Oil price and economic growth get married

It used to be that when it came to the world economy, oil prices and economic growth were more like distant cousins who disliked each other rather than a happily married couple always seen nuzzling together in public. The received wisdom was that low oil prices are good for the overall economy even if they are bad for the oil industry and for countries that are heavily dependent on oil for their revenues.

That's what many believed when suggesting that even though high oil prices and an attendant oil boom had underpinned economic recovery in the United States after the 2008 financial crash, low oil prices would now somehow on balance deliver even more recovery. And, low prices would also benefit the rest of the world as well.

Nowadays, as the oil price dips into the low $40 range again and economic growth weakens simultaneously, we must re-evaluate. U.S. economic growth declined significantly after oil prices began to fall in 2014. Only last week, U.S. growth for the second quarter of 2016 came in at 1.2 percent (annualized), less than half the forecast of 2.5 percent. First quarter growth was revised down to 0.8 percent from a previous estimate of 1.1 percent. That's down significantly from a peak of 5 percent growth for the third quarter of 2014, the last quarter during which the price of oil was over $100 per barrel.

World economic growth instead of speeding up, slowed down slightly from 2.6 percent in 2014 to 2.5 percent in 2015 according to the World Bank.

There are many reasons for the subpar growth of the world economy since the Great Recession. Record average daily prices for oil four years running from 2011 through 2014 helped sap the world economy of its strength by siphoning funds from the non-energy economy.

Of the other causes, chief of among them is the heavy buildup of private and public debt which may be hindering growth by siphoning funds from consumption and investment into debt service. In the first quarter of this year, U.S. credit growth was $644.9 billion. U.S. gross domestic product growth was $64.7 billion. It took $10 of credit growth for every $1 of GDP growth. There was a time long, long ago when the ratio was 1 to 1.

China's credit growth had been running twice its GDP growth through the end of last year. (I don't have dollar or yuan amounts.)

Debt isn't necessarily a bad thing if one uses it to invest in something that will produce goods or services rather than merely to consume. But much of our debt creation has been exactly for consumption. That isn't particularly bad either if we as individuals, nations or a world society can afford to service that debt. But there is a level we cannot afford and it stunts growth. To get a better understanding of how too much debt is affecting economic growth around the world, listen to economist Steve Keen explain why debt matters and how the rate of credit creation affects growth. You may need to watch it twice before you get the "aha" moment.

But let's look further now into the relationship between debt and energy to find out more about why oil prices seem much more correlated to the health of the overall economy than they used to be.

First, oil remains the central energy source for the world economy, especially critical as transportation fuel. It provides 33 percent of total energy according to the BP Statistical Review of World Energy.

Second, our desperation for additional sources of oil led to a debt-fueled boom in the United States, debt used by drilling companies to reach deep shale deposits and release oil found in them through a new version of hydraulic fracturing called high-volume slickwater hydraulic fracturing.

It turns out that the low oil prices of today make these deposits largely unprofitable and production has been falling. Many of the high-flying drillers during the boom are now in or headed for bankruptcy.

Debt, it must be remembered, is simply a way to bring what would be future consumption into the present. We have brought energy consumption from the future into the present with debt through the fracking boom in the United States and to a certain extent the boom in oil sands in Canada. And, we've shifted consumption of so many other natural resources and finished goods from the future to the present through the vast expansion of private and public debt.

Still, we are faced with slower world economic growth than in the past despite our herculean financial efforts. The simple explanation is that cheap energy was the cornerstone of growth of the industrial economy. As long as that energy was cheap, we could grow at a relatively rapid pace. Once it becomes expensive, growth must decline for most sectors of the economy as more and more resources are sent to the energy sector.

By this logic then today's low prices should be providing substantial stimulus to the global economy. Why are we not feeling it? The short answer would be that the debt we built up procuring expensive energy during a period of high and rising energy prices over the last 15 years is holding back economic growth. We are experiencing the hangover.

The hangover manifests itself as slow growth which is a reflection of the difficulty consumers are having maintaining their growth in spending in a high-debt world. That means everything is less affordable at the margin, and this has led to a creeping slowdown in the world economy.

Now, here's the kicker. If we as a global society can no longer afford high-priced oil--and that's what's left to get out of the ground--then as long as oil remains the central energy component of our economy, we will be trapped in a low- or no-growth economy where oil prices can't rise high enough to make new drilling in high-cost deposits profitable; and, when prices do rise, they simply squeeze the life out of economic growth and send the economy back into a stall or near stall. (Gail Tverberg has explained this phenomenon in detail on her blog, Our Finite World.)

Far from a sign of good things for the economy as whole, recently declining oil prices now tend to indicate a weakening economy that was already in a weak state. It turns out that the oil price and the economy are now in a very tight relationship, and we are going to be seeing them together a lot for a long time to come. But I don't think their marriage will be the happy one I alluded to at the beginning of this piece.

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he has written columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin (now Resilience.org), The Oil Drum, OilPrice.com, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at kurtcobb2001@yahoo.com.