Business Blog: Hoover’s Business Insight Zone

As I write this, oil is trading at an eye-popping $123.39 per barrel on the NYMEX futures board. Part of the high price of oil stems from the low value of the dollar relative to other currencies — especially the euro — so the other day I pulled together some figures to see how much cheaper oil would be if it were priced in euros instead of dollars.

Inputs:

• Price of oil in dollars, taken from the Energy Information Administration of the US Department of Energy.
• Exchange rate, dollars to euros, taken from Exchange-Rates.org.

Timeframe:

• 5 November 2007 through 29 April 2008 (i.e. Tuesday of last week).

Results (greenbacks in green, euros in blue):

My simple-Simon conclusions:

• The exchange-rate divergence has meant more and more over the past couple of months.
• Even when priced in euros, oil is still plenty expensive.

Other items potentially of interest in this vein:

• Statistics Matter: Oil, Dollars, Euros & Gold — This one includes a chart scanned from the Wall Street Journal earlier this year.
• Crude Oil Prices, Dollars vs. Euros: Is There a Difference? – I used this post’s sources in formulating my own chart.
• U.S. gas: So cheap it hurts: “Relatively low taxes have kept pump prices far below most other developed nations, which some say is precisely why the current runup is so painful.” — This article explains why “the U.S. is actually one of the cheaper places to fill up in the world” and digs into the effect of government policy on gasoline prices.

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(Please bear with a little bit of roundabout Friday-afternoon philosophizing here. And please share your opinions in the comments.)

In a 1986 lecture, computer scientist Richard Hamming talked about his work at Bell Labs during the early days of digital computing. There was never enough computing power available for all the projects that the Bell Labs scientists and engineers wanted to do, so they had to get clever about how to optimize their programs to run better with less horsepower. Much the same thing happened in the Soviet Union during the Cold War, where good computing hardware was often available only for top-secret projects tied to nuclear weapons or the Soviet space program. (Even then, the state of the art for Soviet computer hardware would often stagnate for years or decades at a time. ) But just like their contemporaries at Bell Labs, Soviet computer scientists were very clever, so they learned to optimize what they could — namely, the code running on the machines.

The contrast to modern computing is clear. Increases in the performance of components, especially microprocessors and memory devices, mean that the laptop on which I’m writing this has more computing power than anything Richard Hamming ever got to use during his heyday. But it also means that I need not be very clever about which files to keep and discard, since there’s plenty of hard-drive space for everything, and it also means that Microsoft, Adobe, Mozilla, and the other software makers whose programs run on this machine need not worry much about “bloat” in their applications. In other words, when more microprocessor cycles and memory space can typically be had on the cheap, software writers don’t need to put much of a premium on efficiency in their code.

Something similar has prevailed in the recent history of energy. Coal and oil have been so cheap for so long that no great emphasis has been placed on efficiency. There have been exceptions, as when Toyota, Honda, and other makers of fuel-efficient cars became more popular in the US market after the oil shocks of the 1970s. Sometimes, external factors like regulation to promote efficiency or to limit pollution have led manufacturers — of cars, washing machines, power plants, or what have you — to improve the efficiency of their products. But for much of recent business history, cheap energy has been so abundant that its users have not needed to worry about conserving it.

Some of this logic still prevails. Coal remains cheap and abundant, and consumers have come to expect ubiquitious availability of cheap electricity. That’s why both the US and China continue to see so many new coal-fired power plants. And despite strains in the world’s system of producing oil, it’s clear there are many billions of barrels of reserves still to be pumped. There’s increasing debate about exactly how long our stocks of coal and oil will last, but under any likely scenario the answer is measured in decades or centuries.

This is different, though, from asking how long our stocks of energy will be cheap — and it pays to remember that it’s the historic cheapness of energy that has profoundly shaped Western standards of living over the past hundred-plus years.

Here, then, is the $64-trillion-dollar question:

What consequences unfold if the price of energy rises high enough that no one sees energy as a commodity that they can afford to waste?

You tell me.

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(Vacuum tube photo by Marcin Wichary. Oil rig photo by jurvetson — yes, that Jurvetson.)

It was news when the price for a barrel of crude oil first hit $100, but mostly for psychological or symbolic reasons. Indeed, the first $100 bid was a single symbolic bid, not a flurry of genuine, price-signaling bids.

Now, though, the novelty value has worn off. Oil took some weeks to slide back from $100 to below $90, then climb back to the triple-digit mark again. Today it has traded in the $101 - $102 range, which means not only that it has set new record highs, but that traders are operating above $100 for non-symbolic reasons.

