Is the recent drop in crude oil prices a boon for the economy? One might think so from the way some commentators are responding to the halving of crude oil prices in recent months. This decline is trumpeted as equivalent to a huge tax cut for consumers and a boon for consumption and the economy. Sounds right, but basic theory suggests this may not be so. Basic theory suggests the effects on the economy as measured by Gross Domestic Product (GDP) may be negligible. If this sounds counterintuitive, it may be because most commentary tells only half the story.
To be sure, consumers are likely to feel much better about their purchases if they can spend less at the pump and more for other things. And this sense of enhanced well-being is entirely valid. Economists would say it represents an increase in “consumer surplus.” It just doesn’t show up in GDP, or in investment incentives, or in hiring trends.
Start with the most intuitive part of the story, the first half repeated every time there’s a major move in the price of oil – the effect on consumer purchases of everything else. In this case, the price of oil fell from around $115 a barrel to below $60 a barrel, and pump prices fell more or less commensurately. Consumers then need to spend less for gas at the pump: $554 less on average in 2015 if the barrel price remains around $60 according to the Energy Information Agency. Spending less at the pump means consumers have more left over for other purchases – like Christmas gifts. Conclusion – consumers will spend more and the economy will strengthen. Sound familiar?
This then raises the question – is $20 spent filling the car less important to the overall economy than $20 spent on Christmas gifts? The oft-neglected rest of the story is that if consumers spend $20 less on gas and $20 more on other things, then the overall level of consumer spending is unchanged. For the overall economy only the composition of demand changes, which granted is important if one’s business is selling any of these other consumable goods. Retailers, for example, should be well pleased. But changes in the composition of consumer demand are not increases in the level of consumer demand – or of GDP.
A similar story plays out on the production side of the economy. For some industries a lower oil price is great. Chemical companies, for example, typically use petroleum as a feedstock. Reduce the crude price and input prices fall, and this either supports profits or allows chemical companies to reduce their prices to the benefit of their customers, and on and on. Oil companies, in contrast, especially those which own the oil pumped out of the ground, see their incomes fall.
So the pattern of production, profits, and income changes much as the pattern of consumption changes, but in each case overall levels and thus GDP are little affected. The complication arises because crude oil is a traded commodity. Thanks to fracking resulting in soaring production, the United States is today nearly energy independent, and this neutralizes net trade flow effects that would have developed in years past, and will still manifest for countries that are net energy importers.
For net oil importers a fall in the crude price would reduce the net trade deficit and improve the nation’s terms of trade – essentially the value of what is sold broad to purchase foreign goods like oil. However, the balance of payments still balances, which means a reduction in the net trade deficit must be matched by a reduction in the capital account deficit – the net inflows of capital. This reduction in net capital inflows don’t just happen miraculously, but result from some combination of a somewhat stronger dollar exchange rate and slightly lower U.S. interest rates relative to the rest of the world. This decline in net capital imports in turn results in a reduction in domestic investment. Therefore, in theory, even the reduction in the trade deficit which would otherwise benefit GDP is neutralized by a reduction in domestic investment as net capital inflows fall.
Does this mean the fall in the price of oil is irrelevant to the overall economy? Not at all. Common intuition is correct, but it is often incorrectly expressed. Consumers can now spend more on what they want most and less on the necessity of gas in the tank. And Americans overall benefit from the stronger dollar because their labor and products now command a higher price in terms of what the rest of the world offers. On balance, Americans benefit from a lower oil price, but perhaps not in the terms usually used to describe the economy like GDP.
The Obama White House may think coal isn’t good enough to power our economy, but it must think it’s good enough to add some Christmas cheer.
While the Obama administration gave coal producers and electricity generators an early lump of coal after EPA released proposed carbon regulations, a coal-fired train is the star of the 2014 White House Christmas ornament.2014 White House Christmas Ornament Features a Coal-Fired Train
As the White House Historical Association explains, the ornament is the first to be composed of two pieces [emphasis mine]:
The locomotive is a detailed miniature replica of one of several steam-powered locomotives that pulled the Presidential Special; it is attached to the coal car that held its fuel. The other miniature car is the Superb, the president’s private heavyweight Pullman car. The last car on the Special, the Superb was outfitted with a public address system. President Harding made appearances and delivered speeches at stops across the country from a platform at the back of the car.
President Warren Harding’s transcontinental speaking and sightseeing tour inspired the design.
