Wages and Oil Prices | Russell T. Rudy Energy LLC
Gail Tverberg, in a very interesting article entitled “U. S. Oil Production and Future Oil Prices” posted on oilvoice.com, contends that consumers are the ultimate driver of oil demand. This relatively long article contains some excellent graphs which help illustrate her point.
The first part of the article defines the various components of what we call “oil” (crude, natural gas liquids, biofuels) and reduces them to their relative BTU values, and then analyzes historical production trends. She points out that conventional crude oil production peaked in 1970, and even with the addition of shale oil, we only reached 98% of that level in 2015.
While this analysis of past production is interesting, it the second half of the article which deals with future oil prices that I found most relevant. Tverberg contends that for oil demand to keep rising, the buying power of consumers has to continue to increase. She defines buying power as consisting of two main components: wages and debt. Debt is important because it enables consumer to buy goods that otherwise might be unaffordable, at least in the short term.
Wage stagnation is nothing new, especially here in the U. S. Since 1968 the income of the top 10% of earners has increased dramatically. However, when adjusted for inflation, wages for the other 90% have remained flat since then. The reasons for this are labor competition from lower labor cost countries, computerization, and automation. Whatever the reasons, consumption is a function of income, and this includes consumption of goods that require energy in their manufacture, and subsequent use.
The other component of consumer purchasing power is debt. Tverberg points out that the world debt burden peaked in July 2014, the same time that oil prices began to collapse. I am not sure that declining debt caused declining oil prices, but the author implies that there is a causal relationship. She then goes on to explain some of the reasons for the decrease in global debt.
One reason the global debt load decreased is the strong dollar. When the U. S. discontinued quantitative easing in 2014, the dollar strengthened against other currencies. Industry observers have long realized that as the dollar becomes stronger, fewer dollars are necessary to buy a barrel of oil, which is denominated in dollars. However, this has the effect of making oil more expensive for economies which are not based on the dollar. A stronger dollar vis-à-vis the yen, for instance, means that more yen are necessary to buy a barrel of oil and consequently, oil is more expensive for the Japanese. If all other factors remain unchanged, and we assume an elastic demand, this would depress demand.
In summary, Tverberg contends that consumers are the basis of the economy, and if their purchasing power (wages and debt) does not increase, their demand for big ticket products, which require energy to manufacture and operate, will stagnate. She elaborates, “Businesses may think that they can continue to grow without taking the consumer along but very soon this growth proves to be a myth. Governments cannot grow without rising wages either, because the majority of their tax revenue comes from individuals, rather than corporations.”
There is a great deal of faith that oil prices would only rise if production is somehow curtailed and the global oil glut eliminated. However, Tverberg contends that we will never see $100 oil again until consumers can afford to buy more goods manufactured and operated with oil products. To do this, she thinks that the problems of low wages, shrinking debt and a strong dollar need to be addressed. She concludes that “These problems are likely to be difficult to fix, so we should expect low oil prices, more or less indefinitely. Lack of oil supply may bring a temporary spike in oil prices, but it cannot fix a permanent problem with consumer spending around the world.”
To read the article in its entirety, please go to https://rudyenergy.com/hedge-funds-bullish-on-oil/ .
Russell T. Rudy Energy, LLC buys oil, gas and mineral interests nationwide. Please call (800-880-0940), or write (info@rudyenergy.com ) to let us know if you agree, disagree or would just like to comment on this, or any of our posts.
