The Problem With Oil Prices Is That They Are Not Low Enough

This is a preview. The full post is available now on my Forbes blog. The full version will be posted on this website at 6:00 p.m. CDT on Tuesday, October 20.

The problem with oil prices is that they are not low enough.

Current oil prices are simply not low enough to stop over-production. Unless external investment capital is curtailed and producers learn to live within cash flow, a production surplus and low oil prices will persist for years.

Energy Is The Economy

GDP (gross domestic product) correlates empirically with oil prices (Figure 1). GDP increases when oil prices are low or falling; GDP is flat when oil prices are high or rising (GDP and oil price in the figure are in August 2015 dollars).

Figure 1. U.S. GDP and WTI oil price. GDP and WTI are in August 2015 dollars. Note: I use WTI prices because Brent pricing did not exist before the 1970s.
Source: U.S. Bureau of Labor Statistics, The World Bank, EIA and Labyrinth Consulting Services, Inc.
(click image to enlarge)

This is because global economic output is highly sensitive to the cost and availability of energy resources (it is also sensitive to debt). Liquid fuels–gasoline, diesel and jet fuel–power most worldwide transport of materials, and electricity from coal and natural gas powers most manufacturing. When energy prices are high, profit margins are lower and economic output and growth slows, and vice versa.

Because oil prices were high in the 4 years before September 2014 and the subsequent oil-price collapse, GDP was flat and economic growth was slow. That, along with high government, corporate and household debt loads, is the main reason why the post-2008 recession has been so persistent and difficult to correct through monetary policy.

This is a preview. The full post is available now on my Forbes blog. The full version will be posted on this website at 6:00 p.m. CDT on Tuesday, October 20.