The ornament reminds us that just as it powered the trains that tied America together into an economic powerhouse, coal still plays a critical role in fueling America’s economy. According to the Energy Information Agency, more electricity is produced by coal (37%) than any other energy source. It’s the backbone of affordable, reliable electricity.Electricity generation by energy source.Source: Energy Information Administration
The United States possesses coal reserves that can last for nearly three centuries. The attacks on this abundant energy source by regulators will mean lost jobs, slower economic growth, higher electricity costs, and a less reliable electrical grid.
President Obama said in 2008 while campaigning, “If somebody wants to build a coal-fired power plant, they can. It’s just that it will bankrupt them.” However, trinkets depicting coal apparently are acceptable.
The ornament is a lovely decoration sure to add character to anyone’s Christmas tree, even of those whose jobs will be lost because of federal regulations pushing coal use out of the economy.
This post originally appeared on June 11, 2014.
Anyone who has followed the six-year drama over the Keystone XL pipeline knows about the lost economic opportunities from its delay. Heck, I spent a week hearing from people living along the pipeline’s proposed route who are waiting for its benefits.
James Hoffa, head of the Teamsters, lists some of lost opportunities from the pipeline’s delay in this Detroit News op-ed:
Completing the final segment of the pipeline from Nebraska to the Canadian border would employ upwards of 2,500 Teamsters and would infuse millions of dollars into local economies. That’s not just where the pipeline is being built either — it’s right here in Michigan, where suppliers could see substantial growth.
How’s that possible? Because a project of this magnitude will require thousands of pieces of equipment like American-made vehicles to be purchased, and those vehicles will need to be kept up with new parts. Similar projects have resulted in automotive companies building facilities to service vehicles. There is no reason to think that wouldn’t happen here as well.
For communities closer to the construction of the pipeline, workers living nearby will add handsomely to their local tax bases. Rent, food and the everyday living expenses will pump dollars into the wallets of local residents. Infrastructure improvements will also need to be made as part of the project to shore up roads and improve wetland areas.
As it stands, the southern portion of the pipeline has already been completed and produced millions of hours of work and positive economic benefits for the local communities in which it was constructed. The project is a shot in the arm to many rural towns that need it the most.
In total, the construction of the Keystone XL pipeline would contribute approximately $3.4 billion to the U.S. gross domestic product. It would support a combined total of 42,100 jobs and approximately $2 billion in earnings nationwide.
There’s been an unfortunate side effect from the Keystone XL delay. It’s inspired anti-energy activists to put up roadblocks to other pipeline projects, the Wall Street Journal reports [subscription required]:
[T]he crude-oil pipeline’s political and regulatory snarls since then have emboldened resistance to at least 10 other pipeline projects across North America. Using Keystone XL as a template, national environmental groups are joining with local activists in a strategy aimed at prolonging government reviews of proposed pipeline routes and their environmental impact.
As a result, six oil and natural-gas pipeline projects in North America costing a proposed $15 billion or more and stretching more than 3,400 miles have been delayed, a tally by The Wall Street Journal shows. At least four other projects with a total investment of $25 billion and more than 5,100 miles in length are facing opposition but haven’t been delayed yet.
The snags could paralyze some projects for years, increase the costs of those that win approval and kill some projects, though that hasn’t happened yet.
It didn’t use to be like this. As recently as 2009, the Obama administration made a great case when approving the Alberta Clipper, an oil pipeline running from Alberta to Wisconsin. Now, an expansion of the very same pipeline is one of the projects under attack by activists.Wall Street Journal table of pipeline delays
Ian Anderson, president of Kinder Morgan’s Canadian business segment calls this a “new normal” for pipeline projects. Simply put, it’s much harder to build energy infrastructure projects in America [emphasis mine] now:
Mr. Girling [CEO of TransCanada] said in an interview that TransCanada company will no longer pursue certain planning, engineering and regulatory steps at the same time because of the opposition. It could take eight years from the project’s initial planning to the start of operations, compared with four years for the first Keystone pipeline, he added.
We can’t say we weren’t warned. Karen Harbert, president and CEO of the U.S. Chamber’s Institute for 21st Century Energy told a House Energy and Commerce Committee hearing in 2013 on the pipeline's five-year delay:
Much of our energy infrastructure is increasingly inadequate to meet current and projected demand. Providing energy is a long and capital-intensive undertaking, and new energy infrastructure projects require long lead times and massive amounts—tens of trillions of dollars over the next few decades—of new investment. Some of that investment and the jobs that go with it will never happen or go elsewhere if the regulatory environment under which companies operate is unreliable and inefficient. Regulatory predictability allows business to plan and invest with greater confidence.
