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Treasury dreams of cheap oil

Written By: - Date published: 2:59 pm, June 3rd, 2008 - 26 comments
Categories: budget 2008, economy - Tags:

This is the graph of the oil price forecasts Treasury used to underpin its fiscal model for the Budget. It assumes that oil would touch $115 a barrel US in about July this year before easing off to a long-run level of $100 a barrel. That is already up on Treasury’s forecast from November, which had the peak at $90 a barrel and the long-run at $75.

The red dot is where oil prices are today. Literally off the chart.

This has some important implications for the economy. Oil consumption is likely to be lower than forecast meaning less fuel excise revenue for the government but expenditure on oil will be higher, impeding growth, and we will get better prices for our oil exports, bringing more growth and bigger tax revenues. Add in that Fonterra’s milk payouts for this year and next also well above the Treasury’s forcasts and the Budget assumptions are starting to look hopelessly out-of-date only 12 days after they were published.

It also illustrates how hopelessly optimistic government assumptions about oil prices are. Oil prices have been rising ever faster since 1998, are up 30% in the last half-year alone, and show no signs of slowing. But acknowledging we are at peak oil, that the price is not going to drop back to ‘normal’, is simply not something that Treasury can do.

26 comments on “Treasury dreams of cheap oil ”

  1. mike 1

    Nationals $50 a week taxcut looks about right then

    [Tane: Mike bro, you can troll better than this. Try a bit harder eh?]

  2. roger nome 2

    Treasury just takes its oil price projections from futures markets. The problem is however that statistical studies show futures markets are poor predictors of oil prices outside of 6 months.

    The biggest problem is that 60% of the world’s oil reserves sit in the lap of the OPEC dictators. Basically people who play in the oil futures market are trying to guess what the dictators are going to do with production. So buyers for futures contracts tend to go conservative, meaning the price tends to be under-estimated often.

    Another problem with relying on the futures markets to predict oil prices at the moment, and going into the future, is the fact that after 2010, all subsequent increases in conventional oil production will have to come from OPEC (non-OPEC will peak according to the International Energy Agency) – meaning that they will play an even greater role in determining the price of oil in the various spot markets. They could decide to let production stagnate in order to get prices higher (as they have been doing for the last 5 years), or they may give in to political pressure from the west and increase production.

    Essentially it’s a gamble that we should be trying to avoid. We need to break our dependence on foreign oil as much as is possible.

  3. Patrick 3

    So while petrol prices continue to rise dramatically, the government is supposed to keep dropping your tax to match?

    Quite frankly, I find this point of view short-sighted and greedy. It just sounds like a 10 year old demanding extra pocket money to afford something that is out of their price range.

    The only real solution to increasing fuel prices, that I can see, is a continued and increased investment in sustainable technology and public transport. It’s not like anything the government can do will actually make the price of oil decrease.

  4. roger nome 4

    Here’s a good discussion between two economists that specialise in the oil market, which gives a bit of context to this.

    http://online.wsj.com/public/resources/documents/econoblog08032005.htm

  5. Stephen 5

    or would be completely useless if say, the price of oil keeps climbing…I would LOVE to know how any political parties are going to reduce NZ’s dependence on oil, as opposed to lowering taxes every time the price goes up.

  6. higherstandard 6

    Clinton

    People might be unaware of the percentage of each dollar in oil the government currently takes. Isn’t it currently around 40% in taxes and duties ?

    [Yes, something like that. But only the GST portion increases with an increase in price (in fact, the portion of govt revenue per dollar falls as the price rises). Also, is that your solution? The market is saying supply isn’t meeting demand, your solution: lower taxes, which pay for roads and public transport, so that demand doesn’t drop. This has the effect of drawing up more of the limited resource quicker, hastening the point where supply really begins to fall while our transport infrastructure degrades and no investment is made in alternatives to private car transport because there are no fuel taxes to pay for them. SP]

  7. lprent 7

    Steve: You should probably put up treasury forecasts of the exchange rate NZD to USD. The landed cost of oil here depends on that, and the combined figure is what will feed into inflation.

    I haven’t been keeping an eye on the USD, but based on the AUD, I’d expect quite a lot of voliatility.

  8. Nedyah Hsan 8

    I love how the price of oil has increased ever so sharply following the Americans invasion of most of the oil producing nations.

    So if the black gold IS discovered in the Great South Basin, will we therefore get cheap petrol?
    People in the oil nations currently pay around 40c a litre.. is it too much to ask that we get the same benefits if we end up an oil nation (as unlikely as it sounds)

    My guess is no. “The Market Will Decide” ultimately.

    As for decreasing oil dependence. Well, it could happen. Increase timetables and halve the fares on the passenger rail network now that we own it. (with the exception of silly ol’ Auckland who has to suffer under Veoila for a few more years)

    LP: USD has been a lot more stable than the AUD with the NZD cross exchange.

  9. BeShakey 9

    HS – as you should know if you want to pretend to be properly informed, the governments take in dollar terms takes a hit if the oil price goes to high. People have already begun reining in the amount of travel they do. So if your complaint is that the actual take is too high, your wrong. If your complaint is that the government is taking too much as a percentage, then presumably you are happy to pull back on the governments investment in transport, since the total amount in the NLTF now exceeds the take from transport.

