Drilling makes us more dependent on foreign oil

Just thought I should point out that US oil reserves are not inexhaustible, and that most of the oil in the world is still elsewhere. If we continue to feed our addiction to oil-based energy by producing more in the US, that means, when our reserves are depleted, we will end up having to feed that addiction by buying more oil from abroad. On the other hand, if we shift to other forms of energy (which unfortunately include coal), we can hopefully break that addiction and really end our dependence on foreign oil.

My title is a bit of an exaggeration, I admit. Drilling doesn't necessarily make us more dependent on foreign oil, but it doesn't make us less dependent either, except in the short run. It shifts our dependence into the future. It makes us more dependent in the sense that we will remain dependent for a longer period of time (but be less so initially).

While I'm on the subject, a nice slogan for the Pigou Club, courtesy of Al Gore, via Battlepanda:

Tax what we burn, not what we earn.

Porn and Transportation are Substitutes

OK, I couldn't leave this one alone. Greg Mankiw points to some research showing that "many websites focused on adult or erotic material have experienced an upswing in sales in the recent weeks" since the stimulus checks were mailed out. I can buy the theory that many of their marginal customers are liquidity constrained, which I'm guessing is the way Greg sees it, but there's another issue here that hasn't been addressed. The stimulus checks are only one of a number of things that have happened over the past few months. You might also have noticed, for example, a dramatic increase in the price of gasoline, coming at a time when people were already adjusting to dramatic increases over the past 4 years. I think that particular change is an important part of the picture.

"Adult or erotic material" is a form of entertainment, or, if you will, recreation. But unlike various other forms of entertainment and recreation, it can be consumed at home. And I suspect that a lot of people think it's more fun than most other forms of entertainment and recreation that can be consumed at home. You can go out to a bar or a club or a ball game or a movie or a show or the beach or, well, a brothel, if you're in Nevada, or you can stay home and consume forms of entertainment that can be consumed at home. I can remember seeing a story recently (I don't remember where) about how brothels in Nevada are being hit hard by the economic slowdown. If you stay home, you don't have to use up gasoline, so the relative cost of at-home entertainment goes down when the price of gasoline goes up. Adult Web sites are probably not a Giffen good, so, if we could hold other income constant, we should expect that the demand for adult Web sites should go up when the price of gasoline goes up.

Granted, other income isn't constant. The rising price of gasoline affects a lot of other areas besides entertainment and recreation, so it represents a general decline in real income. And the economy is weak. So maybe the stimulus checks compensate for these declines in income. If the effect of the stimulus checks is to bring income up to the level that it was before the increase in gasoline prices, we should expect an increase in demand for adult Web sites. So the stimulus checks matter, but it isn't just the stimulus checks.

I should give credit where credit is due. The basic substance of this idea about gas prices and porn comes from this YouTube video:



Not coincidentally, the woman in the video (Isobel Wren, whom you may remember from an earlier post on this blog) has her own Web site "focused on adult or erotic material." And in the interest of smoothing the transition to a less energy-intensive economy, or maybe just to be naughty, I'll give you the link again. (Note that it is an adult Web site, so don't click the link unless you're over 18 and your boss isn't watching.)


UPDATE: I just noticed that this video is the same one that I linked to in the earlier post. Oh, well, now you get to watch it in embedded form.

Should we develop alternative fuels?

Until someone convinces me otherwise, I'm going to go with "no" -- at least if by "fuels" you mean carbon compounds that are used to release energy through combustion. Combustion of carbon compounds produces carbon dioxide, which aggravates global warming. If we're running out of oil, let's just run out, start driving less, flying less, doing less of things that produce greenhouse gases, and doing the remainder more efficiently. Or else let's find replacements that don't involve "fuels" in the sense I described: try electric cars that run on power from wind, solar power, hydroelectric power, nuclear power, etc..

From an environmental point of view, running out of oil is a good thing, an opportunity to slow down climate change, and are we now to try replacing that oil with other combustibles? When opportunity knocks, close the curtain and pretend you're not home?

If the government is going to subsidize anything, let it subsidize alternative sources and uses of electric power, or solar heating, or something like that. Why subsidize products that are going to aggravate our environmental problems?

A Crude Form of Inflation Targeting

In his latest sermon against core inflation, Barry Ritholtz makes an important point – sort of. At least, he brings up an important issue, but I think his message that the core is evil distracts him from thinking more subtly about the implications. The title of his post, “Rising Crude Oil Pushes Consumer Prices Higher,” says most of it, and when he says, “consumer prices,” he means, “even core prices.” It’s a fact that we can’t escape: energy is a critical input to many goods (and services) that are part of the core. And even if it is only targeting a core price index, the Fed still has to worry about oil prices.

