Peak Oil Deflation business expenses G20 meeting
Living under this sense of repeating deja vu all over again there is the report from the Bureau of Labor Statistics that energy costs are driving inflation – that is, rising prices – in a deflating economic environment.
The 0.4 percent seasonally adjusted increase in the CPI-U was driven
by a 9.1 percent rise in the gasoline index. This increase accounted
for almost the entire advance in the energy index and over 80 percent
of the overall increase. Despite the August increase, the gasoline
index has fallen 30.0 percent over the last 12 months.
The gasoline index has fallen from last summer’s extreme, but has accelerated from the lows of earlier this year. All this in the context of declining individual earning power.
The U.S. Census Bureau announced today that real median household income in the United States fell 3.6 percent between 2007 and 2008, from $52,163 to $50,303. This breaks a string of three years of annual income increases and coincides with the recession that started in December 2007.
This price increase- in- deflation phenomenon is effecting businesses such as Best Buy:
MINNEAPOLIS–(BUSINESS WIRE)–Best Buy Co., Inc. (NYSE:BBY – News):
Second-Quarter Performance Summary (U.S. dollars in millions, except per share amounts) Three Months Ended Aug. 29, 2009 Aug. 30, 2008 Revenue $11,022 $9,801 Comparable store sales % change (3.9%) 4.2% Gross profit as % of revenue 24.4% 24.3% SG&A as % of revenue 21.8% 20.8% Operating income $280 $339 Operating income as % revenue 2.5% 3.5% Net earnings $158 $202 Diluted EPS $0.37 $0.48
SG&A are selling, general and administrative expense. Note that in a strongly deflationary environment, this expense rose over one percent. Put this in the context of an $45 billion (revenue) company with 155,000 employees. It ships consumer electronics, mostly from eastern Asia and Mexico to stores in North America and Europe. Sprawling operations such as this embed the increased costs for petroleum used to ship and manufacture the goods it sells … costs that appear in the SG&A.
This metric – rising energy prices effecting the CPI top line – appeared in the period 2002 – 2007, which compelled the Greenspan Fed to raise interest rates. The rationale for the increase can be found in FOMC minutes for the period and was noted here.
I will show an even greater connection between energy prices, interest rates, and the financial sector, based in large part on a review of minutes of the Federal Reserve Open Market Committee (FOMC) from the end of 2002 to 2007. It appears the Fed’s inflation expectations were very closely linked to petroleum prices. Because of this, the rise in oil prices led the Fed to raise interest rates in an attempt to control inflation, which in turn had unintended consequences.
Overall, the increase in energy costs is extremely deflationary. A choice must be made by individuals and purchasing managers between fuel or some other good or service. At some point, fuel becomes too expensive and its use is then curtailed in a manner that reduces income. For a retailer, this means higher shelf price for items that narrows the market for that good. This choice is amplified along the good/service supply chain. A small increase in a primary input cost manifests itself over time in large swings in profitability or the propulsion of a large segment of the population into unemployment.
As for the oil price, OPEC – rather, Saudi Arabia – has control. It will adjust output to maintain the floor under prices in the $65- 75 range. At this level, the market dynamic changes. There is no real overall equilibrium, the power of the sellers – to keep oil in the ground and drive prices – is greater than the buyers, who can only collapse economically as a means to constrain price increases.
Collapse as the only effective constraint on oil prices is an indictment of the policy makers of the consuming world. The evolution to this state of affairs is absent from any policy discussions as well … certainly, there will be no mention of this at the G20 summit in Pittsburgh beginning the 24th. The virtuous logic of a rigorous conservation policy enabled worldwide is self- evident. It would give oil purchasers leverage and rebalance the marketplace. It would allow consumers to regain control over their own economic destinies … but, the obvious sense of this is too obscure for political administrators and economists to acknowledge.
Gregor puts this in a different light:
Hotelling in Brasilia
August 31, 2009Harold Hotelling was an economist in the 1930’s who wrote on a number of topics, but is known for his work in resource economics, and the eponymous Hotelling Rule. Writing in the Journal of Political Economy in 1931, Hotelling theorized that a rational producer of resources, say oil, would only be inclined to extract and sell that resource if the investment opportunities available with the capital proceeds were greater than simply leaving that resource to appreciate in the ground. Sounds reasonable, yes? But it’s not clear that the world–at least in the case of oil producers–has operated this way.
What, for example, did Britain exactly do with 30 years of oil revenues from the North Sea? Did Britain reinvest the proceeds in productive assets? What about all the oil that Britain sold before the era of high prices finally arrived? And how about Indonesia, and Nigeria? While these questions are not easily answered, we do know that a lot of the world’s oil was indeed sold too cheaply. And that is why Brazil, with its sea change in resources policy announced this month, is signalling that a new era of oil production is underway.
Why should an owner of oil produce and sell that precious resource as quickly, and as efficiently as possible–to a foreign buyer? To merely fulfill a theorist’s model of maximum efficiency? It will surely be amusing to watch many observers try to rinse this policy through the outdated filters of capitalism, socialism, or nationalism. On the contrary, scarcity rent is in its own separate class.
Yet another piece of evidence that Peak Oil took place in 1998- 99 rather than in some ‘undetermined future’ … You cannot claim scarcity rent without economically apparent scarcity or ‘relative scarcity’.
Which leads to the next macro question; when will the economic undertow abate?
When oil prices fall to under a current dollar $35 a barrel and remain there. Otherwise, there will be more of the steady erosion of profits as ‘SG&A expenses’ eat into the profits of every business and activity in the world.
Punctuated with panics and a diversion of government borrowing/spending into bailouts. Given enough of this over a long enough time frame, the governments themselves will fail.