Page 2 of 4 Flat-earther blind to oil facts
By Henry C K Liu
barrels, leaving a deficit of 2 million barrels, which are being made up from
inventory. That fact is the fundamental reason why oil prices have risen.
It can be expected that production will increase as a result of high prices to
remove the supply deficit. US consumption has been fairly constant in the past
few years. About 10.2 million barrels were imports and only 5.5 million barrels
from OPEC. At $100 a barrel, the aggregate oil bill for the US comes to $2
billion a day, $730 billion a year, about 5.6% of 2007 US gross domestic
product (GDP). About 50% of US consumption is imported at a cost of $1 billion
a day, or $365 billion a year. Oil and gas import is the single largest
component in the US trade deficit, not
imports from Japan or China.
As oil prices rise, consumers pay more for heating oil and gasoline, truckers
pay more for diesel, airlines pay more for jet fuel, utility companies pay more
for fuel as coal price rose with oil prices, petrochemical companies pay more
for raw material, and the whole economy pays more for electricity. Now those
extra payments do not disappear into a black hole in the universe. They go into
someone's pocket as revenue and translate into profits for some businesses and
losses for others.
In other words, higher energy prices do not take money out of the economy, they
merely shift profit allocation from one business sector to another. More than
$365 billion a year goes to foreign oil producers who then must recycle their
oil dollars back into US Treasury bonds or other dollar assets, as part of the
rules of the game of dollar hegemony. The simple fact is that a rise in
monetary value of assets adds to the monetary wealth of the economy.
Fact 2: Since energy is a basic commodity and oil is a predominant
energy source, high energy cost translates into a high cost of living, which
can result in a lower standard of living unless incomes can keep up. High
energy cost translates into reduced consumption in other sectors unless higher
incomes can be generated from the increased cash flow. Unfortunately, pay
raises typically have a long time lag behind price increases. Higher prices
translate into higher aggregate revenue for the economy and explain why
corporate profit is up even when consumer discretionary spending slows. A large
part of the oil problem comes from the fact that higher corporate revenue from
rising prices has failed to translate into higher wages.
Fact 3: As cash flow increases for the same amount of material
activities, the GDP rises while the economy stagnates from wage depreciation.
Companies are buying and selling the same amount or maybe even less, but at a
higher price and profit margin and with employees at lower pay per unit of
revenue. As the oil price rose within a decade from about $10 a barrel to $150,
a 15-fold increase, those who owned oil reserves saw their asset value increase
Those who do not own oil reserves protect themselves with hedges in the rapidly
expanding structured finance world. Since GDP is a generally accepted measure
of economic health, the US economy then is judged to be growing at a very
acceptable rate while running in place or even backwards. There is an expanding
oil bubble, albeit smaller than the recently collapsed housing bubble, if one
understands that a bubble is defined as a price regime that has risen beyond an
economy�s ability to sustain it with compensatory income from wages.
Fact 4: With asset value ballooning from the impact of a sharp rise in
energy prices, which in turn leads the entire commodity-led price chain in an
upward spiral, the economy can carry more debt without increasing its
debt-to-equity ratio, giving much-craved support to the residual debt bubble
that began to burst before oil prices began to rise. Since the monetary value
of assets tends to rise in tandem over time, the net effect is a de facto
depreciation of money, misidentified as growth.
Fact 5: High oil prices threaten the economic viability of some
commercial sectors, such as airlines, trucking and motor vehicles, which have
exhausted their price elasticity. These sectors cannot pass on increased cost
without causing their sales volume to fall. Detroit, namely Ford and General
Motors, with their most profitable models being the gas-guzzling trucks and
sport utility vehicles (SUVs) that can now take more than $300 to fill their
tanks, are going down the same distress route as their under-funded pension
Fact 6: Industrial plastics, the materials most in demand in modern
manufacturing, more than steel or cement, are all derived from oil. Higher
prices of industrial plastics will mean lower wages for workers who assemble
them into products. But even steel and cement require energy to produce and
their prices will also go up along with oil prices. While low Asian wages are
keeping global inflation in check through cross-border wage arbitrage, rising
energy prices are the unrelenting factor behind global inflation that no
interest-rate policy from any central bank can contain.
