Economy

Falling Oil Prices are a Warning

By Ryan McGreal
Published August 06, 2008

A recent article in Fortune warns against celebrating falling oil prices. After pointing out the obvious immediate benefits to consumers, the piece points out:

[F]alling oil prices also suggest that the recession the U.S. has so far avoided is well on its way, as consumers pull back from the spending spree that drove economic growth earlier this decade. A weakening economy will mean more layoffs, further pressuring already reduced spending.

The article also manages to connect falling oil prices with falling North American demand:

Perhaps the biggest factor behind the recent 18% drop in the price of a barrel of crude is sinking North American demand. Federal Highway Administration data show the number of miles driven in the U.S. dropped from year-ago levels for the seventh straight month in May.

Aside from debunking the exceptionalist fantasy that North Americans drive because it's in our blood rather than because it's cheap and convenient, this suggests that the drop in oil prices is largely illusory: if we need a recession to make driving affordable, there's something wrong with the underlying transportation model.

Automakers in Jeopardy

At the same time, the Big Three automakers continue to struggle with herculean quarterly losses as consumer demand for bloated SUVs collapses, to the extent that the prospect of bankruptcy can no longer be dismissed.

Credit rating firm Standard & Poor's cut GM and Ford deeper into junk bond status last week, leaving their debt just barely above the level normally associated with firms at significant risk of near-term default.

The automakers are struggling to reposition themselves, with smaller, more efficient vehicles and more competitive cost structures, but these strategies will take years to play out.

In the meantime, the overall energy situation will continue to tighten. The Big Three may well discover that by the time they adjust their products for $100 oil, they're stuck trying to sell in a market with $200 oil.

Lower Prices Still High

Despite the recent drop, energy prices are still very high in real terms. It's bittersweet at best to observe relief over an oil price - around $120 a barrel - that would have produced howls of pain just a year ago.

An alarming NY Times article from yesterday suggests that home energy prices this coming winter will "far exceed those of last year."

Even after a precipitous decline from its peak in early July, the price of natural gas is still 11 percent above where it was last winter.

Heating oil is 36 percent higher, with the government projecting that the costs of both fuels will stay high. Electricity prices are also up moderately.

Prices have become so volatile that energy retailers are now reluctant to offer price protection plans, meaning that consumers will be on the hook, month to month, for unpredictable heating bills.

Load that on top of the existing pile-on of flat wages, increasing layoffs, higher transportation costs, falling property values, ongoing foreclosures, tightening credit markets, and rising inflation rates.

Today's Suburbs, Tomorrow's Slums?

If all this is starting to feel a bit cataclysmic, think of people living in ghostly, half-finished subdivisions that were started at the tail-end of the housing bubble.

The WSJ article reads:

In the past year, roughly 15% to 20% of residential developers have gone out of business, suspended operations or changed their line of work, according to an estimate by the National Association of Home Builders.

Canada mostly escaped the real estate mania, and so far it has mostly escaped the real estate collapse as well. However, the premise on which most of our new residential developments over the past several decades have been planned is still highly vulnerable to the forces shaping the global economy.

Many of today's suburbs may will turn out to be tomorrow's slums when it becomes too expensive to drive everywhere. The worst thing we can do in response to falling oil prices is ease back into our old habits of single use zoning and car-centric transportation.

Instead, we should snatch the opportunity to invest in more sustainable land use while we still have the wealth to do it.

Ryan McGreal, the editor of Raise the Hammer, lives in Hamilton with his family and works as a programmer, writer and consultant. Ryan volunteers with Hamilton Light Rail, a citizen group dedicated to bringing light rail transit to Hamilton. Ryan writes a city affairs column in Hamilton Magazine, and several of his articles have been published in the Hamilton Spectator. He also maintains a personal website, has been known to share passing thoughts on Twitter and Facebook, and posts the occasional cat photo on Instagram.