As much as we might like to think that markets operate with nothing but cold logic to drive them, the fact is that they respond to human decisions — and humans are often emotional and sometimes irrational.

At this point, a lot of rational actors have decided that a barrel of oil is “really” worth more than $100. With that psycholigical price barrier well and truly breached, it won’t surprise me a bit to see oil run much higher, especially if worldwide financial and geopolitical indicators continue to go the way they have been.

(Image by weirdvis.)

In May of last year the Wall Street Journal ran an interesting interview* with George David, the highly regarded chief executive of United Technologies Corporation:

Transformer in Transition

(Note that the whole story is available only to WSJ subscribers.)

David is one of the all-stars of the corporate world: in the fifteen years that he’s run UTC, the company’s value has grown tenfold. Today its offerings include everything from Pratt & Whitney aircraft engines to Otis elevators.

One of the things that struck me in David’s comments was his insistence on the importance of energy efficiency and conservation.

I think the solution to the energy problem is actually not alternative energy. To me, the solution immediately is conservation by greater efficiency. Too much in the mind of the public is this idea that conservation means deprivation. You’ve got to be cold at night, shut off the lights, stuff like that. That’s simply not true. The bottom line is that energy is wasted in the world to a phenomenal extent. There’s enormous energy savings potential in the conservation agenda where you do it by efficiency. In our own internal operations, we dropped the energy consumption at UTC by 19% over a decade at the same time the company doubled its size. All of America can drop its energy consumption by 20% in a decade easily. We’re now working with the World Business Council for Sustainable Development to come up with a building that uses zero net energy.

This is music to my ears, especially considering its source. I happen to think that the solution to our energy problems must also include alternative sources of energy, but I also welcome mass adoption of David’s views about the current level of waste in our human operations.

The truth is, an abundance of cheap energy over the past century, while enabling huge strides in technology, global travel, and trade, has also instilled an ethic of waste in many of us. It has become incredibly easy and cheap, relative to the prior course of human history, to make more things, to ship them quickly, and then to whisk away the leavings. In other words, it has been incredibly easy to build pockets of waste into our systems simply out of habit, or for want of better forethought. It has become normal to waste. Indeed, in some cases it seems like we’ve come to see wasteful habits as our birthright.

George David isn’t buying it. He sounds like he wants a revolution in efficiency.

Mr. David: You can’t walk through life with a trained eye and not see the opportunities for productivity. Every time you sit in traffic, that’s a productivity loss. Every time you go to the doctor and fill out a bunch of forms and he refers you to somebody else and you fill out the same forms all over again, that’s a loss of productivity. Whenever you wait for something, that’s waste. I believe you can have 10 times more. I really do.

WSJ: Ten times more of what?

Mr. David: Everything. Everything. Just look at the differences in personal productivity between people, educated versus not educated. Or people in good, really productive labor environments, versus people who are kind of struggling because they’re in disorganized or ineffective companies.

Why am I thinking of this? Because this morning I pulled up to a light that had just turned red. Ah, well, what’s the rush, right? Then I waited . . . and waited . . . and waited while no more than a handful of cars passed on the cross street. It’s a busy street at rush hour, but not at the time I was trying to cross it — yet the technology we’re using so far isn’t smart enough to tell the difference. More sophisticated timing in the lights or, even better, sensor-based technology that tells the light when it should change patterns, would mean less wasted time all around.

If it were just me, and if it were only a couple of extra minutes in the car, it would be no big deal. But the truth is that it’s not just me, and the problems of waste extend far beyond the time, productivity, and fuel wasted sitting in traffic. As George David suggests, we surround ourselves with patterns of waste and call it normal. But it doesn’t have to be that way.

What’s the biggest source of waste you face every day?

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UPDATE, Thursday morning: I forgot that, back in May, my friend Dan Markovitz wrote something in the same vein in response to my initial thoughts on the subject:

The Normalcy of Waste

Worth a read.

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* Does it seem strange to anybody else that the date of the story doesn’t show anywhere on that page?

[Photo by Rivertay.]

That’s a question I’ve talked over with several friends lately. So far, $3/gallon gas hasn’t made a big dent in U.S. driving habits, but then again it’s pretty hard to move closer to work — especially in a bad real-estate market — and a lot of people are set in their ways when it comes to driving. Or, to put it another way, for a lot of people, $3/gallon gasoline isn’t expensive enough to get them to change their driving patterns.

Keith Johnson has more on these issues, including links to recent research, in this Wall Street Journal Energy Roundup post:

Pump Prices: Will Drivers Finally Squeal For Real?