  10. T-rex 10

    Stephen – Here’s my policy.

    Change cars, and build wind turbines.

    Rogernome and I had a long winded argument on the topic in a previous thread – “Ambitious for big oil”.

    His stance is that we need to improve public transport and rail to reduce oil dependence.

    Probably we actually need to do both. Happily (if you’re me), oil is now so expensive that there’s an incentive to change technology platforms even without paying for all the externalities ignored with oil(pollution, GHG).

    HS: So what? Are you advocating a reduction in the tax on petrol? How would you fund new transport infrastructure?

  11. roger nome 11

    higher:

    If anything the government under-taxes petrol. The fact that we’ve let it be so cheep over the last two decades (we’ve got amongst the lowest petrol tax level in the OECD) means that our economy is more dependant on foreign oil, and more vulnerable to oil price spikes.

    After the OPEC embargos of the 1970s and 1980s most OECD countries raised oil taxes in order to insulate their economies from oil prices spikes. The US left taxes low, and consequently has an oil intensity (units of oil consumed per unit of GDP) figure nearly twice as high as the EU average.

    See the fourth graph at the following link:

    http://www.med.govt.nz/templates/ContentTopicSummary____20094.aspx

  12. Stephen 12

    “Change cars, and build wind turbines.”

    I’m sure that both of those will happen, it’s just that the transition period looks set to be both long and painful…

  13. T-rex 13

    Maybe…

    I swing between optimism and pessimism on the issue. The obstacle isn’t a technical one, people just need to change what they’re asking for.

  14. Phil 14

    Nedyah Hsan

    “People in the oil nations currently pay around 40c a litre.. is it too much to ask that we get the same benefits if we end up an oil nation (as unlikely as it sounds)
    My guess is no. “The Market Will Decide’ ultimately.”

    Oil producing countries do tend to pay less for oil, but only in the sense that it costs an afwul lot less to transport oil from the Persian Gulf to Tehran, than it does to transport the same oil to Wellington.

    You’re also ignoring the impact of gov’t taxes or subsidies – which vary greatly between countries.

    Sweden, for instance, is not even remotely concerned about expensive oil, because the crude component in their retail cost is “two-fifths of f**k all” in comparison to the huge taxes their elected officials put upon it.
    Meanwhile, gas prices in the US, which are internationally quite low, have a lower tax rate – and consequently consumers feel the rise in crude oil costs more acutely.

    As a result, your assertion that “the market will decide” is blatantly incorrect.

  15. roger nome 15

    T-Rex:

    As you know, my opinion is that wind will only make up a small percentage of our energy needs in the next 20-30 years. We need to increase base-load capacity. Now, as the government AFAIK isn’t looking to build dams in order to create the wind-hydro pump loop that we discussed before, it’s difficult to see how wind can help us with that.

    We should also remember that with the current economic paradigm, 3-4% economic growth is expected, and that will mean roughly an equivalent increase in energy demand. It’s a very hard road ahead.

    Stephen:

    “I?m sure that both of those will happen, it?s just that the transition period looks set to be both long and painful”

    Ultimately we need to be looking at the demand side of the energy markets as well. Our transportation infrastructure was all built in the time of very cheep energy, and the wastage inherent in its design reflects that. So rail, busses, boats and cyclist-friendly roads need to be given more priority by the government. It’s a nonsense to think that the market mechanism by itself is the best way to negotiate the coming energy crisis.

    Thinking at the planning level has to change as well.

  16. T-rex 16

    Roger – did you see my latest reply to you in the other thread?

    3-4% economic growth does not necessarily imply 3-4% increase in energy use – there is huge potential for reduction in energy intensity.

    That aside, I agree with most of your last paragraph… at least in as much as the govt should balance its transport investment a bit more than the historic focus on roads.

    Buying back the railways is a fantastic start!

  17. BeShakey 17

    Phil and Nedyah Hsan

    You also need to remember that the stuff that comes up out of the ground isn’t the same as the stuff people pump into cars. My understanding is that NZ doesn’t have the facilities necessary to do the processing, hence the need to export the oil we extract, and import oil for use. Unless huge amounts of oil are discovered (making it worthwhile to locate processing facilities here), I can’t imagine that changing.

  18. roger nome 18

    T-Rex-

    Oil used for Road transport equates to about 30% of the energy used in the NZ economy. I estimate (pull a number out of my arse 🙂 ) that about half of that will be commercial and half personal. So probably about 15% of our energy needs goes to personal transport. So in your “personal transport powered by electricity” future, it will only affect domestic energy prices marginally.

    Also, your vision involves less trucks on the road for long haul, and lighter, more efficient vehicles used for personal transport, both of which will mean less damage to roads. So we can spend less on roads, and more on re-designing transport infrastructure. You agree?

    Of course there are energy efficiency gains to be made in industry as well, and you’re right to think that market mechanism will cause adaptation. I just think that the demand side of the equation needs to be looked at in the short to medium term to help with efficiency gains. There’s just no glut of energy on the global or national scale in sight. We are, for the foreseeable future, living in an energy-constrained world.