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By Capitalist (anonymous) | Posted August 06, 2008 at 13:31:00

Could you please set a target date for when you think that oil prices will hit $200/barrel or some other ridiculous price? That way if you are right then you will garner some respect. But if you keep going on with these rants without being able to stick your neck out with a hard prediction, that you can be held accountable for, then the people who read your stuff will know you are just blowing stuff out your a$$.

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By adam2 (anonymous) | Posted August 06, 2008 at 14:09:09

Here is $/barrel over the past 5 years:

5 yrs ago - $25 / barrel
4 yrs ago - $40 / barrel
3 yrs ago - $60 / barrel
2 yrs ago - $75 / barrel
1 yr ago - $75 / barrel
today - $120 / barrel

As you can see, oil prices went up 500% in the past 5 years. In the past year, they went up 200%

According to this exponential growth model, we should reach $200/barrel sometime next year. I'll be conservative and set my own personal estimate in 2010.

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By adam2 (anonymous) | Posted August 06, 2008 at 14:17:20

According to the stats, average growth rate for oil ($/barrel) over the past 5 years is 40%

If this average growth rate remains the same, we'll have $235/barrel in 2010. I'll put my "neck out" and say this is inevitable unless something drastic happens -- like a major recession.

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By Capitalist (anonymous) | Posted August 06, 2008 at 14:24:53

adam2,

According to the figures you provided, oil prices have increased by 380% not 500% in the past five years. This is the formula for calculating a percentage:

((120-25)/(25))*100 = 380%

In the past year, oil prices increased by (again according to your figures) 60% not 200%:

((120-75)/(75))*100 = 60%

Secondly, data on oil prices exists as far back as 1890. To use the last five years of data and fit an exponential growth model to forecast future prices is completely nonsensical.

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By highwater (registered) | Posted August 06, 2008 at 14:57:30

I can see why someone named 'Capitalist' would be dubious about a bunch of rants in pinko rags like Fortune, NYT, and WSJ.

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By Running Dog (anonymous) | Posted August 06, 2008 at 15:06:40

Oh, oh, don't forget the agitprop streaming from Goldman Sachs.

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By adam2 (anonymous) | Posted August 06, 2008 at 15:41:47

Price of oil today is 480% the price of oil 5 years ago. There, did I get the wording right that time?

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By Capitalist (anonymous) | Posted August 06, 2008 at 15:49:23

adam2

Using your figures: Oil price today = $120
Oil price 5 years ago = $25
That is a 380% increase not 480%. Please see the formula I provided earlier.

Sorry to keep pressing this point, but I find it incredible that you are unable to do a simple percentage change calculation.

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By adam2 (anonymous) | Posted August 06, 2008 at 15:49:40

Price of oil today is 480% the price of oil 5 years ago. There, did I get the wording right that time?

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By adam2 (anonymous) | Posted August 06, 2008 at 16:08:46

We are saying the same thing in different words: oil today is 480% of the price 5 years ago or as you put it, a 380% increase.

Now to answer your original question, I expect based on extrapolation that oil will reach $235 / barrel in 2010. Can you provide reasons why you believe the trend will not continue?

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By gullchasedship (registered) - website | Posted August 06, 2008 at 18:47:36

The other factor affecting price that you're not adding into the equation is new production. Even when demand remains high, increased production will lower prices.

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By Melville (anonymous) | Posted August 06, 2008 at 21:40:43

Yep, more stats to fit your own conclusions.. starting to be par the course around these parts.

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By another capitalist (anonymous) | Posted August 09, 2008 at 11:44:45

Let's start a contest.

I say by the end of next spring oil will hit $90/barrel, the Cdn dollar will be $.86 against the U.S. dollar

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By David (anonymous) | Posted October 03, 2008 at 02:57:12

Despite all the bright people writing on the Web about these and similar concerns, Ryan always encapsulates the story better than anybody.

Matt Simmons says $100 oil is cheap because of what he knows about supply and demand. Prices falling below that is an indicator of economic slowdown. And this one is "the big one", folks. The ship has hit the sand. Books on edible nuts and berries are a good investment right now.

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