Ironically, from a central bank's perspective, a commodity-led asset
appreciation, which central banks do not define as inflation, is the best cure
for a debt bubble that the central banks themselves created with their loose
money policies. Since most assets are exponentially larger than the rate of
consumption, the wealth effect of higher asset value can neutralize the rise in
consumer prices. This is the key reason why central banks are not sensitive to
the need to keep wages rising. The monetary system is structured to work
against wage earners who do not own substantial assets.
Fact 7: War-making is a gluttonous oil consumer. With high oil prices,
America's wars will carry a higher price, which will either lead to a higher
federal budget deficit, or lower social spending, or both. This translates into
rising dollar interest rates, which is structurally recessionary for the
globalized economy operating under dollar hegemony. But while war is
relentlessly inflationary, war spending is an economic stimulant, at least as
long as collateral damage from war occurs only on foreign soil. War profits are
always good for business, and the need for soldiers reduces unemployment.
Fighting for oil faces little popular opposition at home, even though for the
United States the need for oil is not a credible justification for war. The
fact of the matter is that the US already controls most of the world's oil
without war, by virtue of oil being denominated in dollars that the US can
print at will with little penalty. Petro-war is launched to protect dollar
hegemony, which requires oil to be denominated in dollars, not physical access
to oil. Much anti-war posturing in an election year is merely campaign
rhetoric. Military solutions to geopolitical problems arising from political
economy will remain operative options for the US regardless who happens to be
the occupant of the White House, populist or not.
Fact 8: There is a supply/demand myth that if oil prices rise, they will
attract more exploration for new oil, which will bring prices back down in
time. This was true in the good old days when oil in the ground stayed a
dormant financial asset. But now, as explained by Facts 3 and 4 above, in a
debt bubble, oil in the ground can be more valuable than oil above ground
because it can serve as a monetizable asset of rising value through
asset-backed securities (ABS) in the wild, wild world of structured finance
(derivatives). So while there is incentive to find more oil reserves to enlarge
the asset base, there is little incentive to pump it out of the ground merely
to keep prices low.
Gasoline prices also will not come down, not because there is a shortage of
crude oil but because there is a shortage of refinery capacity. The refinery
deficiency is created by the appearance of gas-guzzlers that Detroit pushed on
the consuming public when gasoline at less than a $1 a gallon was cheaper than
Refineries are among the most capital-intensive investments, with nightmarish
regulatory hurdles. Refineries need to be located where the demand for gasoline
is, but families that own three cars do not want to live near a refinery. Thus
there is no incentive to expand refinery capacity to bring gasoline prices down
because the return on new investment will need high gasoline prices to pay for
it. After all, as Friedman tirelessly reminds us, the market is not a charity
organization for the promotion of human welfare. It is a place where investors
try to get the highest price for products to repay their investment with
highest profit. It is not the nature of the market to reduce the price of
output from investment so that consumers can drive gas-guzzling SUVs that burn
most of their fuel sitting in traffic jams on freeways.
Fact 9: According to the US Geological Survey, the Middle East has only
half to one-third of known world oil reserves. There is a large supply of oil
elsewhere in the world that would be available at higher but still economically
viable prices. The idea that only the Middle East has the key to the world's
energy future is flawed and is geopolitically hazardous.
The United States has large proven oil reserves that get larger with rising oil
price. Proven reserves of oil are generally taken to be those quantities that
geological and engineering information indicates with reasonable certainty can
be recovered in the future from known reservoirs under existing economic and
geological conditions. According to the Energy Information Administration
(EIA), the US had 21.8 billion barrels of proven oil reserves as of January 1,
2001, twelfth-highest in the world, when oil price was around $20 per barrel.
These reserves are concentrated overwhelmingly (more than 80%) in four states -
Texas (25%, including the state's reserves in the Gulf of Mexico), Alaska
(24%), California (21%), and Louisiana (14%, including the state's reserves in
the Gulf of Mexico).
US proven oil reserves had declined by about 20% since 1990, with the largest
single-year decline (1.6 billion barrels) occurring in 1991. But this was due
mostly to the falling price of oil, which shrank proven reserves by definition.
At $100 a barrel, the reserve numbers can be expected to expand greatly. The
reason the US imports oil is that importing is cheaper and cleaner than
extracting domestic oil. At a certain price level, the US may find it more
economic to develop more domestic oil instead of importing,