  19. Clarke 19

    Every time I see one of Treasury’s dumber predictions I’m reminded of that old joke …. “The problem is not that Treasury could cease to exist and New Zealand would never notice … it’s that New Zealand could cease to exist and Treasury would never notice.”

    To call them a bunch of ivory-tower theorists is a slur on ivory-tower theorists everywhere.

    – Clarke

  20. Draco TB 20

    But acknowledging we are at peak oil, that the price is not going to drop back to ‘normal’, is simply not something that Treasury can do.

    Of course they won’t. If they accepted that we have reached Peak Oil then their projections wouldn’t be of a normal boom/bust cycle that averages exponential growth. It would be of declining economic activity and resource wars.

    Quoting the NZHerald:

    Salameh said Iraq had offered the United States a deal, three years before the Gulf war, that would have opened up 10 new giant oil fields on “generous” terms in return for the lifting of sanctions.”This would certainly have prevented the steep rise of the oil price,” he said.

    This is interesting not in what it says but in what it says very obliquely and that is that the only spare capacity for oil production is in Iraq which is at war with itself while being occupied by hostile forces. The rest of the world cannot increase production, ergo, we are at peak now. It’s just a matter of time before oil production goes into decline. From here on out the price of oil goes up and economic activity goes down.

    T Rex and r nome:
    Would the possible efficiencies available be able to offset the decline in oil use as prices rise? Because if they can’t then we are looking at economic decline and the associated decline in living standards that goes with it.
    From what I can make out they can’t in the time needed to make a difference. Time here is the critical factor because the national power generation would have to be expanded before we run out of spare energy and that isn’t going to happen as we’ve already run out of spare energy.

  21. T-Rex 21

    Draco – for my money, yes, they can.

    I think I’ll write a book about it. People must have had about enough of the preachers of famine and shortage… I reckon a book of solutions might sell well. Although an opportunity for a good whinge is often embraced much more wholeheartedly than its alternative… sigh.

    Roger – Yup, I think we more or less agree on allocation of funds.

  22. T-Rex 22

    Man, my book is going to rule SO HARD! It’s going to retail for $27.95 and everyone will talk about it all the freaking time for at LEAST 3 weeks. It’ll be ‘The god delusion’ of 2009. Only not by Richard Dawkins. Awwwwww yeah.

  23. Ari 23

    Firstly, I can assure you that some Treasury staff accept the eventual reality of peak oil. They just disagree that it’s peaking now, and so keep looking for medium-term price drops.

    My disagreement is essentially that regardless of whether the peak is soon or not, speculators are now informed on the nature of peak oil and are deliberately undoing the market collaboration that has kept oil so low for so long. (ie. this is not an unreasonable price for oil that we are paying now, it’s actually a lot closer to its natural price as an extremely valuable, extremely demanded commodity in somewhat limited supply. We’re still probably seeing considerable seller-side subsidy* on the current price though)

    Because of this, regardless of whether we are peaking now or peaking later, prices for oil will start to act as if we’re peaking now, and prices at the pump will soon follow, and the need to act on it is more urgent than the way we’re acting right now.

    *That is, it’s not being sold as expensively as it could be in all cases in order to maintain economic stability.

  24. Stephen 24

    .

    [lprent: Like profound, man. But was this exercise in punctuation intended? Or do I need more simulation.
    Sorry – just bored]

  25. Dean 25

    “Yes, something like that. But only the GST portion increases with an increase in price (in fact, the portion of govt revenue per dollar falls as the price rises).”

    Did you forget about the temporary which then became permanent taxes the government levied? Say it isn’t so.

  26. Jamesey 26

    We’ve been having this argument at Frogblog.

    I think Treasury’s reevaluation is actually quite realist given a variety of factors that you’ve failed to take into account.

    a) The US dollar is rising due to news that the FED will not cut interest rates, because of inflation fears,
    http://tinyurl.com/5l2r67

    b) Fuel consumption in the U.S. has fallen, because of the recession and high fuel prices
    http://tinyurl.com/5lfjeq

    c) Three major Asian nations dropping their fuel subsidies, because they have become unaffordable.
    http://tinyurl.com/5jsn7z

    China’s fuel demand growth has also fallen compared to recent years,
    http://tinyurl.com/58gy5y

    Massive new oil reserve have been discovered in Iraq.
    http://www.tinyurl.com/5vr3y5

    The claims are corraborated by a conversation that an influential Iraqi Oil Consultant had with a Brazilian Senator on an unrelated subject.

    “He stated that Iraq had surpassed Saudi Arabia and is now the first country in the world in terms of known oil reserves. From the top 12 places in the world where higher quantities of oil are found, 9 are in Iraq, he emphasized.”
    Eduardo Suplicy
    http://www.usbig.net/papers/182-Suplicy–Iraq.doc

    As of May 2007, companies like ExxonMobil are not making nearly the investment in finding new oil today that they did in 1981.[25] Nor are they using state of the art extraction technologies.
    http://en.wikipedia.org/wiki/1980s_oil_glut

    That doesn’t mean we shouldn’t reduce our fuel consumption

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