor to the increase in oil prices since 2003, so a global drop in oil demand of a couple of million barrels per day would probably deflate oil prices sharply. But in the short term, we can't create that big a fall in demand through higher efficiency alone. The scenario that comes closest to being able to deliver that looks similar to what we experienced in the Asian Economic Crisis of the late 1990s, when the combination of falling regional demand and rising global production cut oil prices in half. However, the global economy has become much more inter-dependent in the last ten years, and this kind of cure would almost certainly be worse than the disease.
Although oil prices have contributed to the current crisis, they didn't cause it. While oil prices will likely fall, if the US goes into recession and the global economy contracts, that by itself won't do much to restore the economy to sound health. Oil looks like a lagging, rather than leading indicator, here, and we need to turn elsewhere to solve the financial mess that has resulted from the popping of the US housing bubble and the debt problem that has created. Later this week I'll take a look at what this might mean for alternative energy.
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