Unfortunately, our energy sector suffers from a lengthy, unpredictable, and needlessly complex regulatory maze that delays, and often halts, the construction of new energy infrastructure. Federal and state environmental statutes such as National Environmental Policy Act, state siting and permitting rules, and a “build absolutely nothing anywhere near anything”—BANANA—mentality routinely are used to block the construction and expansion of everything from transmission lines to power plants to pipelines.
The Keystone XL pipeline is a symbol of a dysfunctional federal permitting process that desperately needs to be streamlined. Our energy infrastructure and future economic growth depends on it.
The U.S. Senate recently voted not to overcome the Administration’s intransigency and thus clear a path for the Keystone Pipeline to transport crude oil from Canada to refineries in Louisiana. That leaves the decision with President Obama, who has managed to avoid making a decision on Keystone for six years now and seems fully capable of avoiding a decision for two more. But what does the Keystone Pipeline mean to the energy sector and the economy?
Opponents of the pipeline typically assert that Keystone would just further entrench the petroleum-based economy for little or no benefit to Americans. President Obama recently captured this sentiment, “I won’t hide my opinion about this, which is that one major determinant of whether we should approve a pipeline shipping Canadian oil to world markets, not to the United States, is does it contribute to the greenhouse gases that are causing climate change?”
The assertion regarding where oil would be shipped is, of course, simply incorrect. The Canadians are not going to leave a valuable resource untapped just because Americans can’t build a pipeline. The oil is going to flow, if not to Louisiana then probably to Canada’s west coast. And when President Obama asserts the oil would go to world markets, not to the United States, this is only true if the oil flows to Canada’s west coast. If the oil is refined in Louisiana, the products are overwhelmingly likely to remain in the United States.
This also means the question about greenhouse gases resulting from the oil is entirely mute. The oil is going to flow either way.
Opponents also make the point that Keystone would not be that important to the American economy. Considered narrowly, they have a point, but as usual they miss the big picture. The specific numbers are in dispute, and ultimately don’t matter much. The Pipeline’s construction phase will provide employment to a sizable number of Americans. When the pipeline is in operation, the number of employees will be much smaller. In a $17 trillion economy, it’s a drop in the bucket, which by the way is true of every single project currently in operation or planned. A $17 trillion economy doesn’t pop into existence. It is built up over time through billions of smaller projects – like Keystone.
But it is the big picture which the President and his fellow Keystone opponents miss most. Keystone is a national symbol now built up and embraced as such by many. One group watching the Keystone drama includes the leaders of America’s businesses from largest to smallest, and the entrepreneurs with dreams, and the venture capitalists looking to fund the next big thing. These are also the people whose defensive inclinations in light of sustained overt antipathy from Washington have hamstrung the economic recovery. The real economic power of Keystone is as a symbol to the job creators and risk takers of America that maybe there is hope Washington policymakers may finally “get it” if just a little. The Senate’s decision, and the President’s attitude, suggests the contrary, so the recovery is likely to run in fits and starts for some time to come. Hope? Nope.
There’s been plenty of talk about the unenforceable U.S. – China greenhouse gas agreement. Let's look at India, a major greenhouse gas emitter with no desire to give up coal as its economy develops. From the New York Times:
“India’s development imperatives cannot be sacrificed at the altar of potential climate changes many years in the future,” India’s power minister, Piyush Goyal, said at a recent conference in New Delhi in response to a question. “The West will have to recognize we have the needs of the poor.”
Mr. Goyal has promised to double India’s use of domestic coal from 565 million tons last year to more than a billion tons by 2019, and he is trying to sell coal-mining licenses as swiftly as possible after years of delay. The government has signaled that it may denationalize commercial coal mining to accelerate extraction.
As you can see from this chart, Indian coal consumption has been increasing rapidly so far this century.Indian Coal Consumption: 2000-2011
Here are two other points from the story. First, India has increased coal-fired generating capacity by 73% in the last five years. “India’s coal use is expected to more than double by 2035,” writes Robert Bryce at the Manhattan Institute.
Second, the average Indian uses 7% of the energy the average American uses. With nearly as many people in India without electricity (300 million) as live in the United States, that percentage will go up, with coal being the source of much of that electricity. “The [Energy Information Administration] projects that India’s coal-fired capacity will increase by about 100 gigawatts by 2040,” Bryce writes.
Todd Stern, climate envoy for the State Department, isn’t sure what India will do in upcoming greenhouse gas negotiations in Paris. It’s unrealistic to think that India will suddenly give up increasing power access through low-cost coal. No one should blame it for striving to improve the lives of its people, especially its poorest.
However, demanding that the United States abandon its abundant supplies of coal—like EPA’s carbon regulations will do--while competing against a growing economy like India’s is also unrealistic.