Wednesday, December 17, 2014

Jamie Galbraith on oil price uncertainty

Jamie Galbraith in his new book The End of Normal: The Great Crisis and the Future of Growth (2014) has this observation about the uncertainly of oil prices up and down and its effect on investment calculations:

... energy markets remain both high cost and uncertain. And energy prices determine the price of all other resources, including food. The age of growth was enabled by cheap oil (and coal, and later gas) at stable prices. It created a system of fixed technologies that make heavy use of energy. Under fixed technologies, there is a world of difference between oil at $30 a barrel and oil at $100 or more. It's the difference between a world of high profits and rapid growth, and a world where margins are thin, profits alternate with losses, and where growth is likely to be slow at best.

Further, and of nearly equal importance, the world no longer expects any price of oil to remain stable. If demand rises sharply, investors know that hoarding and speculation will drive up the energy price. When the price is rising, it always makes sense to hold the product and sell it just a bit later, when the price is higher still. Volatile resource prices strongly discourage private investment at both ends of the energy market. When the price is high, new energy-using investment becomes unprofitable, so less of that will be done. But while high prices encourage new high-cost energy production, those investments (including renewables) can be undermined by the ensuing price fall. In this way, cost uncertainty as such slows the pace of economic activity. To the choke chain of speculative energy prices, one must add a whiplash effect of rapid changes. [emphasis in original]
The recent plunge in oil prices and its particular effect on Russia have been attracting attention lately. Sergey Radchenko writes in A Geopolitical Nightmare: No Happy Endings If Russia Melts Down The National Interest 12/17/2014:

Today’s Russia is not the Soviet behemoth, comparatively disconnected from the world economy. Nor is it the struggling reform economy of the 1990s. It is the world’s eighth largest economy, well integrated into the global marketplace. If Russia goes into a prolonged recession, it is not just Russia itself that bears the consequences—it will be the rest of the world as well. First in line is the European Union, whose member states—some barely emerging from recession—have extensive trade links with Russia.

Ukraine’s economic fiasco has already put Europe under stress. Russia’s collapse will make Ukraine’s problems seem insignificant. In our days of global risks and mutual interconnectedness, “losing” Russia is like shooting yourself in the foot. Or in the head. [my emphasis]

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