[GHung]

An interesting take from Gail:

Posted on December 29, 2014 by Gail Tverberg

Since about 2001, several sectors of the economy have become increasingly inefficient, in the sense that it takes more resources to produce a given output, such as 1000 barrels of oil. I believe that this growing inefficiency explains both slowing world economic growth and the sharp recent drop in prices of many commodities, including oil.

The mechanism at work is what I would call the crowding out effect. As more resources are required for the increasingly inefficient sectors of the economy, fewer resources are available to the rest of the economy. As a result, wages stagnate or decline. Central banks find it necessary lower interest rates, to keep the economy going.

Unfortunately, with stagnant or lower wages, consumers find that goods from the increasingly inefficiently sectors are increasingly unaffordable, especially if prices rise to cover the resource requirements of these inefficient sectors. For most periods in the past, commodities prices have stayed close to the cost of production (at least for the “marginal producer”). What we seem to be seeing recently is a drop in price to what consumers can afford for some of these increasingly unaffordable sectors. Unless this situation can be turned around quickly, the whole system risks collapse.

Increasingly Inefficient Sectors of the Economy

We can think of several increasingly inefficient sectors of the economy:

Oil. The problem with oil is that much of the easy (and thus, cheap) to extract oil is gone. There seems to be a great deal of expensive-to-extract oil available. Some of it is deep under the sea, even under salt layers. Some of it is very heavy and needs to be “steamed” out. Some of it requires “fracking.” The extra extraction steps require the use of more human labor and more physical resources (oil and gas, metal pipes, fresh water), but output rises by very little. Liquid extenders to oil, such as biofuels and coal-to-liquid operations, also tend to be heavy resource users, further exacerbating the problem of the rising cost of production for liquid fuels.

I have described the problem behind rising costs as increasing inefficiency of production. The technical name for our problem is diminishing returns. This situation occurs when increased investment offers ever-smaller returns. Diminishing returns tends to occur to some extent whenever resources of any kind are extracted from the ground. If the extent of diminishing returns is small enough, total costs can be kept flat with technological advances. Our problem now is that diminishing returns have grown to such an extent that technological advances are no longer keeping pace. As a result, the cost of producing many types of goods and services is growing faster than wages.....

More: http://ourfiniteworld.com/2014/12/29/ho ... more-39471

[ROCKMAN]

Ghung - I think I get the point and kinda agree. I might not call it "inefficiency" but that's not a terrible tag IMHO. I might describe it more as "diminishing returns". As oil prices increased a little...little adjustments take place. Maybe a few less trips to the mall. Which also means a little less retail activity. Maybe a shorter road trip for that summer vacation...or even a "staycation". And that means a little less motel income, a little less Cracker Barrel revenue, etc. And then the delivery company lays off one of its 20 drivers to cover the increased fuel costs.

You hopefully get the point: each cut back has repercussions...and those repercussions have repercussions like the laid off driver takes a lower paying job and thus has less disposable income. And enough decreases in all the disposable incomes lead to more lay offs and business cut backs. And then it's easy to call upon the handy "tipping point" to blame the dramatic decline in oil prices. But I have trouble seeing that. It's not like we all live in the same hive. Maybe the expectations of the real oil buyers, the refiners, jump faster then the consumers cut backs. And maybe the futures players, who are always watching the refiners, pushed the throttle harder. Or maybe it was the refiners watching the futures market that jump too hard too fast.

Maybe that's what happened in the late '08 price collapse. But as pointed out before: the global economy consumed less $58/bbl oil in 2009 then it did $98/bbl oil in 2008. Which seems to imply that it takes time for "increasing returns" to create max improvement of the economies just as "diminishing returns" take time to inflict max damage. And then what: increasing returns ramp the economy up enough to afford higher oil prices. Etc. etc. etc.

[Pops]

I like Gail but I'm pretty sure a weak global economy and a bump in production has built a nice little spare capacity cushion that explains the fundamental reason for the falling price - over-exuberance on the part of the fund-a-managers explains the extent of the drop. I read the IEA yesterday predicting a 4.5mbd OPEC spare capacity figure over the next few years.

I take my IEA pronouncements with a grain of salt. If the reason for the weak economy has been the stubbornly high oil prices and they are turning less stubborn then the economy could well heat up and melt that spare capacity PDQ and badda-bing, up go prices.

Seems we are always too quick to label a curve a turning point, sometimes a dot is just a point on a line.

[Paulo1]

I agree with Pop on this one, but readily admit to diminishing returns.

We used to always say this about the forest industry, (which is our mainstay). "Yes, it is cyclical. There are peaks and valleys with prices adjusted as the swings take place. Lower prices increase sales, etc. But the next peak is never as high as that last one, is it"?

In Gail's explanation, it seems to me she put the cart before the horse to explain the drop in prices. I believe the drop in oil prices is because of a shitty economy, not the other way around, and that the drop will stimulate an eventual economic resurgence, but never as high as preceeding swings. This reflects the EROEI in scraping the barrel for anything that will burn. I would also like to say that this assumes the economic wheels stay on, which I have my doubts.

Plus, we have aging populations in consuming nations/developed markets.

Hasn't debt been used to simulate lower energy prices?

My analogy: the boat starts to founder...overloaded, Italian captain , people slide off into the sea as she settles, 1% sharks circle and pick off the weak, folks rush about not knowing what to do, and.......

Stay tuned 2015! danh dah dah danh.