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2019: World Economy Is Reaching Growth Limits; Expect Low Oil Prices, Financial Turbulence

2019: World Economy Is Reaching Growth Limits; Expect Low Oil Prices, Financial Turbulence

Financial markets have been behaving in a very turbulent manner in the last couple of months. The issue, as I see it, is that the world economy is gradually changing from a growth mode to a mode of shrinkage. This is something like a ship changing course, from going in one direction to going in reverse. The system acts as if the brakes are being very forcefully applied, and reaction of the economy is to almost shake.

What seems to be happening is that the world economy is reaching Limits to Growth, as predicted in the computer simulations modeled in the 1972 book, The Limits to Growth. In fact, the base model of that set of simulations indicated that peak industrial output per capita might be reached right about now. Peak food per capitamight be reached about the same time. I have added a dotted line to the forecast from this model, indicating where the economy seems to be in 2019, relative to the base model.1

Figure 1. Base scenario from The Limits to Growth, printed using today’s graphics by Charles Hall and John Day in Revisiting Limits to Growth After Peak Oil with dotted line at 2019 added by author. The 2019 line is drawn based on where the world economy seems to be now, rather than on precisely where the base model would put the year 2019.

The economy is a self-organizing structure that operates under the laws of physics. Many people have thought that when the world economy reaches limits, the limits would be of the form of high prices and “running out” of oil. This represents an overly simple understanding of how the system works. What we should really expect, and in fact, what we are now beginning to see, is production cuts in finished goods made by the industrial system, such as cell phones and automobiles, because of affordability issues.

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UK Govt Report: Oil Companies Drilling in the Arctic Will Find It’s Unprofitable

Major oil companies from the US, UK, Norway, Sweden, and Russia are all set to drill in the Arctic, but a report from the UK Ministry of Defence (MoD) suggests they may be setting themselves up for failure.

Drilling in the Arctic is “economically prohibitive,” according to the report, which was commissioned by the Swedish Armed Forces and finalized in January 2016.

In other words: The companies seeking riches from Arctic’s vast untapped oil and gas wealth are going to be disappointed.

“…It is becoming increasingly likely that low oil prices, and reducing dependence on fossil fuels, will mean that extracting much of the oil in the Arctic will be economically prohibitive,” the report says. “The strategic importance of these resources may well have been overplayed.”

If this analysis is accurate, then the Arctic scramble is doomed to backfire on the oil industry.

The report’s authors conclude that by 2035, fossil fuel extraction will be largely unprofitable

According to another MoD report published by the DCDC in December 2015, over the next 20 years, oil majors will be driven to explore expensive resources in search of new profits as reserves become more scarce, but will face increasingly prohibitive costs in extracting those resources.

By 2035, the report says, the world may face a situation of dramatic “fossil fuel scarcity” due to rising demand and production costs.

Titled Future Operating Environment 2035, the report does not represent official government policy, but will “inform UK defence and security policy makers and our armed forces more broadly.”

The report acknowledges input from US, Australian, Swedish and New Zealand defense agencies, as well as UK government departments, major defense contractors like Boeing and BAE Systems, and oil giant Shell.

Demand for a range of natural resources is likely to increase over the next two decades, the report says.

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Why Low Oil Prices Haven’t Helped The Economy

Why Low Oil Prices Haven’t Helped The Economy

Many analysts had anticipated that a dramatic drop in oil prices such as we’ve seen since the summer of 2014 could provide a big stimulus to the economy of a net oil importer like the United States. That doesn’t seem to be what we’ve observed in the data.

There is no question that lower oil prices have been a big windfall for consumers. Americans today are spending $180 B less each year on energy goods and services than we were in July of 2014, which corresponds to about 1 percent of GDP. A year and a half ago, energy expenses constituted 5.4 percent of total consumer spending. Today that share is down to 3.7 percent.

(Click to enlarge)

Consumer purchases of energy goods and services as a percentage of total consumption spending, monthly 1959:M1 to 2016:M2. Blue horizontal line corresponds to an energy expenditure share of 6 percent.

Related: Natural Gas Trading Strategies 

But we’re not seeing much evidence that consumers are spending those gains on other goods or services. I’ve often used a summary of the historical response of overall consumption spending to energy prices that was developed by Paul Edelstein and Lutz Kilian. I re-estimated their equations using data from 1970:M7 through 2014:M7 and used the model to describe consumption spending since then. The black line in the graph below shows the actual level of real consumption spending for the period September 2013 through February of 2016, plotted as a percent of 2014:M7 values. The blue line shows the forecast of their model if we assumed no change in energy prices since then, while the green line indicates the prediction of the model conditional on the big drop in energy prices that we now know began in July of 2014.

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Nine Reasons Why Low Oil Prices May “Morph” Into Something Much Worse

Nine Reasons Why Low Oil Prices May “Morph” Into Something Much Worse

Why are commodity prices, including oil prices, lagging? Ultimately, it comes back to the question, “Why isn’t the world economy making very many of the end products that use these commodities?” If workers were getting rich enough to buy new homes and cars, demand for these products would be raising the prices of commodities used to build and operate cars, including the price of oil. If governments were rich enough to build an increasing number of roads and more public housing, there would be demand for the commodities used to build roads and public housing.

It looks to me as though we are heading into a deflationary depression, because prices of commodities are falling below the cost of extraction. We need rapidly rising wages and debt if commodity prices are to rise back to 2011 levels or higher. This isn’t happening. Instead, Janet Yellen is talking about raising interest rates later this year, and  we are seeing commodity prices fall further and further. Let me explain some pieces of what is happening.

1. We have been forcing economic growth upward since 1981 through the use of falling interest rates. Interest rates are now so low that it is hard to force rates down further, to encourage further economic growth. 

Falling interest rates are hugely beneficial for the economy. If interest rates stop dropping, or worse yet, begin to rise, we will lose this very beneficial factor affecting the economy. The economy will tend to grow even less quickly, bringing down commodity prices further. The world economy may even start contracting, as it heads into a deflationary depression.

If we look at 10-year US treasury interest rates, there has been a steep fall in rates since 1981.

Figure 1. Chart prepared by St. Louis Fed using data through July 20, 2015.

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