When we observe how human psychology links up to economic decision-making, we see some curious things. (This reality is the root of the discipline of behavioral economics, which I plan to talk about much more in 2008.) In the case of gasoline prices, we notice that people tend not to make cold, rational calculations that weigh the dollar cost of gas against the dollar costs of other utilities — things like hanging on to less fuel-efficient cars, keeping the same jobs, keeping the same houses, or keeping the same office schedule instead of telecommuting.

Rather, people tend to trundle along as they’ve been doing until they reach some sort of psychological or financial tipping point– say, when the family gasoline bill passes some round number like $300 per month.

Apparently, $3/gallon gasoline isn’t expensive enough to drive these changes for many people. But if oil prices trend north — if they park above $110/barrel, for instance — the follow-on increases in gasoline prices will start to have much more of an effect. A move from $3/gallon to $4/gallon should have far more impact than the move from $2/gallon to $3/gallon.

In any event, it will be interesting to see what shapes up through the course of 2008. Meanwhile, I’m glad I live within 15 minutes of work.

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[Photo by racoles; used under CC Attribution license.]

That’s the verdict of Eric Janszen’s provocative cover story in the current Harper’s magazine:

The next bubble:
Priming the markets for tomorrow’s big crash

Online access is limited to Harper’s subscribers, but here are two choice tidbits:

Our economy is in serious trouble. Both the production-consumption sector and the FIRE [finance, insurance, real estate] sector know that a debt-deflation Armageddon is nigh Read more

3 comments

The other day I was talking with a friend who’s convinced the U.S. is headed for a serious energy crunch — a point where we hit “national peak energy” — a point beyond which various sorts of societal mayhem may ensue. My pal is hardly from the scaremongering wing of the Peak Oil movement, but he sees this as a serious threat.

My take: this sort of things implies that American consumers (and energy utilities, regulators, etc.) will continue to insist on having their cake and eating it, too — or, in other words, that they will continue to drive up their energy use AND insist on cheap energy rates AND worry about (but not act upon) U.S. reliance on foreign energy sources. I may be missing a couple of AND-conditions there, but I think you take my point.

More likely, in my view: if energy prices continue to climb, then at various points along the way energy use will change for broad groups of consumers (and utilities). Our current standard operating practices that rely on cheap energy will change, tier by tier, as pricing mechanisms (or, in some cases, new regulations) kick in and make them too costly. Individuals and enterprises alike will start to view more and more once-ordinary activities — flying off to meetings at the drop of a hat, express-shipping everything, commuting an hour each way in a gas guzzler, and so on — as being too expensive anymore.

Mind you, I’m not a subscriber to the Whig theory of history, so I do think some substantial dislocation are likely. Long-haul trucking, for instance, may suffer if many enterprises switch to relatively more fuel-efficient options like railroads and barges. SUV makers may suffer. People may steer away from buying the biggest boats, pickups, ATVs, and so on. But I don’t think it’s going to be a crash.

A possible datum in my favor comes from this High Country News item:

A little could mean a lot

The Department of Energy just released a study showing that if you give people digital tools to monitor their power use, they’ll cut their electricity consumption during peak periods by 10 to 15 percent — and that modest amount eliminates the need for $120 billion worth of new power plants and transmission lines over the next 20 years. . . .

At some point, the opportunity to save that kind of money — to avoid that magnitude of cost — should lead individual and enterprise power consumers to change behaviors. It will also create winners among the makers of equipment that helps consumers monitor their energy use.

When the California electricity market blew up in 2001, many people who previously showed no particular devotion to “green” living suddenly found that they could cut their energy bills by a third or more with little effort. They used simple expedients like hanging their clothes up to dry instead of running them through the dryer. They shut off the air conditioning during the day when they were off at work, and they slept with the windows open at night.

The point is, we’re adaptable people. And we’re helped enormously in this case by the power of the free market.

This is a first crack at a larger idea that’s been sitting in my head, which I’ll summarize thus:

Over time, our concepts of what we can afford to waste change radically. We’d be silly to think they won’t keep changing.

Examples of what I mean:

• Back in the old days, natural gas was considered a waste product in the process of drilling for oil. Drillers would set up special pipes to flare off the natural gas at the wellhead. I once read a story about a man who worked in the oil fields of West Texas, back in the heyday of Permian Basin drilling in the mid-20th century: after work, he would read his newspaper . . . by the light of the gas flares. These days, flaring off gas = burning free money. But back then, there wasn’t a market for it, so why not burn it off?
• If you compare early integrated circuits with the current state of the art, you can be forgiven for thinking that they’re entirely different animals. In fact, though, generations of electrical engineers have been applying many of the same basic concepts over time, but continuously revising downward the standards on how much space on an IC can afford to be “wasted” by having no circuits on it. And it’s not that the earlier engineers didn’t know what they were doing — just that they were working at a different level of miniaturization.
• Edison’s light bulb was an amazing invention, not just for its time but in the century-plus since then. But it wastes a large part of the electricity that flows into it. For a long time that was fine, but increasingly light-bulb users aren’t willing to put up with that.
• Smokestack emissions and other factory effluents have long been seen as unavoidable byproducts of production processes. But quite a few years ago now Pasquale Pistorio, who was then head of STMicroelectronics, made a push in his company to think of effluents as indicators of inefficient manufacturing processes. The company became a leader among chip makers in pollution control — as an economic move, not just an environmental one.
• Prosaic and obvious, but germane: if gasoline costs $1.50 per gallon, you’ll use it differently than if it costs $4.50 per gallon. If you have a 3,000-square-foot house, you can afford to waste more closet space hoarding old clothes and tchotkes than you can if you live in a 350-square-foot apartment.

Maybe I should call this “Attack of the Obvious” Friday — but sometimes the obvious bears repeating.

My estimate is that coming years will see us substantially alter our views on what constitutes “acceptable” waste in terms of water, petroleum, electricity, and many other things we tend to take for granted. In many cases, for many of us, these alterations will be driven much more by economic pressures than by any sort of environmental consciousness.

Earlier today crude-oil prices briefly hit $100 per barrel, once again reacting (in part) to geopolitical news.

• Crude hits $100 on supply jitters, Nigeria violence — SAN FRANCISCO (MarketWatch) — Crude-oil futures hit the $100 mark Wednesday, surging more than $4 a barrel on expectations that U.S. crude inventories fell for a seventh consecutive week and on concerns that violence in Nigeria may cut output from Africa’s biggest oil producer.

• Oil Touches $100 a Barrel on Supply Concern, Increased Demand — Jan. 2 (Bloomberg) — Crude oil rose to $100 a barrel for the first time in New York as record global fuel consumption threatens to outpace production.Oil’s gain, extending last year’s 57 percent rally, was boosted by forecasts that U.S. stockpiles dropped to a three-year low last week. Unrest in Nigeria, Africa’s largest oil producer, also spurred prices.

Welcome to 2008!

These days, breaking news that has any geopolitical angle is apt to set off fluctuations in the market for crude oil futures. Oil supplies are tight worldwide, and in recent years there has been ever more speculation in the oil-futures markets, not just by traditional oil traders, but by hedge funds and other financial outfits looking for diversified asset classes to hold.

As I write this, oil futures are $96.15 per barrel, and there are no shortage of headlines tying the price surge to the assassination of former Pakistani prime minister Benazir Bhutto. (Details on her death here.) An example:

Crude rises above $96 on news of Bhutto’s death
By Polya Lesova, MarketWatch

Crude-oil futures rose above $96 a barrel on Thursday, as news of the assassination of former Pakistani Prime Minister Benazir Bhutto rekindled concerns about rising tensions in the Middle East.

This comes on top of yesterday’s news about Turkish air strikes on Kurdish bases across the Turkish-Iraqi border:

Oil Rises After Report Turkey Attacked Kurdish Rebels in Iraq

Dec. 26 (Bloomberg) — Crude oil rose for a third day in New York on concern shipments from Iraq may be disrupted after the Turkish military attacked bases of Kurdish rebels in northern Iraq.

Oil prognosticators have spent zillions of column inches trying to explain the complex forces affecting oil prices. One of the major divides for petroleum-watchers separates those who credit long-term price trends to above-ground or below-ground forces. The below-grounders include the various subsets of the Peak Oil community, whose members generally agree that the world is running short on new oil supplies simply because we have already tapped the biggest and best pools of oil in the century and a half that we’ve been looking.

The above-grounders, led by prominent oil expert Daniel Yergin and his Cambridge Energy Research Associates firm, argue that the world still enjoys ample petroleum reserves below the ground, but that we can expect more above-ground problems — e.g. unrest in Pakistan and Kurdistan — to keep prices high.

These days, there seems to be plenty of fodder for both camps. Oil supplies remain tighter than one would expect, given that prices have been this high for this long; this would seem to support the idea that readily expoitable reserves are hard to come by. Then again, the many, many geopolitical complications that have beset oil-producing regions (Iraq, Iran, Pakistan, Venezuela, Nigeria, . . .) during this decade would likely keep prices high even with plenty of reserves in the ground.

Time will tell which of these arguments holds more weight. For now, we can expect prices to stay at levels we’ve never seen, and we can expect every piece of bad news coming from any oil-producing country to drive them still higher.  For better and for worse, we are living in very interesting times on the oil front.