This is, as I said, an important point, but I don’t think it implies that everyone who emphasizes the core is either a liar or an idiot. It just means that anyone who claims to make an optimal forecast of the core without taking oil prices into account is not being careful. It also means that, even if we are confident that the Fed is targeting a core index, we should expect the Fed to take into account the inflationary impact of large oil price increases. At the same time, the Fed may take into account the potential recessionary impact of rising oil prices, if it judges that the price increases are a supply-side effect and not a demand-side effect.

So the monetary policy implications of rising oil prices are ambiguous, but they clearly don’t follow the simple formula that the bond market sometimes seems to expect: tighter oil => weaker economy => easier money. If the change in oil prices is a demand-side effect, then it’s actually a symptom of a stronger economy rather than a cause of a weaker economy, and the formula goes something like this: stronger economy => tighter oil => tighter money. If the change in oil prices is a supply-side effect, it will unambiguously tend to weaken then economy, but the Fed may perhaps prefer an even weaker economy to an unchecked inflationary impulse, and the result may still be tighter money.

If it were up to me, the Fed’s target would not be core consumer prices but something (such as unit labor costs) that excludes the effects of energy shocks altogether. Such a target would allow the US to take an adverse energy shock entirely in the form of a higher price level (rather than going through the painful process of squeezing profit margins, which tends to have unemployment as a side effect) without raising long-term inflation expectations. (An abrupt energy shock could still weaken the economy by James Hamilton’s mechanism of forcing difficult transitions – squeezing profit margins in some areas while raising them in others – but I don’t think there’s much we can do about that.) Since unit labor costs seem to be a politically unacceptable target (and the data are unreliable in the short run), one could perhaps imagine a core price index that is corrected for the indirect effects of food and energy prices. (I guess that would piss Barry Ritholtz off even more.) I’d also like to exclude import prices, so the GDP deflator might be a reasonable first-round candidate, though it brings in another set of problems.

Backward Oil

Interesting article in the Wall Street Journal Weekend Edition (starting on the front page of the print edition). Over the past 12 months the price of oil has risen by about $21/barrel. But that’s just if you want the oil right now. The futures price of oil for delivery 2 years hence has only risen by about $8/barrel.

A year ago, the oil futures markets were in contango, meaning that distant futures were more expensive than spot oil. There is a theory that contango is normal for most commodities, since by buying distant futures, you can avoid storage costs (including the cost of financing inventories) and therefore should be willing to pay more than if you had to store the commodity yourself. Apparently, a year ago, the contango was too severe to be explained by storage costs. The usual explanation is that traders were worried about demand oustripping supply in the future – so much so that they were willing to give anyone with storage capacity a strong incentive to use that capacity. That has to be only part of the explanation, though. The other part is that oil producers were not so worried about demand outstripping supply in the future; otherwise they would have put off production into the future (expecting prices to rise) and driven up the spot prices. So presumably the contango happened because speculators were more bullish on oil than producers were. (I guess the speculators got it right this time – so far anyhow.)

But as I understand it (from casual reading: I’m no oil expert), contango is not normal in the oil market. The situation today – known as backwardation – where spot prices exceed distant futures prices – is apparently much more typical. The standard “theory of normal backwardation” (due to John Maynard Keynes) is that producers, being risk-averse, are willing to accept lower prices on distant contracts in order to lock in a price rather than being subject to unpredictable price changes. That theory works even for competitive markets, but I’ve heard that there is something else going on in the partially monopolized oil market – namely that OPEC (and perhaps Saudi Arabia in particular) deliberately tries to keep spot supplies tight in order to maximize its control over spot prices. In other words, it’s not because producers sell the futures; it’s because they refuse to sell enough of the spot.

I wonder if what’s going on is an interaction between producer expectations and producer capacity constraints. If producers a year ago (and in recent years in general) expected prices to fall (as some of their public statements suggested, though such statements are often seen as untrustworthy), they would have an incentive to produce at full capacity. And if, for example, Saudi Arabia was producing at full capacity, it might also have had an incentive to increase capacity so as to have more control over prices in the future. If capacity has subsequently increased relative to demand, and if the Saudis have begun to doubt their forecasts for falling prices (which one could imagine they might have, since the forecasts keep being wrong), then we’re back to the old situation where they hold back on production to keep control over spot prices.

I’m not sure if this makes sense. I’m not sure what it means. I’m not sure if it’s bullish or bearish for oil. But it seems really interesting.